How (And Why) To Transfer Your TSP To An IRA

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After years of military retirement, my spouse just transferred her Thrift Savings Plan to a traditional IRA. That’s the first step in converting the TSP funds into a Roth IRA.

Image of Roth IRA Scrabble tiles | The-Military-Guide.com

… instead of the TSP

It’s taken us nearly three decades to get to this point. We started contributing to our traditional IRAs in 1986. (I was a little slow to catch on to tax-deferred investing. Before then all my investments were in taxable accounts.) We were a dual-military active-duty couple for over 13 years, but for most of our careers a “tax-deferred” account meant traditional IRAs. When the military TSP program started in 2002, we maximized our contributions. I stopped in June (when I retired) while my spouse contributed her Reserve drill pay until her 2008 retirement.

Because I could only contribute to the TSP for five months, a few years later they kicked me out for having a low balance. (Well, duh.) We transferred the amount to my traditional IRA. Meanwhile my spouse’s traditional TSP account has enjoyed seven years of contributions and over 13 years of tax-deferred compounding.

 

Why we decided to convert

We’d happily leave her funds in the TSP for the rest of our lives. But as you approach your 60s, there are a few hassles with holding a traditional TSP account:

  • Required minimum distributions (optional at age 59.5, mandatory around age 70.5)
  • Potentially paying income taxes in a higher bracket
  • Possible taxation of Social Security benefits
  • Potentially paying higher Medicare premiums (known as IRMAA)
An image of Taxes Scrabble tiles | The-Military-Guide.com

A big part of the decision.

Don’t get me wrong: we stuck with the TSP for as long as it made sense, and we have no complaints. The TSP has been a great investment for us. It’s the world’s largest collection of passive index funds with the world’s lowest expense ratios. In 2014 the TSP’s average net annual expense ratio was 0.029%. That’s less than half of Vanguard’s comparable index funds, and a fraction of the typical “low cost” index fund offered by most financial institutions.

Our next generation will benefit even more from the TSP. Last year our daughter started her own military TSP account as soon as she signed her commission. She’ll contribute as much as she can to the Roth TSP for as long as she can, and she’ll keep it there as long as possible. She’ll get almost all of the TSP benchmark’s return for zero personal effort.

Low expense ratios will accelerate your financial independence, and even paying taxes on RMDs is worth the decades of tax-deferred compounding. But here’s a military retiree #FirstWorldProblem: we can reduce our taxes now by converting a traditional TSP account to a Roth IRA while we’re in a lower tax bracket.

 

Paying lower taxes now (we hope)…

Our income dropped dramatically when my spouse transferred to the Reserves and I retired. We dropped a couple of income tax brackets too, even with my active-duty pension. (Her Reserve pension starts at age 60.) However my spreadsheets forecast that when she started her Reserve pension then we’d jump right back up into those higher tax brackets. We had nearly 20 years to convert our traditional IRA and TSP accounts to Roth IRAs by paying the taxes now (in a lower bracket) in the hopes of avoiding higher brackets later.

Her TSP shares are the last of our conversions. Between 2002-2014, we converted both of our traditional IRAs to Roth IRAs. During those years our low income put us in the 10% or 15% income tax brackets (instead of the 25% bracket) and each year we converted part of our traditional IRAs. We’d start by using last year’s tax returns to estimate this year’s taxable income. Then I’d use Part II of IRS Form 8606 to determine how much of our traditional IRA we could convert while still keeping our taxable income in the 15% tax bracket. We paid the conversion taxes with money from our taxable accounts, so the full amount of the conversion was now working for us in a Roth IRA.

 

… But not quickly enough

In 2012, I realized that we were running out of time to finish our conversions. Our traditional IRAs and my spouse’s traditional TSP had come roaring back from the Great Recession, and we also had higher income from our rental property. (Those are still good “problems” to have!) Staying within the 15% income-tax bracket meant that we were converting smaller amounts of our traditional IRAs every year, and we’d still be converting when my spouse’s Reserve pension started. Finishing the conversions sooner meant that we’d pay some of the taxes in the 25% bracket. But at the slower pace of our current conversions, we’d still be doing them in our 60s– and my spouse’s Reserve pension meant that we’d be paying the taxes in the 25% bracket.

