Ask The Experts: Money Matters

By Mike Miles

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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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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Pay off mortgage with TSP?

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Q. I know that you say (almost always) not to pay off the mortgage on retirement with Thrift Savings Plan funds. So when it is a good idea to do so? I’m CSRS Offset ending at GS-14, Step 8 with 32 years of service, $300,000 in TSP, $30,000 in cash on hand, will have no credit card or vehicle debt shortly as we are selling an investment property (taking the tax hit instead of identifying a new investment property because I really don’t want to be a landlord anymore), the usual monthly expenses, and will get the law enforcement/firefighter retirement benefit bump (did my 20, then moved to a noncovered position). I am 60 (and, at 62, the offset kicks in, and beyond my way of thinking, will increase my monthly pension).

We owe about $100,000 on the 6 percent rate 15-year mortgage that has 10 remaining years. We plan on selling the house in six years when the last kid leaves for college and downsizing into a condo up the street for about $300,000. The house will sell for around $600,000+ (100+ year old historic neighborhood, prices and sales were barely affected during the recession so these numbers are pretty solid). The caveat is, we are restoring this historic house ourselves (this is the third one that we have done) and put $1,000 to $2,000 a month in parts or subcontractors for the renovation and probably have about 36 months left of work on weekends to finish the house ($36,000 to $50,000).

The calculator says my retirement income after adjusting my life insurance, tax adjustments (I claim zero now cause I am a lousy-saving person and get $10,000 average back every year) will be 87 dollars less a pay period than what I take home now (without touching the TSP). So the reason for paying off the mortgage is my wife, who works in social work at a low wage, can quit working as not having the mortgage (paid off with TSP funds)  will make up for about half of what she brings in and then help me swing a hammer and finish the house and party a bit more. On a final note, we have not taken out old-age insurance for care.

A. You’ve identified an objective: To take a lump sum from our TSP account to pay off your mortgage. So the question is whether or not this is a safe — and, if safe, an optimal thing to do, given your current circumstances and future goals. Unfortunately, it’s not possible to answer this question responsibly without analyzing it in the context of your lifetime plans. Visit my website and www.variplan.com and contact me if you’d like to discuss your needs further.

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Exemption from early withdrawal penalty

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Q. I have been reading your responses to the questions of federal agents and early withdrawals of their TSP accounts. The publication, 575, specifically states that law enforcement officers are exempt from the penalty if they are at least in their 50th year and the plan is a “qualified retirement plan.” IRS Form 8880 instructions refer to the TSP as a “qualified retirement plan” and in various other places within the IRS publications. Why do you insist it is not? Can you please clarify your position on this? Also, the IRS defines a law enforcement officer as one that is authorized to be armed, make arrests and serve warrants. Why are federal agents any different from nonfederal agents? I do not think your assessment of IRS publication 575 is accurate. Can you please educate me as to why federal agents are not exempt as other public safety employees?

A. The exemption only applies to withdrawals from defined benefit plans. The TSP is a defined contribution plan. I’m not your tax preparer, however, so you should consult yours before making any decisions.

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Age 55 exemption

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Q. I have more than 20 years of service as a federal law enforcement officer and will turn 55 in 2014. I plan to retire under FERS from my agency this year, before my age 55, and immediately (with no break in service) become re-employed on a full-time basis with another federal agency. I understand that my salary during the period of re-employment will be offset by the amount of my FERS annuity, and that retirement deductions (including Thrift Savings Plan contributions) will be made from my re-employment salary.  I understand further that I would earn a supplemental annuity upon termination of re-employment if I am re-employed for more than a year, and that I could alternatively elect a redetermined annuity if I am re-employed for at least five years.

However, if my re-employment terminates before I reach age 59½ (but well after 55), and I wish to make withdrawals from my TSP account at that time, how will the Internal Revenue Service calculate my “separation from service” date?  That is, will the IRS consider that I “retired” in 2013, prior to age 55, and thus apply the 10 percent penalty for early TSP withdrawals? (That would effectively force me to lock myself into the life expectancy withdrawal option for a full five years after the termination of my re-employment period.) Or, would the IRS determine that I “retired” on the date of the termination of my period of re-employment – after age 55 – enabling me to withdraw from my TSP account penalty-free?

A. To the best of my knowledge, your TSP account, if it is kept going through the transition in federal employment, will be eligible, in its entirety, for penalty-free withdrawal under the “age 55 exemption.” But, you should consult a qualified tax accountant before you make any plans.

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TSP matching funds

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Q. I am a federal law enforcement officer covered by FERS and, by Sept. 30, I will have more than 29 years of service plus more than a year of sick leave. To obtain my annuity beginning Oct. 1, I would like to retire on Sept. 30, but it is in the middle of a pay period. I plan on front-loading my Thrift Savings Plan and TSP catch-up contributions starting in April for the rest of this year to reach the maximum for both. Would there be any TSP match in my last, partial pay period, or should I just aim to reach my TSP limits in the previous complete pay period?

A. There will be matching on every pay period.

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TSP vs. IRA tax burden to spouse and heirs

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Q. I will retire April 30 under FERS (law enforcement agent; I will be 66½ years old) and have been exploring options available regarding my Thrift Savings Plan account. I read with interest your Feb. 4 Federal Times article “Don’t overlook TSP for lowest-cost investment” but have the following questions concerning what happens to my TSP account funds if I predecease my wife/heirs before or after the required minimum distribution takes effect.

As the annuitant, upon reaching 70½, I would have 10 years to draw down my TSP funds. What happens if I predecease my wife/heirs during this time frame? It is my understanding they will have a 5-year drawdown period, which would subject them to a heavier tax burden. Is this assumption accurate?

If I roll over my TSP into an IRA and I predecease my wife/heirs, then they would have the option of rolling over the funds into their own individual IRAs therefore avoiding a significant tax burden. Is this accurate?

A. The rules for this are complex and depend upon a number of factors. Your questions leave open too many possibilities to cover here. I suggest that you review the notice at https://www.tsp.gov/PDF/formspubs/tsp-776.pdf and then come back with any specific questions that remain unanswered.

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Converting TSP to annuity

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Q. I am a U.S. Capitol Police officer. I plan to retire in 2014 at age 55, although I can stay until 57. If I convert my TSP funds to an annuity, will I be able to draw on it right away? If not, when? Will I be penalized prior to age 62?

A. If you retire during or after the calendar year in which you reach age 55, you will be exempt from the early withdrawal penalty for all of your TSP assets as you withdraw them and may take them within the usual TSP limits, including using some or all of the money to buy an immediate annuity.

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Matching contributions

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Q. I plan to retire under FERS law enforcement on May 30, contributing my full $17,500 and $5,500 catch-up contribution in my first 10 to 12 paychecks. If I purposely make larger contributions early in the year in an attempt to reach the annual maximum contribution before retiring, will I lose out on agency matching contributions?

A. Not if you spread the contributions out evenly over the duration of your remaining employment.

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