Edward A. Zurndorfer, Certified Financial Planner

As a result of the passage of the Pension Protection Act of 2006, effective Jan. 1, 2010 any owner of a qualified pension plan -- this includes a 401(k), 403(b), and 457 retirement plan and the Thrift Savings Plan (TSP) -- is eligible to  transfer all or part of those retirement accounts to a Roth IRA.

This is  regardless of an individual's filing status or adjusted gross income (AGI). Note that prior to Jan.1, 2010, only those individuals with AGIs of less than $100,000 and who did not file their income taxes as married filing separately, could qualify to make such transfers.

TSP account owners who: (1) have retired or left federal service, or who are currently in federal service and are at least age 59.5 and wish to make a one-time "age based" withdrawal; and (2) are currently have established a Roth IRA or a "rollover" Roth IRA are allowed to rollover their accounts to a Roth IRA. However, rollovers from the TSP to a Roth IRA are subject to full federal (and state income tax, if the TSP account owner lives in a state with a state income tax) income taxes in the year of transfer. However, there is no additional 10 percent early withdrawal penalty upon transferring a TSP account to a Roth IRA.

If the TSP account owner requests that the TSP directly transfer the TSP account to a Roth IRA, then the TSP will not withhold any federal income taxes. But if the TSP directly sends the TSP account to the account owner, then the TSP will automatically withhold 20 percent in federal income taxes. The TSP account owner is responsible for paying any state income taxes due upon the transfer of a TSP account to a Roth IRA.

The amount of the total tax liability will be reported on the TSP account owner's federal (and state) income tax returns in the year of transfer. For example, if a TSP account owner transfers $30,000 of a TSP account into a Roth IRA during 2010, then the $30,000 will be reported on the account owner's 2010 federal and state income tax returns which will be filed in the spring of 2011. 

In this example, how much in income taxes will be due upon the transfer of the $30,000 from the TSP account to a Roth IRA? If the account owner is in a 28 percent federal and an eight percent state marginal tax bracket, then the account owner will owe 28 percent of $30,000, or $8,400, in federal taxes and eight percent of $30,000, or $2,400, in state income taxes. Once these taxes are paid, the Roth IRA owner will not owe any taxes on future earnings and growth in the Roth IRA. Furthermore, the account owner will not be required to withdraw anything from the Roth IRA, even when the account owner becomes age 70.5. In the event the Roth IRA owner dies, a beneficiary inherits the Roth IRA and any withdrawals by the beneficiary -- and this includes earnings -- will also be tax-free.

Lifting the Roth IRA transfer and conversion restriction related to the $100,000 AGI limitation essentially allows TSP account owners for whom wealth transfer is a top priority to prepay income taxes on their TSP accounts. Furthermore, since Congress did not modify the one-year repeal of the federal estate tax enacted in 2001, for the year 2010 those TSP account owners who transfer their TSP account to a Roth IRA during 2010, pay the taxes due, but unfortunately die before Dec. 31, 2010 will essentially pass on their TSP accounts federal estate and income tax-free to their heirs.

One's outlook on future federal tax policy can also justify transferring at least some portions of one's TSP account to a Roth IRA. Many financial professionals believe that income and estate tax rates today are lower today compared to where the rates will be when most TSP account owners transfer their accounts to heirs in the future.  That is why conversions from traditional IRAs to Roth IRAs and transfers from qualified retirement plans and the TSP to Roth IRAs makes sense from the standpoint of overall tax savings.

Given the recent performance of the stock and bond markets and the current status of the federal estate tax laws, TSP account owners are also advised to evaluate their accounts as well as to review their beneficiary designations. Those employees who will be retiring from federal service during 2010 should give some serious considerations to the Roth IRA transfer election. Retiring employees are also strongly advised and encouraged to discuss their individual circumstances with their tax professionals. Legal matters related to estate planning and beneficiary designations should be discussed with a qualified estate attorney who practices in the state in which the TSP account owner is a legal resident.

About the Author

Edward A. Zurndorfer is a Certified Financial Planner and Enrolled Agent in Silver Spring, MD. He is a seminar speaker at federal employee retirement seminars throughout the country for the National Institute of Transition Planning, Inc. , and an author of numerous publications on federal employee benefits.

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