Edward A. Zurndorfer, Certified Financial Planner

The Thrift Savings Plan (TSP) announced in early February the anticipated launch date of the newest TSP option available to TSP participants, the Roth TSP.

Starting in April or May 2012, all TSP participants who are eligible to contribute directly to the TSP via payroll deduction will be able to contribute to the Roth TSP. This column discusses how the Roth TSP will work, including contribution limits, fund choices, matching and tax consequences associated with Roth TSP investing. The next column will discuss which employees could benefit most by contributing to the Roth TSP and why.

Before discussing how the Roth TSP will operate, it is important to point out that the current TSP -- commonly referred to as the "traditional" TSP -- will continue with the same fund choices -- the C, S, I, F and G funds and the life cycle funds -- the L income, L 2020, L 2030, L 2040 and L 2050 funds available to all TSP participants. With the traditional TSP, employees elect to contribute a portion of their gross (before-taxed) salary to their traditional TSP accounts. Earnings in an employee's TSP account -- this includes any interest, dividends and capital gains -- grow tax-deferred. When a participant withdraws a traditional TSP account, both the contributions and accrued earnings will be taxed.

The Roth TSP will operate differently in two important ways.

First, contributions to a Roth TSP account will be made with after-taxed salary. Because contributions to one's Roth TSP account were already taxed, upon withdrawal these contributions will not be taxed again. Earnings will accrue in a participant's Roth TSP account.

Second, assuming a Roth TSP participant is at least age 59.5 (or disabled) and the withdrawal of earnings is made at least five years after the beginning of the year in which a Roth TSP participant made his or her first Roth TSP contribution, the accrued earnings will also be withdrawn tax-free.

Some additional Roth TSP rules:

· When an employee starts contributing to the Roth TSP, any monies in the employee's traditional TSP account will remain in that account. Traditional TSP accounts cannot be converted or transferred to Roth TSP accounts.

· Starting in 2012 and in future years, employees may contribute both to the traditional TSP and to the Roth TSP provided their total contributions do not exceed the overall limits. For example, during 2012 the combined total of an employee's Roth and traditional TSP contributions during 2012 cannot exceed the IRS elective deferral limit of $17,000 and the "catch-up" contribution amount of $5,500.

· For FERS-covered employees, the employee's agency automatic one percent gross pay contribution and the agency's four percent matching TSP contributions will always be deposited into the employee's traditional TSP account. This is true even if the employee's contributions via payroll deduction are directed to the Roth TSP account.

· Any contribution allocation or inter-fund transfer will apply to the investment of both a TSP participant's Roth and traditional contributions or balances respectively.

· Those Roth TSP participants with any Roth retirement account balances held with a previous employer will be able to transfer without limit any Roth 401(k), Roth 403(b) and 457(b) account balances into their Roth TSP accounts. However, Roth TSP participants will not be able to transfer Roth IRA money into their Roth TSP accounts.

· Roth TSP participants will be able to request TSP loans, in-service withdrawals, and partial withdrawals as they can from traditional TSP accounts. Loans, in-service and partial withdrawals will come of their account on a pro-rata basis -- with a proportional amount from their traditional and Roth TSP balances.

· When a TSP participant withdraws his or her account; the participant will be able to separately transfer any portion of the Roth and traditional TSP balances to IRAs or other eligible employer retirement plans.

Which employees will benefit most from the Roth TSP?

The answer to this question depends in part on one's income tax bracket now versus what it will be after one retires and withdraws one's TSP account. For example, those TSP participants who are in a low tax bracket now -- for example, 15 percent -- and who think they will be in a higher tax bracket once they retire -- for example, 30 percent -- will benefit. They will avoid paying taxes at the expected higher tax bracket in the future.

Other TSP participants who might benefit from the Roth TSP are those who want "tax diversification" and see an advantage in making after-tax contributions in order to have tax-free withdrawals in retirement. The next MFR column will illustrate how TSP participants should go about analyzing which TSP option would be best for them.
 
Once the Roth TSP option starts - estimated to be sometime during the second quarter of 2012 - participants will elect to make Roth contributions in the same way as they have always elected traditional contributions, using either the electronic system of their agency or Form TSP-1.

Those TSP participants who are 50 or older or who will be age 50 by Dec. 31, 2012 and are eligible for "catch-up" contributions, will enroll through their agency's electronic system, or Form TSP-1-C to elect Roth TSP "catch-up" contributions.

Posted: 02/21/2012

About the Author

Edward A. Zurndorfer is a Certified Financial Planner, Registered Health Underwriter, Registered Employee Benefits Consultant and Enrolled Agent in Silver Spring, MD and the owner of EZ Accounting and Financial Services, an accounting, tax preparation and financial planning firm also located in Silver Spring, MD.  He is an instructor at federal employee retirement seminars throughout the country and writes numerous columns and books on federal employee benefits.

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