Retirement Rollover: TSP Rollover to IRA

by | Apr 3, 2023 | Investment, Multifamily, Retirement

If there is one thing that everyone has in common, it is that everyone wants to retire early. One of the ways that people increase their contributions for retirement is a Thrift Savings Plan (TSP) rollover to an Individual Retirement Account (IRA). Now, what is this strategy and what does it do?

What is a TSP and an IRA?

First things first, what is a TSP? According to Investopedia, “A thrift savings plan (TSP) is a retirement investment program open only to federal employees and uniformed service members, including the Ready Reserve.” It is known to offer federal employees most of the benefits that are available to workers in the private sector. Think of the TSP as a public sector 401K plan.

An individual retirement account (IRA) is a long-term savings account that individuals with earned income can use to save for the future while enjoying certain tax advantages, Investopedia says. The two most common types of IRA are a traditional IRA and a Roth IRA, with other less common IRA plans also available.

Why rollover a TSP to an IRA?

There are some key reasons why people perform this move on their retirement funds. First, investors have full control of their investments in an IRA, and it offers more investment options, according to Chris Reddick. Reddick also mentions that a TSP rollover to an IRA also offers portability and professional money management.

How to conduct a TSP rollover to IRA

When it comes to the TSP rollover to IRA strategy, first it is important to note that you must have completed your federal service. If you are currently still in federal service, a rollover is not possible. If you have completed your federal service, Daniel Liberto of Investopedia breaks down how to move forward. While the transactional process may be different for various companies, there are two ways of transferring the money: 1) The direct rollover (transfer), and 2) The indirect rollover (rollover).

For the direct rollover, the user needs a Roth IRA set up and the account details at hand. They will also be required at tax time to pay taxes on the transfer amount to the Internal Revenue Service (IRS). The U.S. Money Reserve states, “When you carry out a direct rollover, you shift money from one account to another. You can move the funds from one retirement plan to a different retirement plan.” Pretty simple.

The indirect rollover is more involved. The funds in a TSP are sent by check to the user (rather than transferred directly into your new account), and then should be deposited into an approved retirement plan within 60 days. Before taking this route, be aware of some key features of the tactic:

  • In this case, the TSP withholds 20% of your funds for federal income taxes.
  • You then have 60 days to redeposit your traditional TSP funds (including the 20% withheld) to your Roth IRA. If you fail to meet this deadline, then any portion not deposited will be taxed.
  • It also will be subject to a 10% early withdrawal penalty if you are younger than age 59½.

Vestwell gives two examples showing the difference between direct and indirect rollover strategies:

Example of Direct Rollover:
Let’s say that Bruce, who is 35 years old, started a new job at ABC company. Bruce decides he would like to rollover his funds from his previous employer’s plan to his new employer’s plan. He gets the rollover information for his new plan and begins a rollover request at his old plan. The rollover is processed and the funds are sent from his prior provider to his new provider in benefit of Bruce. The full amount of his account is rolled over between providers and no taxes are withheld.

Example of Indirect Rollover:
Let’s say that Bruce, who is 35 years old, leaves his job at 123 company. He decides he wants to open an IRA and move his funds from his old provider to his new IRA. He does an indirect rollover for $10,000 and $2,000 of that is withheld for taxes. Bruce receives a check for $8,000. He has 60 days to redeposit the full $10,000 into his IRA to avoid additional tax and penalties. If he does so, the initial $2,000 that was withheld for taxes will be returned to him as a tax credit for the year the rollover process is completed. If he does not deposit the full $10,000, and only rolls over the $8,000 he received via check, the $2,000 that was withheld, would be considered an early distribution subject to income taxes and a 10% penalty.

Key Considerations Before you Rollover TSP to IRA

Before taking the TSP rollover to IRA leap, be sure you’ve done your homework and know the ins and outs of this strategy. FINRA has specified the following points to consider when performing a TSP rollover to an IRA:

Evaluate your transfer options
Typically, you have four transfer options to consider: 1) You can keep some or all your savings in your TSP, 2) You can transfer assets to your new employer’s plan if allowed (check with a new employer’s benefits or human resources office), 3) You can roll over your plan assets into an IRA, or 4) You can cash out your balance. Understand the costs and risks associated with each of these options before choosing your approach.

Think twice before you do an indirect rollover
Indirect rollovers have significant tax consequences. You will not get the full amount because the plan is required to withhold 20% to ensure that taxes will be paid if the rollover is not completed.

Be wary of “free” or “no fee” claims
Even if there are no costs associated with a rollover itself, there will almost certainly be costs related to account administration, investment management or both. Don’t roll over your retirement funds solely based on the word “free.”

Realize that conflicts of interest may exist
Financial professionals who recommend an IRA rollover might earn commissions or other fees as a result.

The TSP rollover to IRA is not for everyone. If you find yourself hesitating after reading the above considerations, maybe it’s time to think about how to use your TSP as is for new opportunities.

Can you still engage in other investments with a TSP?

If you are looking for more diverse ways to leverage your TSP, and want to avoid the challenges of a TSP rollover to IRA, multifamily real estate is a great way to make your TSP funds work for you. Passport REI is a real estate investment syndication group that specializes in providing support to U.S. Foreign Service employees and their families seeking to build wealth and create their legacy while serving. Passport REI offers investment solutions that are compatible with a TSP. If you’d like to learn more, reach out to Tom and James at Passport REI today and book a call to get a conversation started.