By far, the most common rollover out of the Thrift Savings Plan is into an IRA. Before we get into a discussion of the pros and cons of rolling money from the TSP into an IRA, it will be helpful if we review the types of IRAs that are available, and the rules that govern them. Here we will look at IRAs in general, as well as the Traditional IRA, while a future article will examine Roth IRAs.
Let’s get one topic covered right away – you are allowed to contribute to both your Thrift Savings Plan and an Individual Retirement Arrangement; they are not mutually exclusive. I find that some participants in pre-retirement seminars are not aware that they can do this. This lack of knowledge keeps them from setting aside more money in tax advantaged retirement plans. The TSP and IRAs are both tax advantaged and have some similarities; yet they are different in many ways. One (the TSP) is an employer sponsored retirement plan; and the other (an IRA) is an individual retirement plan. Some of the rules that govern them are the same (e.g., the definition of a “qualified withdrawal” for a Roth), while others are different (e.g., the age at which one will face an early withdrawal penalty).
In order to contribute to any IRA, you must have earned income, though there is a provision where you can contribute to an IRA for your non-working spouse as long as you have enough earned income. There is an age limit (70 ½) above which you will not be allowed to contribute to a Traditional IRA, though there is no age limit on contributing to a Roth IRA.
As with the TSP, the amount you can contribute to an IRA is limited, and that limit is quite a bit lower for an IRA. The dollar amounts that follow, both in this paragraph and throughout this article, are the dollar amounts that are in effect in 2016. You are allowed to contribute up to $5,500 a year to an IRA, with an extra $1,000 allowed as a catch-up contribution from the year in which you turn age 50 and beyond.
Traditional IRAs have been around since 1974 and there is no income restriction in contributing to a Traditional IRA. However, your income can affect your ability to deduct your Traditional IRA contributions from your federal income tax if you belong to a retirement plan at work (as all federal employees do).
A Traditional IRA has the following features:
- Contributions may be deductible from your federal income tax.
- The money in the IRA grows tax-deferred.
When the money is withdrawn:
- All of it is taxed as ordinary income if you were able to deduct your contributions from your federal income tax; or
- Only the earnings are taxed if you were not able to deduct your contributions from your federal income tax.
- There is a 10% early withdrawal penalty for money taken out before 59 ½, although the penalty can be avoided by following a life-expectancy based withdrawal strategy for the longer of five years or until you reach the age of 59 1/2.
- If you were able to deduct your contributions from your federal income tax, the early withdrawal penalty will apply to everything you withdraw; or
- If you were not able to deduct your contributions from your federal income tax, only the earnings withdrawn will be subject to the early withdrawal penalty. You are viewed as withdrawing proportionally between your contributions and your earnings.
- The same 50% penalty for failing to take a required minimum distribution after reaching 70 ½ that applies to the TSP, applies to a traditional deductible IRA.