Thrift Savings Plan Launches Roth In-Plan Conversion
The U.S. federal government's Thrift Savings Plan (TSP) has launched a new feature allowing participants to make in-plan conversions of their traditional balances to a Roth account. The change provides new opportunities for retirement-focused fintechs and advisory platforms to offer automated tax optimization and conversion analytics to federal employees and other TSP participants.
- The amount converted from a traditional TSP balance to a Roth balance is added to the participant's taxable income for that year. This could potentially push the individual into a higher marginal tax bracket. - Taxes owed on the conversion must be paid with funds from an outside source, like a savings account; money cannot be withheld from the converted amount to cover the tax liability. - Participants are permitted to make up to 26 in-plan conversions per calendar year. If an individual holds both a civilian and a uniformed services TSP account, this limit applies to each account separately. - The Roth TSP option was first authorized by the Thrift Savings Plan Enhancement Act of 2009 and became available to participants in May 2012. - A five-year rule applies to converted amounts; if money is withdrawn within five years from January 1st of the conversion year, a 10% early withdrawal penalty may apply unless the participant is 59½ or older or another exception applies. - Before this feature, the primary way to convert traditional TSP funds to a Roth account was a multi-step process involving transferring the funds to a traditional IRA and then converting that IRA to a Roth IRA. - Funds invested in the TSP's mutual fund window are not eligible for direct conversion; they must first be sold and transferred into one of the core TSP funds before they can be converted to Roth. - Participants who are required to take minimum distributions (RMDs) must satisfy their annual RMD before they are eligible to perform a Roth in-plan conversion for that year.
