New Way Around “Roth Tax Trap”

Thrift Savings Board has announced an upcoming change that will make the Roth option in the Thrift Savings Plan much more appealing to federal employees by allowing them to avoid a big tax bill; especially those who plan on separating and withdrawing money from their TSP account before they reach the age of 59 ½.

Account holders will soon be able to specify how much of a withdrawal comes from a Roth account, and how much from a traditional account. Currently, withdrawals are proportionate, leading to tax penalties on those making a withdrawal before age 59 ½, with the portion coming out of a Roth account taxed as ordinary income.

This change is particularly important to those required to to retire at an age younger than 59 ½ (Law Enforcement Officers, Firefighters, etc.). They will no longer have to either pay taxes on Roth earnings, or delay accessing their TSP until they turn 59 ½. Those who are going to be separating from federal service at 59 ½ or older are allowed to be blasé about this change.

“By the way, in addition to the changes made by the new law, we’re also adding the ability to specify how much of your withdrawal should be Roth and how much should be traditional; withdrawals currently come our pro rata from both sources,” according to TSP Fact Sheet – FS10.

In it, the board says they are working as fast as they can to implement changes to the TSP, including for withdrawal options recently signed into law with the TSP Modernization Act.

Key points to note: The IRA provision that all Roth withdrawals are considered to come first from contributions and only later from earnings does not apply to the TSP and other employer sponsored retirement plans. Also, this withdrawal change has nothing to do with the early withdrawal penalty that applies to those who begin withdrawals from the TSP prior to age 55 (or 50 for special category employees).