Once these conversions are allowed, any TSP participant may move money from traditional to Roth balances. Image: Andrey_Popov/Shutterstock.com
By: John GrobeWhat new improvements will the Thrift Savings Plan have in store for participants next year? Beginning in January, TSP participants will be able to do in-plan conversions, moving traditional TSP monies into the Roth TSP.
This is a really big deal, and the Thrift Board hopes to allow these conversions as early as next January. Let’s hope that there’s no slippage in the date.
Once these conversions are allowed, any TSP participant may move money from traditional to Roth balances. Currently, if a TSP participant wants to move money from their traditional TSP balance to a Roth account, they’ll have to do it in a Roth IRA. This requires that they roll over the money they want to convert into a traditional IRA and then convert that traditional IRA to a Roth IRA
BUT most current employees are not able to roll money from their TSP to an outside IRA. In order to do so, they’ll have to:
• Be a separated employee (e.g., retired, former federal employee, etc.); or
• Have a financial hardship that meets the criteria for hardship withdrawals set out by the TSP; or
• Be over the age of 59 ½.
As it stands today, employees who want to get money into the Roth TSP have to designate their current contributions to the Roth. Apparently not many do so, as recent statistics show that only 7% of plan assets are in Roth balances.
Expect quite a few participants to take advantage of the ability to do in-plan conversions beginning in January.
Of course, when you convert traditional money to Roth money, you must pay taxes on the conversion. Though we don’t yet know a lot about the mechanics of in-plan conversions, one thing the Thrift Board has already made clear is that the taxes due cannot be taken from the TSP money – all of the conversion amount must be go into the Roth TSP and the taxes paid from outside sources. This mirrors advice frequently given by financial planners to those who are considering conversions from traditional IRAs to Roth IRAs.
Below is how the traditional TSP differs from the Roth TSP.
The traditional TSP has been around since 1987.
• Contributions are 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• When the money is withdrawn, all of it is taxed as ordinary income.
• 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 ½.
• There is a 25% penalty for failing to take a required minimum distribution after reaching 73 (changing to 75 in 2033). If you promptly correct the missed RMD, the penalty will be lowered to 10%.
The Roth TSP was introduced in 2012.
• Contributions are from already taxed dollars.
• Earnings are tax free if you make qualified withdrawals. In order for a withdrawal to be considered qualified:
o The account must have been open for at least five years; and
o You must be at least age 59 ½.
• There is a 10% early withdrawal penalty for any earnings taken out before 59 ½. Roth TSP withdrawals are viewed as being taken proportionally between contributions and earnings.
• Minimum distributions are not required.
Which makes more sense – traditional or Roth? It depends. In a future article we’ll take a look at those things on which it depends.
John Grobe, President of Federal Career Experts, is an expert in the area of federal employee retirement and benefits. This expertise comes from his 26 year federal career in which he managed the retirement program in a 3,500-employee office of a large federal agency.
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