It was a compelling deal to pay lower conversion taxes during our 50s. Paying conversion taxes in the 25% bracket, however, puts us in the same income tax bracket now that we’ll be in during our 60s. It looks as though we’re paying taxes before we need to, and that’s always risky. However I realized that if we started our Social Security withdrawals before age 70, or if our income exceeded the Medicare IRMAA threshold after age 65, then we might pay taxes above the 25% bracket.

We decided that we’d rather take a prudent risk and pay the taxes now. We’ll feel stupid if Congress lowers taxes later, but we’ll feel even worse if tax rates go up.

 

Keep it simple

At this point some of you are wondering “Hey, Nords, why not just convert her traditional TSP account to a Roth TSP? Isn’t that a lot easier than moving it through a traditional IRA?” You would be right. Unfortunately the TSP does not allow converting a traditional TSP account to a Roth TSP. It’s permitted by federal law, but the TSP board is minimizing expenses by not implementing the feature. It saves them millions of dollars every year in salary, computers, compliance, tracking, and auditing.

Another option would be leaving her funds in the TSP and later buying a TSP annuity. Longevity insurance is a great idea for retirees, and a TSP annuity will also help protect against portfolio failure. (No matter what the markets do to your other investments, you’ll have enough annuity income to support a bare-bones lifestyle.) However we’re dual-military retirees with two inflation-fighting pensions, and we’ll also have Social Security. The last thing we need is another annuity, and we’d rather have the financial flexibility afforded by converting the TSP funds into a Roth IRA.

We also have a personal motive for finishing the conversion before my spouse’s Reserve pension: simplification. Today (in our 50s) we’re at the hypothetical peak of our cognition, and we want to consolidate our finances under as few withdrawal rules as possible. We don’t want to deal with the hassle of RMDs. Our lifestyle expenses are low enough that we won’t even have to touch our Roth IRAs, so they’ll help us self-insure for hurricane damage or long-term care expenses.

Best of all, I’m cleaning up my duty station for a turnover. My spouse and I manage our finances together, but she’s always been “Supervision” and I’m “labor”. For example, she’s always asked the questions “What if we…?” and I’ve always built the three-page spreadsheets to answer them. Then she’s asked “Does that mean we could…?” and I’ve built more spreadsheets. I tracked our investments during the recessions so that we could hold hands when it was time to rebalance. I set up our accounts and reconciled our credit cards and paid the bills and screened the fund choices so that we could discuss strategy– and then I could execute tactics.

But when she turns 60, she’s taking over the duty. She’ll handle all of our family financial chores (especially because I’ve finished the heavy lifting). She’ll sweep the dividends and the rent checks as they come in. All the bills will be in autopay and she’ll only check the monthly statements. We’ll have just our checking accounts, our savings accounts, our taxable brokerage account, and two Roth IRAs.

There’s a pragmatic reason to turn over the financial tools: women tend to live longer than men. This turnover gives her plenty of time to figure out how she wants to run the family finances while I’m still around to explain what I was thinking when I set things up. Besides, I suspect that she’ll only keep the job for 20 years or so and then dump it on our daughter. Yeah, our daughter reads this blog, but she’s already heard that news.

Enough of the “why”. Now let’s talk about how to transfer your traditional TSP to a traditional IRA and convert it to a Roth IRA.

 

Transfer your traditional TSP to an IRA

We started the process in early May. I clicked the link for the “full withdrawal” using Form TSP-70 and the TSP website obligingly offered to start its transfer wizard. That lets you answer a few questions and it fills out just the parts of the form that are needed. You print it out along with a set of the processing instructions. The form looks great and nobody had to decrypt my handwriting. Best of all I don’t have to write a blog post with screenshots, circles of the inputs fields, and arrows pointing to data boxes.

Next my spouse had to notarize the transfer request. Since my spouse’s TSP account balance was more than $3000, I also had to sign away my spousal rights to a TSP annuity– and have that notarized too. We used the (free!) notary at our local branch of the Navy Federal Credit Union.

