Voluntary Contribution Program (VCP): Withdrawal Options for CSRS and CSRS-Offset Employees
(Part 2 of 2)

Edward A. Zurndorfer, Certified Financial Planner
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A previous column discussed the Voluntary Contribution Program (VCP) including which CSRS and CSRS-Offset employees are eligible to participate and how much employees can contribute to the VCP. This column discusses the withdrawal options from a participant's VCP account and the tax consequences for each withdrawal option. 

There are three options available to a VCP participant for withdrawing his or her account. They are: 

1.  request a lump sum payment of all contributions and accrued interest;

2.  request a lump sum payment of all contributions together with a request to directly transfer all accrued interest to either a traditional IRA or to the participant's TSP account; or

3.  request a VCP annuity. The VCP annuity is in addition to the participant's regular CSRS annuity that the annuitant is receiving.

Let's take a look at the three options.

An employee may withdraw all voluntary contribution together with all accrued interest at any time before receiving a VCP annuity. The withdrawal is not subject to the spousal notification requirements that apply to requested refunds of regular CSRS retirement contributions. If the employee plans to make the withdrawal prior to retirement, the employee must notify OPM of his or her decision by completing and submitting to his or her employing office Form SF 2802 or RI 38-124.

If the employee dies while an employee in federal service, or after separation from service but before receiving the first CSRS annuity check, the entire VCP account - including all contributions and accrued interest - will be paid in a lump sum payment to the person or persons entitled under the normal order of precedence. Note that OPM normally pays any remaining monies in a VCP account in a lump sum payment to the person or persons entitled under the normal order of precedence if the annuitant and any designated survivor annuitant die without having received the total amount of the VCP account (including unpaid interest) as annuity payments. A CSRS or CSRS Offset employee can designate beneficiaries of the lump sum payment on form SF 2808.   

Since all contributions were made to an employee's VCP account with "after-taxed" dollars, a lump sum payment of the employee's VCP contributions are not taxable. But any accrued interest in a VCP account is taxable in the tax year in which the interest is received unless the interest is directly transferred by OPM to the retiring employee's designated traditional IRA or to the retiring employee's TSP account.

If the VCP account owner receives a lump sum payment of the entire VCP account before he or she attains age 59.5, then the interest portion is generally subject to federal and, if applicable, state income taxes and to an additional IRS 10 percent early distribution tax. Exceptions to the 10 percent tax early distribution tax are:

  • payment resulting from disability;
  • monthly annuity payments elected at the time of retirement.
  • payment after separation from service if the separation accrued during or after the year in which the recipient attains age 55; or
  • payment to survivors after the death of the employee or annuitant.

The early distribution tax is calculated by multiplying 10 percent times the amount of interest paid as part of the lump sum VCP payment. 

Interest refunded and directly paid to the VCP account owner is subject to mandatory 20 percent federal income tax withholding. To avoid being taxed on the accrued interest and assuming the total interest in the VCP account is at least $200, the account owner can elect to have OPM directly transfer all of the accrued interest to a traditional IRA or to a qualified retirement plan such as a 401(k) plan or the TSP. But a direct payment to the account owner will not avoid the mandatory federal income withholding tax, even if the account owner chooses to deposit the interest payment in an eligible traditional IRA or to the TSP within 60 days of receiving the interest payment.

VCP account owners can request to directly transfer the interest at the time they submit their election to receive a lump sum VCP payment. This request is made on form SF 2802 or RI 38-124.

Here are two examples to illustrate:

Example 1:

Robert, age 51, needs the funds in his VCP account to make a downpayment on a house. He files form SF 2802 with his employing agency in February 2009 and receives a refund from OPM of $46,795 in April 2009. The $46,795 consists of $40,000 of voluntary contributions Robert's VCP account has accumulated $6,795 of accrued interest.

1. The $6,795 accrued interest is taxable income to Robert during 2009.

2.  Since Robert received the refund before he attained age 59.5, he does not meet one of the exceptions for not paying the 10 percent early distribution tax on the interest received because he separated from service before age 55.

3.  OPM will withhold the mandatory 20 percent federal income tax of $1,359 (20 percent of $6,795. Robert is responsible for paying the 10 percent early distribution tax when he files his 2009 federal income taxes.

