Ask The Experts: Money Matters

By Mike Miles

72(t)

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Q. Is it OK to transfer an established 72(t) program from one institution to another?

A. As long as you don’t disturb the series of payments, I believe you can. But you should consult your tax preparer before you do it, to be sure.

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72(t) distributions

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Q. I’m about to retire at age 47 after 25 years as a federal law enforcement officer. I plan to roll my 401(k) (TSP) over to a traditional IRA and begin taking substantially equal periodic payments per 72(t) from the IRA, which, as I understand, once I start, I have to continue until age 59 ½. I plan to use the annuitization method to make equal monthly withdrawals, but I would like to take the first year’s withdrawal in a lump sum to help pay off some debt. Will the IRS allow that without the 10 percent penalty, or do I have to consistently stick to either monthly or annual payments?

A. The IRS only cares about the annual requirement being met. They don’t care about how the money is distributed. Monthly payments are not required, and as long as you meet the annual 72(t) requirements, there should be no penalty.

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VERA and TSP

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Q. I have an opportunity to retire under a Voluntary Early Retirement Authority. I have 30+ years of FERS service, non-law enforcement. My age will be 53 years and 11 months if I retire under this VERA offering.

At what age will I have full access to my Thrift Savings Plan without the 10 percent early withdrawal penalty by “taking substantially equal payments over my life expectancy.”

At what age will I have full access to my TSP without the 10 percent early withdrawal penalty by NOT “taking substantially equal payments over my life expectancy.”

If immediately upon retirement I begin collecting TSP funds “paid as substantially equal payments over my life expectancy”:

Do I avoid the 10 percent early withdrawal penalty?

Must I continue this withdrawal option for life, or only until I reach age 55?

Must I continue this withdrawal option for life, or only until I reach age 56, my minimum retirement age?

Must I continue this withdrawal option for life, or only until I reach age 59½?

A. If you retire prior to the calendar year in which you reach age 55, you will not have unrestricted access to your TSP account, without penalty, until you reach age 59½ unless you become totally disabled. This is true whether or not you initiate a Series of Substantially Equal Periodic Payments (SOSEPP) as defined in IRC section 72(t) if you retire prior to the calendar year in which you reach age 55.

If you properly initiate and maintain a SOSEPP, you will avoid the early withdrawal penalty on the SOSEPP withdrawals. The SOSEPP must continue for five years, or until you reach age 59½, whichever is longer. If you disrupt the SOSEPP or otherwise violate the rules for this, the early withdrawal penalty will be assessed on all withdrawals that were protected under the SOSEPP.

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TSP withdrawal strategy

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Q. My wife and I are FERS employees. We are both considering retiring early if offered Voluntary Early Retirement Authority at ages 50+/- (both with more than 25 years of service). With children still in the picture for some time, access and flexibility with our Thrift Savings Plan accounts are crucial to any plan. I would like to accomplish two things:

1). 72(t) withdrawals until 59½ in one account.

2). Flexibility to roll over funds currently in TSP into a Roth IRA held at another institution (from an IRA as I see no method to do that while the funds are in TSP).

My plan would be to roll over just enough to “fill up” a certain tax bracket, say 15 percent, especially while we have many deductions related to children.

So, my thinking would be to have substantially equal payments out of one account soon after early retirement but not immediately. For the other TSP account, make a one-time partial withdrawal and transfer that to an IRA currently held at another institution. I’m assuming I can make that transfer/withdrawal at age 50 with no penalties, correct? This would allow me to each year assess our taxes and determine what amount of the IRA I would like to convert to my Roth IRA. I would only do a partial withdrawal as I appreciate the low expenses of the TSP, but the inflexibility to convert to a Roth is too limiting.

Does this make sense? And is everything I’ve laid out reasonable and doable?

A. What you’ve proposed is doable, but I’m not sure I see the value in the Roth IRA conversions.

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Roth TSP and law enforcement

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Q. I am a federal law enforcement officer. I recently read an article that discussed the downside of the Roth TSP for federal law enforcement officers and firefighters. Is this true?

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Many of you are probably unaware of the serious pitfalls you will encounter if you opt to contribute to the Roth TSP.  For a federal law enforcement officer or firefighter, the Roth TSP is a poor choice. It wasn’t until this week that a reader posed a question to me that caused me to realize what a bad idea the Roth TSP is for many of us.

The idea behind the Roth TSP is that you contribute after-tax monies and when you withdraw funds from the account in retirement, the earnings are tax-free. The trick here is that the withdrawal must be a “qualified withdrawal for the earnings to be tax-free. In order for the withdrawal to be considered a “qualified withdrawal” by the IRS, “five years must have passed since January 1 of the calendar year when you made your first Roth TSP contribution AND you are at least 59½, permanently disabled (or deceased).

Here’s the problem: As a law enforcement officer or firefighter, you can retire as early as 50 years of age and are mandatorily retired at age 57.  If you decide to take post-retirement withdrawals from the TSP (under the life expectancy option or the age 55 exemption), you will not meet the age test for the Roth TSP withdrawal to be considered “qualified.”  (You may also not meet the five-year rule as the Roth TSP has only been an option since May 2012.)  Since your withdrawal is not “qualified,” you will be taxed on the portion of your withdrawal that represents the attributable earnings. This eliminates the tax-advantaged nature of the Roth TSP. You’d be just as well off having a regular post-tax investment account outside of the TSP. You’re contributing after-tax dollars and paying taxes on the earnings generated by the post-tax investment.