We could have had the TSP mail us a check for my spouse’s account balance, but it’s far easier to let the new traditional IRA custodian do all the transfer work. We mailed our notarized TSP-70 to Fidelity in mid-May. When I e-mailed them that it was coming, they asked her to go on their website to open up a rollover (traditional) IRA account. Ten minutes later she had a new traditional IRA whose status was “to be funded later” and Fidelity had an account number to fill in on their section of the TSP transfer form.

On the same day that I mailed the transfer request to Fidelity, she e-mailed the TSP that Fidelity would be handling the transfer. Two days later the TSP auto-responder effectively said “We didn’t read your e-mail but here’s our boilerplate reply to your keywords”:

This responds to your inquiry concerning your TSP account. You asked for the status of your withdrawal request.
We have reviewed your account, and your Form TSP-70, Request for Full Withdrawal, is not yet showing in our system. Under normal circumstances, your form should appear within three business days of receipt and finish being processed within 10 business days of receipt.
Once your form appears in our system, you will be able to check the status of your request in My Account under Withdrawals.

On 1 June we received a Fidelity letter (dated 22 May) that our transfer request had been completed by Fidelity and mailed to the TSP. It also included a pre-addressed prepaid envelope just in case the TSP sent the check to us instead of to Fidelity. It was nice to get the status report, but it was even nicer to get the envelope. Maybe Fidelity has had problems with TSP transfers, or maybe they do that for every IRA account transfer.

I don’t know when the TSP received our TSP-70 transfer request from Fidelity, but on 2 June the TSP sold her shares (they were all in the “S” fund) and executed the transfer by mailing a check to Fidelity. The TSP posted a notification to my spouse’s account on their website and sent out a letter. The second page of the TSP’s letter had her Fidelity IRA account number on it, so we were reassured that the transfer was done correctly.

The TSP’s letter also included their TSP-9 change of address form for the 1099-R tax form that will be mailed out next year. I guess they’ve had problems with people leaving the military, transferring their TSP, and moving to a new (undisclosed) location. When you leave the military, remember to tell the TSP where you live.

A Fidelity e-mail alerted my spouse on 9 June when her TSP check was deposited in her rollover IRA. The next day we logged in and purchased shares in the iShares S&P Small Cap 600 Value ETF (ticker IJS). That’s roughly equivalent to the TSP’s “S” fund, but it carries a 0.25% expense ratio instead of the “S” fund’s 0.029% expense ratio.

Overall, the most “difficult” part of the transfer was the time spent notarizing the request form.

 

Now what?

Once that share trade cleared, we used Fidelity’s website to convert part of her traditional IRA account to her Roth IRA account. We decided to convert 20% of the transfer amount each year, which should finish the conversion process the year before her Reserve pension starts. (Fidelity’s conversion process took five minutes and six mouse clicks.) Fidelity automatically tracks the amounts and will send us a 1099-R early next year. Since every one of her TSP contributions was made before taxes, the full amount of the conversion is subject to income tax. Some of that will be in the 15% income-tax bracket, but most of it will be in the 25% bracket.

Readers frequently ask me how to access the funds in a tax-deferred account before reaching age 59.5. We could withdraw our contributions from our Roth IRAs at any time for any reason with no taxes or penalties. We don’t intend to do that, but this year’s conversion is the first step in a Roth IRA conversion ladder. If we wanted more of the Roth IRA funds, then the amount of a conversion can be withdrawn five tax years after the conversion. The funds that she converted to a Roth IRA last month will be available for withdrawal anytime in 2020.

Neither of us has ever made tax-exempt contributions to our TSPs. Now that you’ve read this post, if you decide to transfer a TSP account which includes tax-exempt contributions then I recommend Ryan Guina’s excellent discussion:
Thrift Savings Plan Rollover – How to Transfer Your TSP into an IRA

A few of you readers are still thinking “0.25% expense ratio?!? They could do a lot better!” You’re right. 0.25% is a fraction of the national average of 1%, but we could still push that down into the teens or even single digits. We’re assessing our asset allocation and whether we want to rebalance during the rest of our lives, and we’d like to reduce our expense ratios along the way. That’s a subject for a whole ‘nother post.