If Robert did not need the interest income, he could have elected to have OPM directly transfer all of the accrued interest into a traditional IRA and in so doing, avoid paying pay federal and state income taxes and a 10 percent early distribution tax on the $6,795 of accrued interest.

Example 2.

Albert retires voluntarily on June 1, 2009 at age 57. Albert has a VCP account with a balance of $67,250 as of his retirement date. The $67,250 consists of $60,000 of voluntary contributions and $7,250 of accrued interest.

1. Shortly before Albert retires, he has the following options:

· receive a full refund of his entire VCP account;

· receive a refund of his VCP account contributions and request a direct transfer of the $7,250 of interest to his traditional IRA rollover account or to his TSP account; or

· receive a VCP account annuity (see below).

Albert elects a refund of his VCP account with a direct transfer of the accrued interest to his TSP account.

2. The accrued interest of $7,250 is not taxable income because Albert requested OPM to directly transfer the interest via Form RI 38-124 or SF 2802 to his TSP account.

3. Since Albert's contribution of $60,000 to his VCP account was with "after-taxed" dollars, he will not be taxed on his lump sum payment of $60,000. Albert also avoided paying taxes on the accrued interest by directing transferring the interest to his TSP account. Had he not transferred the accrued interest he would have avoided the 10 percent early distribution tax because he retired from federal service when he was older than age 55.

Another option for VCP account owners who are eligible is to directly transfer all VCP contributions to an existing nondeductible traditional IRA. Identical to nondeductible traditional IRAs, Roth IRAs are also funded with "after-taxed" dollars. But unlike nondeductible IRAs in which earnings are taxed when withdrawn, any earnings within a Roth IRA grow tax-free because all withdrawals from a Roth IRA - contributions and accrued earnings - are tax free. An individual may be eligible to convert a nondeductible IRA to a Roth IRA. Once monies go into a Roth IRA, the monies grow tax-free.

To convert a nondeductible (traditional) IRA to a Roth IRA in which some of the converted monies in the nondeductible IRA originate from the VCP, a VCP account owner must:

  • have an adjusted gross income (AGI) of less than $100,000 during 2009. But starting Jan. 1, 2010 the $100,000 is no longer in effect, meaning that any individual with a traditional IRA (deductible and nondeductible) may convert that IRA to a Roth IRA;
  • file his or her taxes using any filing status except married filing separately. This restriction will be eliminated as of Jan. 1, 2010; and

  • own at least one nondeductible traditional IRA;

To take advantage of a Roth IRA conversion from a VCP account and assuming the three conditions just given are met, the VCP account owner should:

  • first instruct OPM- via Form 2802 or RI 38-124 - to directly transfer any accrued interest in the VCP account to the TSP; and
  • file TSP Form 60 and have any earnings in any nondeductible IRA(s) and the entire balance of any deductible (traditional) IRA(s) the VCP participant owns, directly transferred to the VCP participant's TSP account; in so doing, the IRA owner will not have to pay taxes upon converting the nondeductible IRA to the Roth IRA; then
  • have OPM directly transfer all VCP contributions to an existing nondeductible IRA and then convert the nondeductible IRA to a Roth IRA.

If these requirements are fulfilled, then any future earnings in the converted Roth IRA can be withdrawn tax free after five years starting from the day the VCP account contributions are transferred and converted to a Roth IRA.

Here is an example to illustrate.

Ann, age 59, retired from federal service on Aug. 1, 2009. She had contributed $40,000 to her VCP account. At the time of her retirement there was $2,375 of accrued interest in her account. Ann completed Form RI 38 -124 in order to directly transfer the accrued interest to her TSP account and directly transfer the $40,000 of VCP contributions to her existing nondeductible traditional IRA. Sometime during 2010, when there will be no income limitation for converting nondeductible traditional IRAs into a Roth IRA, Ann directly transfers any earnings in her nondeductible IRA in 2010  into her TSP account. In so doing, Ann will be left with already taxed monies in her nondeductible traditional IRA. In converting what is left in her nondeductible traditional IRA to a Roth IRA, Ann will not have to pay taxes. This is because a nondeductible traditional IRA is always funded with monies that have already been taxed.