The TSP will not allow you to specify that your post-retirement withdrawals come only from your traditional TSP balance, nor will the TSP allow you to roll over/transfer out only the Roth TSP portion of your account.  When you make any withdrawal from the TSP, the withdrawn amount will be taken ratably from both your traditional and Roth balances under TSP rules.

If you roll over/transfer both your traditional TSP and Roth TSP to another custodian, then you lose your eligibility under the age 55 exemption, as that requires the funds to be left in your employer-sponsored account.  If you retire between age 50 and 59½, at retirement, you could roll over/transfer your traditional TSP and Roth TSP to another custodian and withdraw only the funds that came from the Traditional TSP account using an IRS Section 72(t) withdrawal plan and wait until age 59½ to start to withdraw the portion that came from the Roth TSP funds.

Please consider these facts when deciding if the Roth TSP is right for you. If you already jumped into the Roth TSP, you can always stop and change your contributions to be 100 percent traditional TSP and limit the tax damage.

Even folks who aren’t covered under the special provisions get affected by these rules if they retire at their MRA.

A. The issue you raise is valid. You can get around it by transferring the Roth portion of a distribution to a Roth IRA. I realize this isn’t ideal, but it is an option to avoid the penalty.

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Meeting the 72(t) exception to the early withdrawal penalty

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Q. I am 49 years old and have 24 years of service with the Bureau of Prisons. If I retire at age 51 with 26 years of service and elect a life expectancy withdrawal from my Thrift Savings Plan account, would I be able to change to a specified amount at age 55 without a 10 percent penalty, or will I have to wait until age 59½ to change my withdrawal option to avoid the 10 percent penalty?

A. To meet the 72(t) exemption to the early withdrawal penalty, your series of payments cannot change until it has been completed — in your case, until age 59½. You must pick a payment calculation method, either life expectancy or qualifying fixed, and stick with it.

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Withdrawing from TSP without penalty

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Q. I’m a Defense Department firefighter (special category). At what can I withdraw my Thrift Savings Plan without incurring any penalties?

A. If you’ll settle for specific monthly payments, you can withdraw it any time after you separate from service without penalty. If you want a lump sum or monthly payments that don’t fall within the limits imposed by Internal Revenue Code section 72(t), then you’ll have to wait until you reach age 59½  unless you separate from federal service during or after the calendar year in which you reach age 55. In the latter case, any withdrawal you make will be exempt from penalty.

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72(t)

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Q. 1. I am retired at 52. If I take a life expectancy withdrawal through the Thrift Savings Plan from now until I reach 59½, can I then roll over the balance of my account to a privately held traditional TSP such as Vanguard? Or does taking the life expectancy withdrawal through the TSP commit me to them for life?

2. If I receive life expectancy withdrawals now through the TSP, can I still take a partial withdrawal (amount of my choosing) when I am 59½ without the 10 percent penalty?

3.  If I roll over my entire TSP account now to a privately held traditional TSP such as Vanguard and establish a 72(t) withdrawal arrangement using 120 percent of the applicable federal rate, does the yearly/monthly amount change each year if the AFR changes or will I receive the exact amount every year/month until I reach age 59½ (at which time I can change to equal monthly payments)?

A. If you want to avoid the early withdrawal penalty using the 72(t) rules, you’ll need to continue the calculated distributions for 10 years, or until you reach age 59½, whichever is longer. Moving the money from one custodian to another has no effect on the distribution requirement. During the required distribution period under 72(t), you may not take any more or less than the calculated annual distribution without violating the rules and invoking the penalty. Once you have committed to a fixed distribution scheme under 72(t), it must continue, unchanged for the entire distribution period, which in your case will be 10 years.

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Special category retiree and TSP access

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Q. I am a 50-year-old 6(c). I am eligible to retire on an immediate unreduced annuity this year and plan to do so. I plan to eventually access my Thrift Savings Plan funds, and I understand that I am able to do 72(t)-type withdrawals and avoid early withdrawal penalties. But I’m not interested in 72(t) systematic payments. I also know I could roll over the account to an IRA, but that is not my desired intention. Since I am retiring at age 50, what is the first date that I could begin to access my TSP via lump sum or monthly withdrawals without the 10 percent penalty: age 55 or 59½?

A. Age 59½.

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72(t)

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Q. I was downsized when I was 46 and rolled over everything into a 72(t). I am currently withdrawing from it monthly as I cannot find a job that pays enough to live off of. I am in a situation now where I need some extra money to clear off some debt and buy a new car. Can I take a one-time withdrawal from my 72(t), in addition to my monthly? If so, what are the tax implications?

A. You may not change the annual withdrawal scheme as calculated and required under 72(t). If you do, the 72(t) exception to the early withdrawal penalty will be voided and you’ll be obligated to pay the early withdrawal penalty on all withdrawals taken under the exception, to date.

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