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How to Rollover or Transfer a TSP Into an IRA — and Why You Should

2021-05-18

Military servicemembers are eligible to contribute to the Thrift Savings Plan (TSP), one of the best retirement programs available. The TSP works similarly to a traditional 401(k) plan in that any money you contribute to the plan is not taxed until it’s time to withdraw it at your retirement. That means you’re building more savings over the years. Additionally, the military will match up to 5% of your salary dollar-for-dollar, then match some additional contributions at a smaller percentage.

For most servicemembers, the TSP is the easiest and best option for retirement savings. However, in some situations, servicemembers may want to consider rolling over all or part of their TSP savings into a Roth IRA. Let’s look at how and why you may want to do this.

What are the differences between a Traditional 401(k) and a Roth IRA?

A Traditional 401(k), like the TSP, and a Roth IRA are both popular types of retirement savings plans that allow you to grow your savings tax-free. However, they differ in some key areas:

  • Taxed savings. 401(k) plans are a pre-taxed option, which means the money is deposited before taxes are deducted from your pay. When you withdraw from your 401(k) plan, however, income taxes are taken out. With a Roth IRA, you pay taxes on the money you contribute prior to placing it in your Roth IRA. However, you withdraw from your account tax-free.
  • Investment options. With a 401(k), your employer sets up the options on how the money will be invested in the market. With a Roth IRA, you have more investment freedom.
  • Employer contributions. With a 401(k), employers often offer contribution matches. The TSP, for example, will match up to 5% of your income dollar for dollar. Roth IRAs do not offer this aspect.
  • Contribution limits. Roth IRAs legally have lower limits on how much you can contribute annually.

TSP Benefits

The TSP is a simple and efficient way to build retirement income for many servicemembers and federal employees. Here’s why you may not want to transfer a TSP into an IRA:

  • No additional fees. The TSP has the lowest administrative expenses than any other retirement plan worldwide. When you switch to a Roth IRA, you will have to pay management and other fees to whoever is handling your account.
  • Simplicity. With your TSP, you do not have as many investment options as you do with a Roth IRA, which streamlines the process and prevents investing from becoming overly complicated.
  • Creditor protection. The TSP is better protected against lawsuits than IRAs. Creditor protection varies by state.
  • Delayed Required Minimum Distributions (RMDs) if you are still employed. An RMD is the amount of money that you must withdraw from a retirement plan by a certain age.
  • Unlimited withdrawals. Through the TSP Modernization Act, federal employees are able to make more frequent withdrawals from their TSP accounts than with a Roth IRA.
  • Early retirement. You can get penalty-free distributions at age 55, provided you are no longer working.
  • Transfers from other plans. With your TSP, you can transfer funds from other retirement plans. You just can’t add new contributions if you are no longer in the military or working for the federal government.

Reasons to Rollover a TSP into an IRA

First, an important note: While the terms “transfer” and “rollover” are often used interchangeably, they are different. Transferring an account is when you transfer the funds directly from one financial institution to another. A rollover is when you send the funds to an investor, then the investor deposits them into a qualified retirement fund within a specific time frame and following IRS regulations. If not done correctly, a rollover can cause major tax implications.

Here are a couple of important points you need to understand:

  1. There is a 10 percent early withdrawal penalty tax if you are younger than age 55 and you don’t complete the rollover within 60 days.
  2. Your TSP is required to withhold 20 percent for federal income taxes to ensure taxes will be paid if the rollover is not completed.

When you leave the military, you can leave your money in your TSP. However, sometimes there are advantages to moving your TSP funds into a Roth IRA:

  • More investment options. If you’re working with a market-savvy financial advisor or investment broker, you may want the option to better diversify your investments. Roth IRAs let you invest in a variety of stocks, bonds, mutual funds, and other investments that the TSP does not. Because Roth IRAs can be purchased through a number of sources, including banks, brokerages, etc., you can have more investment strategy support than you would get through your TSP.
  • Consolidating funds. If you already contribute to both a Roth IRA and a TSP, you may want to put all of your funds in one retirement plan for the sake of simplicity. If this is the case, rolling your TSP into a Roth IRA may make sense.
  • Tax-exempt withdrawals. Earnings on Roth IRA contributions are tax-free when a qualified withdrawal is made.
  • Lower RMDs for young spouses. If your spouse is more than 10 years your junior, you can use a different IRS table to calculate RMDs.

How to Rollover a TSP into an IRA

If — after speaking with a financial advisor — you decide to rollover your TSP into an IRA, you’ll want to ensure everything is in order prior to withdrawing funds so that you’re not racing against the IRS deadline and risking having to pay taxes:

  • Decide if you want to transfer all or just some of your TSP. You can keep your TSP account open by leaving at least $200 in the account.
  • Complete the required TSP paperwork.
  • Open a Roth IRA. It’s important to make sure this is a Roth IRA, not a traditional 401(k) plan. Otherwise, you will be taxed on your contributions, which means you’ll be losing money that would otherwise gain interest.
  • Provide your bank or broker with the IRA number to ensure the funds transfer quickly.

AAFMAA Can Help You Select the Right Retirement Plan

Before deciding to rollover your TSP into an IRA, talk to a financial expert who can help take the guesswork out of your retirement planning. Explore more topics for further insights.