The retirement plan world is breathing a sigh of relief after the IRS announced on August 25, 2023 a two-year hold on requiring high-income employees who make contributions to qualified retirement plans (including the Thrift Savings Plan) but only to Roth accounts.
A provision coming out of SECURE Act 2.0, passed into law in December 2022 requires that “catch-up” contributions for employees aged 50 or older whose Social Security wages for the prior year exceed $145,000 must be made to the Roth retirement account such as the Roth TSP account. This rule under Section 603 of the SECURE Act 2.0 was supposed to have taken effect on January 1, 2024.
SEE ALSO: Some Federal Employees Required to Make ‘Catch-Up’ Contributions Only to Roth TSP in 2024
However, the IRS said in IRS Notice 2023-62 that it will provide a two-year “administrative transition period” until January 1, 2026 before retirement plans must comply with the new tax law.
The effect of the delay is that until January 1, 2026, federal employees aged 50 and older will not be required to make catch-up contributions only to the Roth TSP rather than to the traditional TSP. All federal employees aged 50 and older– including those with Social Security wages in excess of $145,000 – will continue to have the option of making their TSP catch-up contributions to the traditional (before-taxed) TSP rather than being required to have their catch-up contributions go the Roth TSP.
For the long term, many federal employees aged 50 and older may fare better by contributing to the Roth TSP even though they are not required to. In so doing, their Roth TSP accounts will grow over time tax-free.
Also, under another provision passed as part of SECURE Act 2.0, effective January 1,2024 the Roth TSP account balance will not be included in the calculation of the TSP required minimum distribution.
Effective Tax Planning
For those employees and retirees who own traditional IRAs, between now and January 1,2026 is an ideal time to consider Roth IRA conversions. For federal employees over age 59.5 and federal retirees of any age, between now and January 1, 2026 is an ideal time to consider direct rollovers of traditional TSP to a traditional IRA. The rollover traditional IRA can then be converted into a Roth IRA
A traditional IRA owner considering a Roth IRA conversion can control each year’s tax liability by converting any amount of the traditional IRA to a Roth IRA that he or she chooses. In so doing, the traditional IRA owner can keep the conversion income in low federal and state income tax brackets.
A traditional IRA that is not converted to a Roth IRA, or a traditional TSP account that is not directly rolled over to a traditional IRA and then converted to a Roth IRA, will continue to grow tax deferred and eventually be subject to required minimum distributions (RMDs).
Once RMDs start for traditional IRA and traditional TSP for IRA owners (once they reach their required beginning date – age 73 starting January 1, 2024 and retired traditional TSP participants (age 73 and older), it is much harder to control one’s tax rates and keep adjusted gross income (AGI) lower (perhaps resulting in higher Medicare Part B premiums which are based on one’s AGI).
What Is the Result of a Traditional IRA Conversion?
A Roth IRA conversion is in fact a “gift” to the IRA owner and to the IRA owner’s beneficiaries. The converted Roth IRA owner has paid tax on the conversion at today’s historically low federal tax rates. The converted Roth IRA owner has in reality accomplished buying himself or herself a “gift” that will pay off for the rest of his or her life and for 10 years after for non-spousal beneficiaries.
Under the 10-year rule for inheritors like children or grandchildren, there are no RMDs for years 1 through 9 of the 10-year term. This means these beneficiaries can hold on for the full 10 years as their inheritance grows tax-free.
The ultimate result for a federal retiree of having a Roth TSP account and/or Roth IRA is tax-free income and “happiness”. A federal retiree does not have to worry about paying federal and state income taxes on withdrawals.
It is not hard for a federal retiree to be happy about locking in a 0 percent tax rate for the retiree’s life and for the retiree’s Roth TSP and Roth IRA beneficiaries. In addition, those retirees who contribute to the Roth TSP and/or convert their traditional IRAs to Roth IRAs are delighted about not having to worry about RMDs, and also love knowing their beneficiaries will also enjoy tax-free benefits for 10 years after the death of the Roth TSP participant and/or Roth IRA owner.
In summary, while the IRS has a granted a two-year deadline extension (until January 1, 2026) to retirement plans such as the TSP to implement Roth TSP catch-up contributions for those employees aged 50 and older whose Social Security wages exceed $145,000, all employees including those aged 50 and older should take full advantage of contributing to the Roth TSP and converting their traditional IRAs to Roth IRAs.
It is important for employees aged 59.5 and older and retirees (who are considering transferring and converting their traditional TSP to Roth IRAs that to be reminded that the current low federal tax rates are due to expire January 1, 2026. The next two years are an ideal time to consider Roth IRA conversions in order to save on federal incomes resulting from these conversions.
Edward A. Zurndorfer is a CERTIFIED FINANCIAL PLANNER®, Chartered Life Underwriter, Chartered Financial Consultant, Registered Health Underwriter and Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, located at 833 Bromley Street Suite A, Silver Spring, MD 20902-3019