With the Roth portion of your TSP account you have contributed out of already taxed dollars, so you will not have to pay tax on the portion of your Roth withdrawals that are attributable to your contributions. In addition, if your Roth withdrawals are considered to be qualified, you will not have to pay tax on the earnings either; resulting in no tax at all on Roth withdrawals.
Two tests must be met for a Roth withdrawal to be considered qualified. First, you must have had the Roth balance in your TSP for at least five years. You will meet the five-year requirement on January 1 of the year that is five years from the year that you opened your Roth balance. Second, you must be at least 59 ½ years of age.
If you have a Roth TSP balance and your withdrawals are not qualified, you will have to pay federal income tax on the earnings in the Roth account. This is an important consideration due to the fact that, for those with both Traditional and Roth balances, all withdrawals from the TSP are required to be proportional. Many federal employees retire before they reach the age of 59 ½ and many are required to retire before that age. Such individuals need to be aware that they cannot separate withdrawals between Traditional and Roth balances. And, unlike in a Roth IRA (where you are viewed as taking out your contributions first), in the TSP you are viewed as withdrawing Roth contributions and Roth earnings proportionally.
You could, however, separate a rollover, rolling the Traditional TSP into a Traditional IRA and the Roth TSP into a Roth IRA, though this would create its own issues. The largest of those issues would be that, once your money is in a Traditional IRA, you will face an early withdrawal penalty on anything you take out before the age of 59 ½, though that penalty could be avoided by following a life-expectancy based withdrawal strategy.
I have come to call the above the “Roth TSP Tax Trap”. Unless the proportionality requirement is changed, those who have a Roth balance in their TSP and begin taking distributions from their TSP before 59 ½ will have to pay federal income tax on their Roth TSP earnings. This requirement is spelled out in federal law; if a retirement account has both before tax and after tax money in it, withdrawals are required to be made proportionally. With the TSP, we do not have separate Traditional and Roth accounts – we have separate Traditional and Roth balances within the same account.
A 10% early withdrawal penalty will apply to the portion of withdrawals from your Roth TSP that are attributable to earnings if you separate from your federal job before the year in which you turn 55. Once again, unlike in a Roth IRA, you are viewed as withdrawing Roth contributions and Roth earnings proportionally. If you were to separate before your 55th year of birth, you could avoid as outlined in the three paragraphs that follow.
You can avoid it if you choose elect monthly payments based on the IRS life expectancy table and continue those payments for five years, or until you turn age 59 ½ whichever is longer. This is often called following IRS rule 72(t).
You can avoid it if you purchase a TSP annuity.
There is also an exception for special category employees. They are exempt from the early withdrawal penalty if they separate from service in the year in which they turn 50, or later. If they retire prior to the year in which they turn the age of 50, they can avoid the penalty as discussed in the previous two paragraphs.
In addition, there is no early withdrawal penalty, regardless of your age if your TSP distributions are 1) made because you are totally and permanently disabled; 2) ordered by a domestic relations court; 3) made because of the death of the account holder (beneficiary participant accounts only); or 4) made during a year in which you have deductible medical expenses exceeding 7.5% of your adjusted gross income.
Here’s another problem caused by the proportionality requirement: Because you must take minimum required distributions (RMDs) from your Traditional TSP balance beginning at age 70 ½, you must also begin taking money from your Roth TSP balance at that age as well. (With a Roth IRA, there are no minimum distribution requirements). There is a 50% penalty for failing to take RMDs beginning at the age of 70 ½. However, the TSP has provisions in place that shield almost all participants from the penalty. The penalty for failing to take a RMD is 50% of the amount of money you should have taken out, but didn’t. For example, if your RMD was $5,000 and you withdrew $3,000 from the TSP that year, your penalty would be $1,000 (1/2 of the $2,000 difference).
If you are still working at your federal job at 70 ½, you are not required to take a minimum distribution. If you are taking substantially equal monthly payments of a fixed dollar amount at 70 ½ and fail to take out enough to meet the minimum required distribution, the TSP will send you an additional payment of the required amount before the end of the year. If you elected the withdrawal option Substantially Equal Monthly Payments Based on the IRS Life Expectancy Table, once you reach the age of 70 ½, your withdrawals automatically follow the RMD schedule.
If you are not working and haven’t begun withdrawals by 70 ½ the TSP will notify you at the beginning of the year after the year in which you turned 70 1/2 that you must begin taking out your money by April 1. If you do not begin withdrawing the money by April 1, the TSP will transfer all your money into the G fund and you are penalized. If you do not begin withdrawing your money within another nine months, you forfeit your account. Don’t panic! Once you begin taking your withdrawals and have paid your penalties, the TSP “un-forfeits” your account.