Essential Facts to Consider Before Transferring Your Roth TSP to a Roth IRA
The question of whether to rollover or transfer a federal Thrift Savings Plan (TSP) to an individual retirement account (IRA) is a common one in the personal finance community. One key factor to consider is the five-year rule, which affects the tax-free status of distributions from a Roth IRA.
Scenarios and Their Consequences
In Scenario #1, where the five-year rule wasn't satisfied with the Roth IRA, any earnings distributed would be subject to income tax, and if you're under age 59 1⁄2, a 10% penalty would apply.
However, in Scenario #2, where the five-year rule was satisfied with the Roth TSP, the entire amount transferred to Roth IRA is treated as an original contribution.
The Five-Year Requirement for Roth IRA Qualified Distributions
The five-year requirement for Roth IRA qualified distributions is met if five years have passed since the first contribution was made, and the account holder is either 59 1/2, disabled, deceased, or distributing up to $10,000 under the first-time homebuyer exception.
Transferring Roth TSP Funds to a Roth IRA and the Five-Year Clock
If you transfer Roth TSP funds to a Roth IRA before satisfying the five-year rule in the TSP account, the five-year clock for qualified tax-free distributions does not carry over to the Roth IRA. This means that your Roth IRA’s own five-year holding period will apply separately, and distributions from the Roth IRA may not be qualified (and could be subject to taxes and penalties on earnings) until the Roth IRA’s five-year rule is satisfied.
Consequences of Transferring Roth TSP Funds Before Meeting the Five-Year Rule
If the Roth TSP’s five-year requirement has not been met, the rollover is still allowed and is generally tax-free because it is a rollover of after-tax contributions. However, the qualified distribution status (no taxes or penalties on earnings) depends on satisfying the Roth IRA five-year rule and meeting an IRA-qualified event (age 59½, death, disability, etc.).
Consequently, any earnings withdrawn from the Roth IRA before meeting the Roth IRA’s five-year holding period and qualifying conditions might be subject to income tax and a 10% early withdrawal penalty.
Key Takeaways
- If the five-year rule is not met in the Roth TSP, transferring to a Roth IRA starts a new five-year period for tax-free qualified withdrawals of earnings.
- Early withdrawals of earnings from the Roth IRA before meeting the Roth IRA’s five-year holding period and qualifying conditions could be taxable and penalized.
- When transferring funds from a Roth TSP to a Roth IRA, contributions can be withdrawn tax and penalty free from the Roth IRA.
- The Rule of 55 only applies to the plan of the employer you are separating from and does not extend to other employer plans or IRAs.
When making this decision, it's important to consider fees, taxes, and conflicts of interest, as advised by the Financial Industry Regulatory Authority (FINRA). For more information, refer to Options for Withdrawing Funds from the Thrift Savings Plan: Option 3 Rollovers and TSP to IRA Rollovers: The Pros and Cons.
In Scenario #3, if an individual transfers funds from a Roth TSP to a Roth IRA without satisfying the five-year rule in the Roth TSP, a new five-year period for tax-free qualified withdrawals of earnings will begin in the Roth IRA.
If early withdrawals of earnings are made from the Roth IRA before meeting the Roth IRA's five-year holding period and qualifying conditions, these withdrawals could potentially be subject to income tax and a 10% early withdrawal penalty, emphasizing the significance of personal-investing strategies in managing personal-finance matters.
