Federal employees can still fund an IRA, even if they are maxing out TSP savings. Image: g0d4ather/Shutterstock.com
Lots of federal employees and retirees have some mistaken ideas and thoughts about the Thrift Savings Plan and how it works. Any federal program tends to be complicated and have rules that are not easily understood. We can say that TSP rules are less confusing than those that apply to our FERS or CSRS annuities; but most would consider that to be damning with faint praise.
A lot of the mistaken ideas regarding the TSP result from confusion between TSP rules and the rules that apply to Individual Retirement Arrangements (IRAs). This is understandable as: 1) IRAs came first; and 2) Employer sponsored defined contribution plans, such as the TSP, were patterned after IRAs.
One big difference between the TSP and IRAs deals with early withdrawal penalties. When IRAs were established in 1974 one of their rules was that there would be a 10% early withdrawal penalty that applied to any money taken out prior to the account holder reaching the age of 59 ½.
With the TSP, and most other employer sponsored plans, if an individual separates in the year in which they reach the age of 55 (or older), they are not subject to an early withdrawal penalty. There is a special provision in the TSP for special category employees (primarily law enforcement officers and firefighters); if they separate in the year that they turn 50 (or later), or when they have reached 25 years of qualifying service, they are exempt from the early withdrawal penalty.
There is however a situation where the TSP will impose an early withdrawal penalty. The 10% early withdrawal penalty would apply if an employee separates before the year in which they reach the age of 55 (50 or 25 years of qualifying service if a special category employee). But that penalty is able to be avoided if the employee follows a life expectancy based withdrawal methodology for the longer of 5 years or until they reach 59 ½.
When it comes to required minimum distributions (RMDs), an IRA requires one to begin taking RMDs in the year in which they turn the age of 73 – so does the TSP. EXCEPT, the TSP has a still working exception that allows those who are still working at their federal job to avoid having to take RMDs. There is no such exception with IRAs.
One misconception that can cause people to set aside less for retirement than they might otherwise be able to is the belief that they cannot contribute to an outside IRA if they are fully funding their TSP account. There is no prohibition on funding an IRA, even if you are maxing out in your TSP savings.
There are some restrictions (income-based) on contributing to a Roth IRA or deducting your contributions to a traditional IRA, but there are no restrictions whatsoever on contributing to a traditional IRA. Even Jeff Bezos or Warren Buffett can make non-deductible contributions to a traditional IRA. If you haven’t been contributing to an IRA because you think you can’t due to your participation in the TSP, you have been missing out on an opportunity to annually set aside another $6,500 ($7,500 in the year you turn 50 and later).
Many TSP participants believe that those who participate in both the Traditional and Roth TSPs have two separate TSP accounts. Not so; they have two separate balances within their one TSP account. When a TSP participant takes a withdrawal from their account, the withdrawal will be taken proportionately between the Roth balance and the traditional balance unless they specify differently. In many cases, such as withdrawals prior to age 55 (50 or 25 years of qualifying service for special category employees), it makes sense to take your withdrawal from only one of your TSP balances.
What you don’t know can hurt you. Stay on top of TSP rules and make sure you make the TSP work for you. Like the TSP on Facebook. Follow the TSP on Twitter. Read each edition of FEDweek’s TSP Investor’s Report. Do this and you’ll be better able to benefit from the Thrift Savings Plan.
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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