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.
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)
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.
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.
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