 

 

 

Related articles:
Early Withdrawals From Your TSP And IRA After The Military
Tax-exempt contributions: Thrift Savings Plan Rollover – How to Transfer Your TSP into an IRA
Contribution Limits of the Thrift Savings Plan + 401(k) + IRA = ?!?
Maximizing TSP Contributions From A Combat Zone
Funding The Gap: “I Need Money From My TSP!”
TSP Annuity Options
IRMAA: How I cost my Dad over $2000 in Medicare benefits



WHAT I DO: I help you reach financial independence. For free. I retired in 2002 after 20 years in the Navy's submarine force. I wrote "The Military Guide to Financial Independence and Retirement" to share the stories of over 50 other financially independent servicemembers, veterans, and families. All of my writing revenue is donated to military-friendly charities.

7 Comments
  1. Reply
    Brad January 8, 2017 at 5:46 AM

    Hi Nords,

    I’ve read your post and MadFI’s posts on the traditional to roth conversions. I want to implement this strategy but I wanted to ask a few things for clarification and advice.

    As I understand the strategy. Max out a traditional IRA now during your working years and then slowly convert the traditional IRA to a Roth IRA post retirement taking advantage of a lower tax bracket. The lower tax bracket is my question.

    Right now I’m an O4 and getting taxed at 25% and have been maxing out my Roth IRA to this point. The conversion strategy assumes a lower tax bracket upon conversion. Even if I only retire active duty as an O4, the after tax yearly retirement is ~40K. This amount is already in the 25% tax bracket so does it even make sense to pursue the conversion strategy if I will not be in a lower tax bracket? I’m sure I’m missing something and I would appreciate your guidance.

    Thank you for your book and posts! I’m pursuing FI with a fierce determination and all your, MMM, MadFI, and JL Collins posts of motivation and guidance is incredible!

    Regards,

    Brad

    • Reply
      Doug Nordman January 11, 2017 at 6:53 PM

      Thanks, Brad, that’s a great question!

      You’re absolutely right: a conversion only makes sense when you do it during a lower tax bracket. A conversion also avoids the hassle of RMDs, and that may also mean that your Social Security income is not subject to taxation.

      Military servicemembers are an edge case because so much of military compensation is untaxed. Especially at the junior ranks, it makes much more sense to contribute to the Roth TSP and Roth IRA(s) because you’re in the lowest tax bracket of your life. Pay the tax now and avoid conversion paperwork (and RMDs) later.

      When you retire (at an O-4 or an O-5 pension) you’re going to start right out in the 15% or 25% income-tax bracket. If you minimize all other income (no bridge career, no dividends, no interest) then every year you may be able to convert a little of a traditional IRA (and a traditional TSP) to its Roth equivalent. You’d do that up to the top of the 15% income tax bracket. You’d also have to either live within your military pension or sell some of your investment shares for capital gains. (You’d try to stay within the 15% income-tax bracket to qualify for the 0% capital-gains rate.) That’s a challenge.

      If you retire to an O-4/5 pension *and* start a bridge career, you’ll be in (at least) the 25% income-tax bracket. The only benefit you’d gain from TSP & IRA conversions would be avoiding RMDs.

      There are two times when it makes sense to contribute to a traditional IRA now and convert to a Roth IRA later.

      The first one is reaching financial independence without earning a military pension. A very few servicemembers with extremely high savings rates (or gifts, or inheritances) can do this within 10-15 years. They’d leave active duty and do a little bit of a conversion every year (perhaps up to the top of the 10% income-tax bracket) to avoid having to deal with RMDs later in life. If their expenses are extraordinarily low then they might be able to do conversions at the 0% income-tax bracket: no taxes at all! See this post from my friend Jeremy:
      http://www.gocurrycracker.com/gcc-vs-rmd/
      (Caution: it’s an extremely in-depth tax discussion.)

      The second case includes servicemembers who leave active duty for the Reserves or Guard. They’ll start a pension at age 60 and RMDs at age 70.5, which (along with other dividend/interest income) will probably push them into at least the 25% tax bracket. In their case it makes sense to do conversions before their pension pension starts at age 60. My spouse is facing this exact situation: she’s converting her IRA and her TSP into a Roth IRA at the 15%-25% income-tax brackets to avoid RMDs at the 28% income-tax bracket.

