TSP & IRA Rollover Mistakes You Should Avoid
Rolling over money from a Thrift Savings Plan (TSP) account or an IRA doesn’t have to be complicated and stressful. Preventing costly rollover errors will make for a smooth, streamlined process. Typically deemed taxable income, rollover funds may be subject to the IRS’s 10 percent early withdrawal penalty (before age 59.5) or to the six percent excess contribution penalty. In addition, regular federal and state income taxes will need to be paid. Here are some of the TSP and IRA rollover mistakes you should avoid.
Missing the 60-Day Rollover Deadline
Funds not rolled over within the 60-day period, without a waiver or extension, do not qualify for tax-free rollover treatment. The amount not rolled over must be regarded as a taxable distribution from the IRA or TSP. These amounts are taxable in the year distributed, even if the 60-day period expires in the next calendar year. The 10 percent early withdrawal penalty may apply if the IRA owner is younger than 59.5 years old.
Violating the Once-Per-Year IRA Rollover Rule
If you make more than one rollover in a 12-month period, the amount rolled over in any subsequent rollovers must be included in income. You also may be subject to the 10 percent early withdrawal penalty. The rule applies only to IRA rollovers IRA to IRA, not to rollovers of TSP funds to IRAs. A TSP participant who has retired from federal service before the new withdrawal rules took effect on September 15, 2019, may perform as many as 12 TSP rollovers to IRAs per calendar year.
Rolling Over RMDs
If you are over age 70.5 (or age 72 if born after June 30, 1949) and own traditional IRAs, Required Minimum Distributions (RMDs) must be taken each year, even if you’re still working. If you have retired from federal service, you must take RMDs from the TSP and any other qualified retirement plan you previously participated in. RMDs can never be rolled over. Common errors happen when converting a traditional IRA to a Roth IRA, which Includes the year’s traditional IRA RMD. This is considered an excess contribution and is subject to the six percent penalty. Once the annual RMD from the traditional IRA is satisfied, any balance remaining in a traditional IRA may be converted to a Roth IRA.
Rolling Over After-Taxed Assets
Only pre-taxed traditional IRA assets should be moved into the traditional TSP. After-taxed traditional IRA assets involve contributions not deducted on your tax return. Those after-taxed contributions are considered the traditional IRA’s “cost basis” to report any nondeductible contributions made to the traditional IRA during any year, as shown using IRS Form 8606 (Nondeductible IRAs). Additionally, Roth IRA assets may not be rolled over into the Roth TSP.
Rolling Over Traditional IRA 72(t) Distributions
To avoid the 10 percent early withdrawal penalty before age 59.5, 72(t) distributions are set up in a series of early traditional IRA withdrawals. You can begin a 72(t)-payment schedule from a traditional IRA at any age, even if you’re still working. To avoid a penalty, IRA withdrawals must adhere to the rules specified in Internal Revenue Code Section 72(t)(2)(A). The payments must remain for at least five years or age 59.5, whichever period is longer, and IRA distributions can’t be rolled over into another IRA. If violated, federal and state income taxes must be paid and the 10 percent early withdrawal penalty applies to all distributions taken prior to age 59.5. IRA funds can’t be rolled into or out of an IRA with an active 72(t) payment schedule.
Rolling Over Traditional TSP Hardship Withdrawals
The TSP permits participants to take approved hardship withdrawals. But they can’t be rolled over to a traditional IRA. These must be applied for and approved by the TSP Service Office. TSP hardship withdrawals are not loans, thus they are not paid back. A participant younger than age 59.5 approved for a TSP hardship withdrawal will pay federal and state income tax on the withdrawn amount as well as the 10 percent early withdrawal penalty.
Withdrawing IRA Funds for a Divorce Settlement
Traditional IRA funds withdrawn as part of a divorce settlement are taxable and can’t be rolled over to the ex-spouse’s traditional IRA. If those funds are withdrawn, the owner who intends to deposit them into the ex-spouse’s traditional IRA will pay federal and state income taxes on the amount withdrawn. If the spouse is younger than age 59.5, the 10 percent early withdrawal penalty also will be added.
At Federal Educators, we can help you better understand your TSP, IRA, and federal retirement benefits. Give us a call and request your free analysis at 866-226-8160.
