Ask The Experts: Money Matters

By Mike Miles

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  When you make any withdrawal from the TSP, the withdrawn amount will be taken ratably from both your traditional and Roth balances under TSP rules.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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TSP allocation

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Q. I’m 25 years old, series 1811 and have been contributing 5 percent into the Thrift Savings Plan (FERS) for three years. Until last week, I was contributing 100 percent into the L2040 fund, but now I’m doing 65 percent into the S Fund and 35 percent into the I Fund. Since I still have about 32 years until mandatory retirement, do you think I am making the right TSP choices now, and do you have any recommendations?

A. Your allocation is risk-inefficient. You could reconfigure it to deliver similar expected growth with much less volatility. If you don’t know how to do that, then I suggest that you go back to using the L funds.

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Roth TSP and 59 1/2

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Q. Federal employees now have the option of investing a portion of their Thrift Savings Plan contributions into the Roth option. As many of us know, contributions to the Roth TSP are from after-tax income. The benefit comes from tax-free earnings. The way I understand the rules, we must contribute to Roth for five years and not make any withdrawals until we are age 59½. The traditional TSP also uses the 59½ rule, unless we retire at age 55 or later.

When we make withdrawals from our TSP account, the money is divided proportionately from both the traditional and Roth funds. For example: Mr. Smith’s account is evenly divided between traditional and Roth. Each withdrawal will consist of 50 percent from the traditional TSP and 50 percent from the Roth TSP. From the way I read it, selective withdrawals from each fund are not allowed.

I am a firefighter who faces mandatory retirement at age 57. I have been contributing to both funds in TSP for over 30 years. Having met the traditional TSP rule of retiring at 55 or later, I elect to receive equal monthly payments for 20 years.

Since I have not reached 59½, am I going to be penalized for early withdrawal from the Roth TSP? There is no penalty for the traditional fund. If different withdrawal rules apply to each fund, should I not have the option of the leaving the Roth TSP untouched until I turn 59½?

A. Distributions of earnings from your Roth TSP will be subject to tax until you reach age 59½ unless you roll them over to a Roth IRA account.

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TSP and the fiscal cliff

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Q. I am a federal forestry tech (firefighter) and am facing mandatory retirement in 1½ years. I am wondering if the fiscal cliff will affect the Thrift Savings Plan like a couple years ago and the bottom will fall out. If so, would it be prudent to move my TSP more to more conservative accounts?

A. No one knows what the future holds, but market timing only adds unnecessary risk to your investment strategy. Select and implement the asset allocation scheme that supports your goals with the minimum of risk and stick to it. That’s the safest bet.

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TSP withdrawal options

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Q. As a federal law enforcement officer facing mandatory retirement in 2013, I have been looking closely at my Thrift Savings Plan withdrawal options. When I retire and I leave my complete TSP balance in the G Fund, can I request withdrawals whenever I want and for whatever amount I want?

I see that there are options for setting up a recurring amount each month or year, but can that be changed to month to month or whenever it is needed? For example, because receiving my full retirement pension amount in a timely manner will most assuredly not happen, would I be able to request a lump sum from TSP the month I retire and then wait a couple of months to see how things go, then request a recurring withdrawal every month for a while? And then, if I deem I don’t need extra money for a couple of months, stop the monthly payouts?

I do not want to buy an annuity. I just want to know how flexible I can be in withdrawing from the TSP.

A. You may take one partial withdrawal from the TSP during your lifetime. In addition to this partial withdrawal, you may take a full withdrawal, either as a lump sum or a series of monthly payments that either deplete your account or end in a final lump-sum withdrawal. You may change the amount of fixed monthly payments once each year, in January. Your question is answered in more detail at www.tsp.gov.

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Mandatory retirement and TSP withdrawal

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Q: I am a firefighter about to be forced to retire at 57 years old because of the mandatory retirement age. I plan on taking out my Thrift Savings Plan earnings to buy my house when I retire. Do I still have to pay the 10 percent penalty for withdrawing from my TSP before turning 59 1/2 even though I was forced to retire because of my age?

A: Because you are retiring during or after the year in which you reach age 55, your subsequent TSP withdrawals will not be subject to the early withdrawal penalty.

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