Following are answers to miscellaneous common questions about the Thrift Savings Plan (TSP) and Individual Retirement Arrangements (IRAs). If you have your own specific questions, post them on FEDweek’s reader forum and knowledge base: https://askFEDweek.com, and get notified by email when its answered.
Q. Why is a Roth (IRA or TSP) called a Roth?
A. Senator William Roth (R-DE) had advocated for this type of account for years and finally got his way when the Roth IRA was created by the Taxpayer Relief Act of 1997. His determination was rewarded by the fact that his colleagues named the new type of IRA after him.
Q. What happens if I contribute to a Roth IRA and my income for the year turns out to be over the limit for contributing to a Roth IRA?
A. You have until the “final due date” of your federal income tax return to re-characterize the contribution as a contribution to a Traditional IRA. The final due date is October 15th, or a day soon after that (the last day a return can be filed with an extension). Generally your accountant, or your tax preparation software, will notify you if you are not allowed to contribute to a Roth IRA for the year. If you do not re-characterize the contribution, you will face a penalty of 6% of the ineligible contribution for the time the excess contribution remains in the Roth IRA. The same is true if you contribute more than you are allowed to the Roth IRA.
Q. Why are the extra contributions that individuals 50 and older can make called “catch-up” contributions?
A. Catch-up contributions were authorized by the Economic Growth and Tax Relief Reconciliation Act of 2001. At that time many employees who were 50 or over had a part of their career where there were no 401(k) type plans available for them to contribute to. Hence, the name “catch-up”, as the extra contributions allowed them to catch-up to where they would have been if they had been able to contribute to a 401(k) from the beginning of their career. Let’s look at a federal employee who was hired at the age of 25. If they turned 50 in 2001, that means they were hired in 1976 – eleven years before the introduction of the TSP. Catch-up contributions would allow them to make up for some of that lost time.
Q. What is the “rule of 72”?
A. The rule of 72 is a way of determining how long it would take an investment to double if invested at a specific rate of return. You divide the rate of return into 72 to get the number of years. For example, if I received a 6% rate of return, my money would double in 12 years. You can also use the rule to determine how long it would take a specific rate of inflation to cut the purchasing power of a dollar in half. If inflation were 3% (roughly its average over the last 30 years), it would take 24 years for a dollar’s purchasing power to be cut in half.