In a previous article, we discussed the tax complications that can be caused by the fact that all TSP withdrawals (lump sum, monthly and court-ordered) must be made proportionately between your Traditional and Roth Balances.  This is due to the fact that when the TSP introduced the Roth option, they did not create a Roth account for participants.  Instead, they just track Traditional and Roth balances in the same account, so the funds are commingled, and as such, IRS regulations require proportional withdrawals.  Because of this, if you have not yet attained the age of 59½ at the time of the Roth TSP withdrawal, you will end up paying taxes on monies that you already paid taxes on!

If you don’t have a Roth TSP balance, or are age 59½ or older, you can skip this article, as it won’t affect you.

I’m not a CPA, and this article is not to be considered to be legal or tax advice, but I see no legal reason, IRS regulation or TSP policy that would prohibit the actions suggested in the following paragraphs.  If you implement this strategy, you do it at your own risk.

To avoid this issue, you could move your Roth balance out of the TSP to an IRA, but leave your Traditional balance in the TSP.  However, the TSP will not let you roll over just your Roth balance or Traditional balance – remember, all actions, including rollovers, have to be proportional.  You can, however accomplish this despite the TSP’s policies; it will just take more steps – kind of like making three right turns in order to go left.

In our example, suppose you have $500,000 in your TSP.  $400,000 is in your Traditional balance and $100,000 is in your Roth balance.  If you begin taking money out of the TSP, it will be distributed at a 4 to 1 ratio.  For example, if you take out monthly payments of $1,000, $800 would come from the Traditional balance and $200 would come from the Roth balance.

The first step is to open up two accounts at a new IRA custodian; one would be a Traditional IRA and the other would be a Roth IRA.

Secondly, you would roll over most, but not all, of your TSP monies to the new accounts.  It is imperative to leave money in the TSP when executing this maneuver.  Let’s say you transfer $499,000 of your TSP to the new IRA custodian.  The TSP will send $399,200 to the Traditional IRA and $99,800 to the Roth IRA.  This leaves $800 in the Traditional TSP and $200 in the Roth TSP.  The minimum required to maintain a TSP account is $200.

Finally, you roll over the Traditional IRA back into the Traditional TSP.  You leave the Roth IRA with the new IRA custodian.  You now have $400,000 in your Traditional TSP – just like before.  But you only have $200 in your Roth TSP; the rest of the Roth money is in the Roth IRA with the new custodian.

You will have to leave your money in the Roth IRA for five years and until you reach the age of 59½ in order to make qualified (i.e., tax free) withdrawals.  But you will be able to withdraw from your Traditional TSP and not have to worry about the proportionality requirement causing additional taxation from your Roth TSP on monies you’ve already been taxed on.

This scenario will not work for those who have already begun taking monthly payments from the TSP or have used their one partial lump-sum withdrawal option – under current TSP rules.  The TSP has stated that they will, at some point in the future, allow greater flexibility in withdrawals.

This topic is also discussed on the Bogleheads website at https://www.bogleheads.org/wiki/TSP_withdrawals