      Side note for dual-military or dual-career couples: if your earned income is too high to contribute to a Roth IRA, then contribute to a traditional IRA (sorry, no tax deduction for you either) and then immediately convert that traditional IRA to a Roth IRA. See: “backdoor Roth IRA conversion”.

  2. Reply
    Doug Nordman December 19, 2015 at 7:39 AM

    Thanks for your questions, RL, that’s a good plan after you’re out of uniform!

    You can roll over your traditional TSP once you’re out of the military, although you should leave your funds in your TSP account as long as possible (for the low expense ratios). But once you’re ready to make the conversion, that’s the plan. The best “conversion window” for active-duty retirees is in small annual increments before you start Social Security or RMDs. Reserve/Guard retirees would convert before their military pension starts.

    Either Vanguard or Fidelity is good (or even both). The former has rock-bottom expense ratios and the latter offers more services (for some higher fees). You’ll find policies and features to like (and dislike) at both firms.

  3. Reply
    RL December 17, 2015 at 5:48 PM

    So here’s my situation:

    Currently, I’m active duty and only have Traditional TSP.
    My plan is to stop contributing to Traditional TSP and switch to Roth TSP now.
    My current marginal tax bracket is 15% and my assumption is that I will be in the 25% bracket during retirement years (with military pension, Social Security, Traditional TSP).
    Additionally, I plan on opening a Roth IRA account with either Vanguard or Fidelity (still researching which company is better).

    Should I pay taxes now by doing the Traditional TSP>Traditional IRA>Roth IRA conversion?
    Is this a good plan or am I missing something?

  4. Reply
    Peter Gregory August 10, 2015 at 9:52 AM

    The single biggest factor in Quality of Life issues post retirement, apart from investment profile and choices, remains one’s health and health care. One’s best laid plans for a financial foundation are put under stress if not decimated by a serious or chronic disease process. In this regard life style choices, food, diet, stress management, are just as required as any well defined financial process.

    Second biggest factor in the 60+ community, especially military, is divorce and those associated costs. Choose the right spouse the first time and watch what you put in your mouth still remains the cardinal rules for a successful and happy retirement life.

  5. Reply
    vanguard23 August 6, 2015 at 9:56 PM

    With my wife’s fast approaching retirement, this is something I/we are planning on doing in the next 10-15 years. I plan on doing a Partial Withdrawal (instead of Full Withdrawal) from our Traditional TSP and roll it over into a Traditional IRA then convert to a Roth IRA. I figure we would keep funds in the TSP for as long as we can to take advantage of the low, low fees. Thanks for clearing up the sequence for me (i.e. opening up the Traditional IRA before withdrawal from TSP). We also have Roth TSP accounts that we would eventually roll over into a Roth IRA before age 70 to avoid the RMDs on those accounts as well…I figure we have more time on that since those are all after-tax contributions.

    I just have to see if it makes sense to withdraw and roll over the Traditional TSP sooner rather than later. I have to look and relook our tax bracket (although it seems like a foregone conclusion that we would be in the 25% tax bracket with 2 military pensions) and see how much space we still have in that bracket before hitting the threshold for the next tax bracket. Who knows, we might withdraw as soon as next year and do the roll overs sooner rather than later so as not to have to worry about it.

    With regards to turning over the “reigns” for our household’s financial management tasks to the wife…might need some time with that.

    Thanks for the post and for the link to Ryan’s blog.

    • Reply
      Doug Nordman August 8, 2015 at 9:41 AM

      Great points, VG23! You’re right about rolling over the Roth TSP directly. Very convenient.

      I was surprised at how quickly our conversion time “ran out”. In your case you may be facing the 28% tax bracket sooner than you expected, especially if political risk boosts the tax rates for high earners. I think it’s also smart to do the partial withdrawal now and do a full withdrawal when that conversion is finished.

      As for those financial “reigns”… in retirement, everything can be re-negotiated!

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