Can You Move Your TSP to a Roth IRA Without Paying HighTaxes?
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If you have spent years building your retirement savings in a traditional thrift savings plan (“TSP”), you may wonder whether you should keep your money where it is or roll it over into a Roth IRA when leaving federal service. The answer is not as simple as a yes or no, because while Roth IRAs offer tax-free growth and more investment flexibility, moving your funds can trigger significant taxes if not done correctly.
For federal employees, the TSP is a powerhouse for retirement savings. Contributions are often matched, investment options are low-cost and the plan allows both pre-tax and after-tax contributions. But once you leave government work, those benefits may no longer be available. A Roth IRA can be a smart next step, allowing tax-free withdrawals later in life, no required minimum distributions and a wider choice of investments.
Two Ways to Roll Over Your TSP
When rolling a traditional TSP into a Roth IRA, you essentially have two paths — a direct rollover, also called a transfer, or an indirect rollover.
A direct rollover is straightforward. You set up a Roth IRA, provide the account details to the TSP, and the funds move directly. You do not have taxes withheld, but the transferred amount counts as taxable income in the year of the rollover. This means you will need to pay federal taxes on the money, even though it is moving from one retirement account to another. To avoid a massive tax bill in a single year, some people first transfer funds into a traditional IRA and then convert to a Roth IRA over time.
An indirect rollover, in which the TSP sends the money to you to deposit into a Roth IRA yourself, is trickier. The TSP withholds 20% for federal taxes, and you have just 60 days to deposit the full amount, including the withheld portion, into your Roth IRA. Miss the deadline, and the shortfall becomes taxable, plus you may face a 10% early withdrawal penalty if you are under age 59 and a half.
Understanding Tax Impacts
Converting pre-tax TSP funds to a Roth IRA triggers a tax event. Traditional TSP contributions were not taxed upfront. Therefore, the IRS expects you to pay now when the funds are transferred into a tax-free Roth account. This can lead to a substantial addition to your taxable income for the year. If you are weighing this option, consider whether you can cover the tax bill without dipping into retirement savings.
Roth TSP vs. Roth IRA
It is important to note that a Roth TSP differs from a Roth IRA. Both are funded with after-tax dollars, but Roth IRAs give you more flexibility in investment choices and do not require distributions at a certain age. Converting from a traditional TSP to a Roth IRA can offer these benefits, but it requires careful planning to avoid unnecessary taxes or penalties.
Step-by-Step Rollover Guide
To move your TSP to an IRA, start by deciding whether you want a traditional or Roth IRA. If you keep your pre-tax TSP in a traditional IRA, no immediate taxes apply. If you are converting to a Roth IRA, plan for the tax liability. Next, choose where to hold your IRA.
Opening the IRA usually takes less than 15 minutes. Then, contact the TSP administrator to initiate the rollover and follow instructions carefully. The TSP will liquidate your investments and issue a U.S. Treasury check to your new account. Make sure your new financial institution can accept the check and provide the necessary certification.
Things to Avoid
Before making the move, consider a few key points. TSP funds have very low expense ratios; moving to publicly traded funds may increase your costs. You will also need to actively manage your investments unless you use a robo-advisor or financial planner. If you have tax-exempt contributions, know that the TSP will handle them proportionally, and your rollover may be slightly more complicated.