How Traditional IRAs Can Bolster Traditional TSP Accounts

Thrift Savings Plan (TSP) participants frequently ask questions concerning the relationship of their TSP accounts and Individual Retirement Accounts (IRAs). There is unfortunately some misinformation about the TSP and IRAs among TSP participants.

It needs to be emphasized that federal employees are eligible to contribute to both the TSP traditional and to a traditional IRA. This column discusses how traditional IRAs can help boost the value of a traditional TSP participant’s account while the participant continues working in federal service and after the participant has retired from federal service.

What TSP participants can do with their traditional IRAs and their traditional TSP account while participants continue working in federal service?

While in federal service, A TSP participant can do the following with respect to traditional IRAs and their traditional TSP accounts:

Contribute to both their traditional IRA and to the traditional TSP

A federal employee’s participation in the TSP does not affect the employee’s eligibility to contribute to an IRA. But the Internal Revenue Code (IRC) establishes limits on the dollar amount an employee each year can contribute to the TSP and to an IRA (traditional and Roth IRAs). These limits usually increase somewhat from year to year. Note that IRA contribution limits are separate from TSP contribution limits and are completely independent of one another. For example, for the year 2021, all federal employees can contribute a maximum $19,500 to the TSP. Employees who will be older than age 49 as of Dec. 31, 2021 may contribute to the TSP an additional $6,500 in “catch-up” contributions. For the year 2021, federal employees can contribute a maximum $6,000 to an IRA and $7,000 if an employee will be over age 49 as of Dec. 31, 2021.

Transfer traditional IRA money to the traditional TSP

A traditional TSP participant is permitted to move money from a traditional IRA into the employee’s traditional TSP account. There are two ways to move traditional IRA money to a traditional TSP account:

(1) A traditional TSP participant can have the traditional IRA money directly transferred into the traditional TSP account. This is referred to as a direct transfer. The TSP participant initiates the transaction but does not have to deposit the money himself or herself. The transfer of money is done between the IRA custodian and the TSP. Note that a TSP participant is not permitted to transfer money from a Roth IRA into a TSP account, even if the TSP participant has a TSP Roth account.

(2) A traditional TSP participant can rollover money from a traditional IRA to the traditional TSP. In this case, the IRA custodian makes out a check to the TSP participant and sends the check to the participant. The TSP participant will have to deposit the check within 60 days of receipt of the IRA custodian’s payment. If not deposited within 60 days, the IRA distribution will be taxable and possibly subject to an early withdrawal penalty.

To request a transfer or a rollover from a traditional IRA into a traditional TSP account, the TSP participant must complete Form TSP-60 (Request for a Transfer Into the TSP). The form is available to download here.

There is no dollar or frequency limitation for transferring money from a traditional IRA into one’s traditional TSP account. IRA transfers and rollovers of IRAs have no effect on what a TSP participant can contribute annually via payroll deduction to his or her traditional TSP account. That limit is called the IRS’ “elective deferral” limit. For 2021, that amount is $19,500. If the TSP participant is over age 49 as of Dec 31, 2021 an additional $6,500 of “catch-up” contributions can be made (also via payroll deduction).

Why would a TSP participant still in federal service want to transfer a traditional IRA into a traditional TSP account?

Possible reasons include:

(1) consolidation of one’s retirement accounts. In addition to allowing the transfer of traditional IRAs into a traditional TSP account, the TSP allows the transfers of qualified retirement plans [401(k) retirement plans, 403(b) retirement plans, 457 retirement plans] into a traditional TSP account. Perhaps a TSP participant who owns multiple retirement accounts including IRAs and qualified retirement plans wants to consolidate all accounts into one account, namely: Into the traditional TSP. This will simplify as well as minimize overall expenses associated with retirement savings; and

(2) using the traditional IRA as a source of cash that can be transferred to a traditional TSP account and invested in the TSP funds. The following example illustrates:

Example 1. Jason, age 45, is a federal employee with a traditional TSP account currently worth $750,000. Jason contributes the maximum to his traditional TSP account every year. During 2021 Jason intends to contribute the maximum $19,500 to the TSP. He also owns a traditional IRA, currently worth $100,000, consisting entirely of high-yield dividend stocks. Jason has directed his IRA custodian to take all stock dividends generated in the IRA in the form of cash, rather than reinvesting in additional stock. The cash dividends are paid into a separate money market account invested with the IRA custodian. After accumulating at least $100 of cash in his money market account IRA, Jason fills out Form TSP-60 and directs his IRA custodian to directly transfer the cash from the money market IRA to his TSP traditional TSP account. Jason is allowed to make these transfers as often as he wants with no tax consequences.

