Rolling funds out of a TSP and into another qualified retirement plan has proven to be a cumbersome exercise over the years. The different dollar types you can accumulate in a TSP (pre-tax, Roth and tax-exempt) create a confusing situation when it comes to which funds should be rolled into what types of account. On top of that, the TSP rules governing how to process rollovers throw an even bigger wrench into the works. Thankfully, our Creative Planning Aviation Team has developed a process to streamline this matter for our clients.
For service members who have built up tax-exempt dollars through contributions made in a combat zone, it’s imperative to protect future growth from being taxed by rolling funds into a Roth IRA. If you’re a service member reading this, you probably know how hard it was to earn these tax-exempt funds and would prefer they stay protected from taxes. When attempting to perform this type of rollover, the front-line customer service of TSP will likely tell you they’re unable to direct tax-exempt funds into a Roth IRA and will instead attempt to pay them out as cash.
What often follows is that participants will take their cash payment of tax-exempt funds and invest it into an after-tax investment account, subjecting them to potential capital gains taxes and completely missing out on tax-free growth.*
However, we have a solution that results in getting pre-tax, Roth and tax-exempt funds all funneled into the appropriate accounts, preserving the tax-exempt status of those combat contributions.
For those with pre-tax, Roth and tax-exempt dollars in their TSP account:
- Add the plans receiving the rollovers to TSP. For those still working, we recommend you add your employer retirement plan (i.e., your 401k) or a traditional IRA as well as a Roth IRA. You can do this online or call TSP to have them do it for you. Then there’s a seven-day processing period before you can initiate any rollovers. For those wishing to make future back-door Roth contributions to a Roth IRA, the employer plan is the preferred location for pre-tax TSP dollars.
- After seven days, log in to TSP and initiate a direct Roth IRA rollover for the Roth funds. It’s important to remove the Roth funds out of the TSP first. Then there’s a 30-day waiting period before the next rollover can be initiated.
- After 30 days, log in to TSP to initiate the pre-tax and tax-exempt rollovers. Pre-tax and tax-exempt funds must be distributed together. Because there are no longer any Roth dollars in the TSP, you can initiate a direct rollover for the tax-exempt funds into the Roth IRA.
To bypass the 30-day waiting period, you can initiate all three rollovers at once: a direct rollover for pre-tax dollars into your 401k, a direct rollover for Roth dollars into your Roth IRA, and an indirect Roth rollover for tax-exempt dollars into the Roth IRA.
Use caution if electing to complete an indirect rollover, as the funds will be paid out to you in cash, and you must deposit them into your Roth IRA within 60 days. Failure to meet the 60-day window will result in your funds being prohibited from going into your Roth! Indirect rollovers typically require tax withholding, but because these are tax-exempt funds, no withholdings are required. You’ll receive a 1099 showing the tax-exempt dollars are after-tax dollars, so no taxes are due on the indirect Roth rollover. Then you’ll receive Form 5498 in May of the following year showing that your tax-exempt dollars were rolled into the Roth IRA.
If you’re an airline pilot, you may not be able to accomplish these tasks in accordance with this schedule because of your flying responsibilities. Creative Planning Aviation can help you with the scenario above and much more. If you’d like to schedule an appointment to discuss your situation with one of our aviation team wealth managers, you can call Creative Planning at 833-416-4702 or request a meeting.
*Any reference to “tax-free” is in regard to qualified distributions from tax-exempt accounts funded with after-tax dollars.