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 When you make any withdrawal from the TSP, the withdrawn amount will be taken ratably from both your traditional and Roth balances under TSP rules.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