Contributing To Your TSP After Separating From Federal Service

Contributing To Your TSP After Separating From Federal Service

Sooner or later, you will separate from federal service, and whether you are called to retirement or the prospects of the private sector, you’ll have to decide what to do with your Thrift Savings Plan. While many federal employees will opt to transfer their TSP to an IRA, many will choose to keep their nest egg in place. For those who decide to stick with the TSP, a question that often comes up is whether they can continue to contribute to their account. So, this week we review two methods for funding your TSP after you leave federal service.

Moving Money Into The TSP

Although once separated, you will no longer be allowed to contribute to your TSP via payroll deductions, as long as you have a balance of $200 or more in your account, you’ll be able to maintain your TSP and move money into the account via transfers or rollovers.

What Are Transfers?
A transfer or “direct rollover” is when you have all or a portion of your money in an eligible plan sent directly to your TSP. Eligible plans include traditional IRAs, SIMPLE IRAs, and employer-sponsored plans such as 401(k)s, Roth 401(k)s, and 403(b)s.

Note: Roth IRAs are not eligible to be transferred into the TSP.

Transfers are relatively easy because the plan administrators do all the heavy lifting, sending the funds directly to your TSP, which means you don’t handle any money. Not only is this hands-off approach less work for you, but it also avoids unintentionally causing an early withdrawal penalty or a tax liability (more on this in a bit).

Note: Although transfers and direct rollovers are slightly different (direct rollovers can be executed via check), I will use them synonymously in this article.

What Are Rollovers?
A “rollover” (aka indirect rollover) is when you receive a check containing a portion or the entire balance of your IRA or plan, and then you deposit the funds into your TSP account. This transaction must be completed within 60 days from the date you received the funds.

NoteForm TSP-60, Request for a Transfer Into the TSP, is the form used to move funds into the TSP.

Tax Considerations

The tax rules will defer depending on which method you select to move your IRA or plan money into the TSP. Understanding the different rules governing transfers and rollovers is critical since a mistake could cost you thousands of dollars in penalties and taxes.

Since the plan administrator moves the funds directly to the TSP, you are never in possession of the money and don’t risk potentially having a tax liability. Moreover, the administrator or custodian is not required to withhold any amount for taxes, so the balance that you initiate the transfer with is the balance that will arrive in your TSP account.

The other advantage of performing a transfer is that you can complete as many as you want throughout the year; there are no limits set by the IRS.

Unlike transfers, rollovers require that you take possession of the funds and redeposit the money within 60 days (not two months). If you fail to meet this deadline or get an extension/ waiver from the IRS, your rollover will be considered a taxable distribution, and you may be subject to an early withdrawal penalty.

Another way that rollovers differ from transfers is that since you are taking possession of the funds, there is generally a mandatory withholding for federal income taxes. The amount withheld will depend on the type of account you are moving your money from; if you are moving money to your TSP from an employer-sponsored plan (401(k) or 403(b)), then the administrator will withhold 20%. If, however, you are moving funds out of an IRA, then the custodian will withhold 10% unless you elect out of the withholding or choose a different amount.

One word of caution with rollovers is that to avoid the amount withheld being treated as a taxable distribution, you must redeposit the funds you received from the plan and make up for the amount withheld. Meaning you must use another source of funds to ensure 100% of the balance is deposited in your TSP.

An Example Of Bob The Fed

Now let’s look at two scenarios of our favorite Fed Bob: He is age 49 and decides to roll over his old 401(k) account of $10,000 into his TSP. The plan administrator withheld $2,000 (20%) from the distribution, and Bob received a check for $8,000.

a) Now If Bob only deposits the $8,000 into his TSP and doesn’t come up with the $2,000 withheld, he will be required to report the following: $2,000 as taxable income, $8,000 as a nontaxable rollover, and $2,000 as taxes paid. Since Bob is under age 59 ½, he must also pay the 10% early withdrawal penalty.
b) On the other hand, If Bob decides to roll over the entire $10,000, pulling $2,000 from other sources, he will report the following: $10,000 as a nontaxable rollover and $2,000 as taxes paid and assuming he has no additional tax liabilities, he will receive a refund for the $2,000 withheld when he files his tax return.

Note: You are limited to one Indirect rollover between IRA or Roth IRA accounts a year.

Final Thoughts

While you may no longer be able to fund your TSP through payroll deductions, you can still move money into your account via transfers and rollovers. And while both methods of funding have similarities, each method has its own distinct set of rules and requirements. With transfers generally being the preferred option, due to its hands-off approach that doesn’t require you to work within a 60-day deadline nor expose you to a potential tax bill or penalty. If you need help deciding what to do with your TSP, consult a qualified financial planner.

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2023 Legislative Change Notice

The SECURE ACT 2.0 passed and impacted many of the articles on this website. While the articles were correct when written, it’s impossible to re-write every article. Please consult a qualified professional (i.e., CFP®, CPA, or attorney) before implementing any strategy.

Published by Jose Armenta, MsBA, CFP®, ChFC®, EA

Jose Armenta is a CERTIFIED FINANCIAL PLANNER™ professional who specializes in helping federal employees get the most out of their federal benefits. Jose’s experience serving federal employees has provided him with valuable insight into federal employees' unique financial planning needs.

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