This article looks at taxes on your Roth TSP balance. “What taxes?”, you ask, “Aren’t Roth withdrawals free from federal income taxes?” It is true that Roth withdrawals are not taxable – if your Roth withdrawals are qualified.
What does it take for a withdrawal to be considered qualified? There are two tests that must be met:
1. 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. Therefore, if you began participating in the Roth TSP when it was first available back in 2012, you met the five-year requirement on January 1, 2017.
2. You must be at least 59 ½ years of age.
If you meet these tests, you’re home free; you will pay no taxes on withdrawals from your Roth TSP balance.
However, if you have a Roth TSP balance and withdraw any TSP funds before reaching the age of 59 ½, 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, up until September 15, 2019, those who have both Traditional and Roth balances in their TSP must withdraw proportionally from each balance. Many federal employees retire before 59 ½ and many are forced to retire before that age (e.g., law enforcement officer, firefighter, etc.). Such individuals need to be aware that, until this coming September 15th, they cannot separate withdrawals between Traditional and Roth balances. The result of this would be that the portion of the Roth withdrawal that is due to earnings is subject to federal income tax. And, unlike in a Roth IRA, you are viewed as withdrawing Roth contributions and Roth earnings proportionally.
This “tax trap” that has been hidden within the Roth TSP for the last 6+ years is going away. As part of the implementation of the TSP Modernization Act, the proportionality rules will be changed. Beginning on September 15, 2019, those who are withdrawing from their TSP will be able to specify from which balance (traditional or Roth) they want their distributions to come.
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 the penalty if:
• You 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; or
• You purchase a TSP annuity.
• There is also an exception for special category employees (Law Enforcement Officers, Firefighters, Customs and Border Protection Officers, Air Traffic Controllers, Supreme Court and Capitol police officers, nuclear materials couriers and DSS Special Agents in the State Department). 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 bullets.
In addition, there is no early withdrawal penalty, regardless of your age if your TSP distributions are:
• Made because you are totally and permanently disabled;
• Ordered by a domestic relations court;
• Made because of the death of the account holder (beneficiary participant accounts only); or
• Made during a year in which you have deductible medical expenses exceeding 7.5% of your adjusted gross income.
Another difference between the Roth TSP and a Roth IRA is that you must take minimum required distributions (RMDs) from your Roth TSP balance beginning at age 70 ½. 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.