An employee may elect to receive a lifetime VCP annuity based on the employee's voluntary contributions and accrued interest. An employee who transferred to FERS from CSRS (a "TransFERS") may also receive a VCP annuity based on his or her contributions to the VCP prior to transferring to FERS and accrued interest.

The amount of the VCP annuity is determined as follows:

1. Each $100 in the VCP account - that includes both principal and interest - provides an annual annuity payment of $7.00. The annuity increases 20 cents per year for each full year the retiree is over age 55 at the time the annuity begins. Here are two examples.

Example 1.

Martha, age 60, has a VCP account balance of $20,000 at the time she retires . She decides to receive the VCP annuity.

 60 years minus 55 years = 5 years

0.20 x 5 years = $1.00

$7 + $1 = $8

$20,000/$100 = $200

 $200 x $8 = $1,600 additional annuity

Martha will receive a VCP annuity equal to $1,600 per year.

Example 2.

Peter is 55 when he retires under CSRS and has a VCP account balance of $100,000 at the time he retires.

$100,000/$100 = $1,000

 $1,000 x $7 = $7,000 additional annuity

Any additional annuity purchased by voluntary contributions continues to be paid as long as the individual remains alive. Once the annuity begins, the annuity is not increased by any cost-of-living (COLA) adjustments.

At retirement, the employee may elect a reduction in his or her VCP annuity in order to purchase a survivor annuity. Any person - related or unrelated - to the employee may be designated. The person to be named does not have to be the same person designated as the survivor annuitant for the regular CSRS annuity.

If the retiring employee does not designate on Form RI 38-124 or SF 2802 that he or she is electing to receive a refund of voluntary contributions, then OPM assumes the retiring employee is electing the VCP annuity. OPM also assumes that the election of a survivor benefit on the retirement application also applies to the VCP annuity. The retiring employee must attach a note to the application stating that he or she does not want a survivor benefit in connection with the additional annuity or wants to designate a different person to receive a survivor annuity.

If the retiring employee elects a survivor annuity for the VCP annuity, then his or her VCP annuity will be reduced. The reduction in the VCP annuity depends on the difference in the ages between the retiree and the designated survivor, as shown in the following table.

Age of Person Named in Relation to that of the Retiring Employee (years younger)

Reduction in Annuity of Retiring Employee (percent)

Older, same as or less than 5

5 but less than 10

10 but less than 15

15 but less than 20

20 but less than 25

25 but less than 30

30 or more








The survivor annuity is equal to 50 percent of the retiree's reduced additional annuity, as illustrated by the following example:

An employee retires at age 60 with a VCP account equal to $160,000 at the time of retirement. The employee's spouse is age 54, six years younger than the employee . A VCP annuity without survivor annuity is equal to: 

$160,000/$100 x $8.00 = $12,800 per year

 A VCP annuity with a survivor annuity is computed as follows:

 $12,800 x 15 percent = $1,920 (cost of survivor annuity benefit)

$12,800 minus $1,920 = $10,880 (net VCP annuity after survivor annuity benefit is deducted)

 The survivor annuity benefit is equal to: 

= $10,880 x 50 percent = $5,440 per year

The reduction of the annuity is permanent if the employee elects to provide a survivor annuity. The reduction will not be eliminated if the designated survivor predeceases the retiree, nor can the survivor annuity be transferred to a different person.

Any remaining monies left in the VCP account at the death of the annuitant will be paid in a lump sum payment to a designated beneficiary(s) in the event that there is no survivor annuity. Beneficiaries may be designated on form SF 2808.

Those individuals who choose to receive the additional annuity will have their annuity payments taxed according to the IRS' Simplified Rule. Information about the Simplified Rule may be found in IRS Publication 721, downloadable from the IRS' website at http://www.irs.gov .

About the Author 

Edward A. Zurndorfer is a Certified Financial Planner and Enrolled Agent in Silver Spring, Maryland. He is also a registered representative with Multi-Financial Securities Corporation (Branch A9X), member FINRA/SIPC, also located in Silver Spring, Maryland