Many of the rules that govern Roth IRAs are the same as those for the Roth balance in your TSP, you will find that there are some distinct differences between them.
The Roth IRA was introduced in 1997. It has several differences from traditional IRAs that may be to your advantage if you meet the Roth’s income restrictions. To contribute to a Roth IRA you must have earned income, though there is no age limit on making contributions. Other features are:
- Contributions are from already taxed dollars.
- Earnings are tax free if you make qualified withdrawals. In order to be considered qualified:
- The account must have been open for at least five years; and
- You must be at least age 59 ½.
- There is a 10% early withdrawal penalty for any earnings taken out before 59 ½. With a Roth IRA, as opposed to the Roth balance in your TSP, you are viewed (for tax purposes) as withdrawing your already taxed contributions first.
- Minimum distributions are not required. This also is different from the Roth balance of your TSP which, due to the requirement that all TSP withdrawals be proportional between your Traditional and Roth balances, has you taking RMDs from your Roth balance at age 70 ½ (or when you retire, if later than age 70 ½).
There are, however, income restrictions on contributing to a Roth IRA. The Thrift Savings Plan (Roth or Traditional) does not impose income restrictions on participants.
There is a penalty for making excess contributions to a Roth IRA. The penalty also applies if you contributed to a Roth IRA and your income exceeded the Roth’s income restrictions. You can avoid the penalty by re-characterizing your Roth contributions to contributions to a Traditional IRA before October 15 of the year in question.
You are allowed to convert a traditional IRA to a Roth IRA, and no income limit applies to this conversion. When converting, you must pay all income tax due at the time of the conversion. Conversion does not make sense for everyone, but there are two reasons people consider converting a traditional IRA to a Roth IRA, they are:
- The potential for tax free growth over a long period of time may outweigh the disadvantage of having to pay tax on the traditional IRA’s gains at the time of conversion; and
- The fact that there are no required minimum distributions in a Roth IRA could be advantageous if you will not need to make immediate withdrawals from the Roth. Roths can be passed on to heirs untouched.
Some individuals whose income is too high to contribute to a Roth IRA choose to fund a Traditional (non-deductible) IRA and convert it to a Roth IRA. This technique, which has become known as a “backdoor conversion” allows those individuals to get money into a Roth IRA even if their income is over the limit. There are some pitfalls to this strategy once money is withdrawn from the Roth IRA, but they are beyond the scope of this article. Folks who are intrigued by the idea of a backdoor conversion should consult a financial adviser who is knowledgeable in the rules surrounding IRA withdrawals. A website that has lots of information on the ins and outs of IRAs (as well as a way to locate trained advisers) is https://www.irahelp.com/, this is the website of Ed Slott and Company. Though Slott’s main business is training financial advisers in IRA rules, his website has a good FAQ section and allows you to sign up for a free newsletter.