What TSP participants can do with their traditional IRAs and their traditional TSP account after participants retire from federal service?

Upon retiring from federal service, a TSP participant has several options what to do with his or her traditional TSP account One option is to transfer or rollover the traditional TSP account to a traditional IRA or to a Roth IRA. This section discusses those options. Note also that a TSP participant who keep their traditional TSP account throughout retirement is still permitted to transfer traditional IRA money into their traditional TSP account, as was the case when they were federal employees.

The following are the options for a traditional TSP participant following retirement from federal service with respect to transfers to IRAs:

The participant can request an unlimited number of transfers from the traditional TSP to a traditional IRA

Although not limited in total number, there is a limit of no more than one such transfer every 30 days, or a limit of 12 such transfers per calendar year. Provided that the TSP directly transfers the TSP funds to an existing IRA, the TSP will not withhold any federal income taxes from the traditional TSP funds. Once withdrawn from the traditional IRA, the IRA funds will be subject to federal and state income taxes.

Some reasons why a TSP participant may want to perform a traditional TSP to traditional IRA transfer:

(a) more investment opportunities with an IRA;

(b) more flexibility with respect to withdrawing funds from an IRA account to the TSP. If the TSP participant is a married FERS annuitant, then once the TSP funds become part of the IRA, the TSP participant’s spouse does not have to give written consent to withdraw money from the IRA, as would be the case if the funds were in the traditional TSP.

Note also that the spouse of a FERS annuitant has to give written consent for the TSP participant to transfer traditional TSP money to the traditional IRA.

Some disadvantages of a traditional TSP transfer to a traditional IRA are:

(1) custodial fees associated with every IRA. These fees will have an effect on the investment performance of the IRA investment;

(2) traditional IRAs can be withdrawn penalty-free (no 10 percent early withdrawal penalty) only when the IRA owner becomes age 59.5. On the other hand, penalty-free traditional TSP withdrawals can be made when a traditional TSP participant is age 55; and

(3) like the TSP, the traditional IRA is subject to required minimum distribution once the TSP participant/IRA owner becomes age 72. Two separate RMDs have to be taken each year for the rest of the TSP participant/IRA owner’s life.

The TSP participant can request an unlimited number of transfers of the traditional TSP to a Roth IRA

Although not limited in total number, the number of traditional TSP to IRA transfers is limited to no more than 12 p er calendar year. Note that the 12 maximum per year includes transfers to traditional IRAs, Roth IRAs, or a combination of both.

The advantages of a traditional TSP to a Roth IRA transfer include:

(1) no income limitations for a transfer. This is unlike making a contribution to a Roth IRA which has annual income limitations;

(2) the transfer will ultimately benefit TSP participants if tax rates increase in the future, which they most likely will.

The disadvantages of a traditional TSP transfer to a Roth IRA include:

(1) full federal and state income taxes are due on the transfer. The TSP does not withhold federal income taxes on the transfer as it normally does on traditional TSP withdrawals, and the TSP never withholds state income taxes. TSP participants are responsible for paying federal and state taxes due on transfer. Depending on the amount of the transfer, the transfer could push the TSP participant into a higher federal marginal tax bracket;

(2) the transfer cannot be “undone” unlike a transfer of the traditional TSP to a traditional IRA which can be reversed via Form TSP-60. A transfer of the traditional TSP to a Roth IRA can also be reversed.

A traditional TSP participant can request a transfer of a traditional IRA to his or her TSP account. There is no limit as to how many transfers can be made and how much money can be transferred. As discussed above, for a TSP participant who is an employee, transferring earnings from traditional IRAs, such as IRAs that are invested in stocks with high yields, dividends, and the dividends are paid in cash, which is transferred to the TSP, these transfers will allow one’s traditional TSP to grow over time even though the TSP participant cannot directly contribute because the participant has retired from federal service.