To roll or not to roll; that is the question. The question to Financial Industry Regulatory Authority (FINRA) reminds us to consider fees, taxes and conflicts of interest.

There are endless articles that dive into the pros and cons of rollovers, so we aren’t going to rehash those here. Instead, I’d like to cover three nuances that are frequently misunderstood and asked about by active federal employees and retirees alike.

Not understanding these could actually transform your tax-free Roth TSP dollars into regular taxable dollars, subject to ordinary income tax and in some situations a 10% early-withdrawal penalty.

Foundation: Qualified Distributions

Before we cover the three nuances, we have to lay the foundation with what are known as “qualified distributions.” These are the type of distributions you want. If your Roth distribution is qualified, it means you’ve met the IRS requirements to get money from the account without tax or penalty. Non-qualified distributions are the ones that may be subject to income tax and a 10% penalty.

Both a Roth TSP and a Roth IRA have their own versions of qualified distributions. Luckily, they are almost identical.

Roth TSP Qualified Distributions (explained on page 2 of TSP BK 26)

#1 – Five years have passed since January 1^st of the year in which you made your very first Roth TSP contribution.

#2 – You are either:

(a) 59 ½,

(b) permanently disabled, or

(c) deceased.

You must satisfy both #1 and either a, b, or c of #2.

Roth IRA Qualified Distributions (explained in IRS Publication 590-B)

#1 – Five years have passed since January 1^st of the year in which you made your very first Roth IRA contribution, to any Roth IRA.

#2 – You are either

• 59 ½,
• disabled (as defined by 26 U.S. Code § 72(t)(m)(7)),
• deceased, or
• distributing up to $10,000 (lifetime limit) under the first-time homebuyer

You must satisfy both #1 and either a, b, c, or d of #2.

Time travel

When looking at the five-year requirements, you’ll see that both IRA and TSP rules say “since January 1^st.” This is because the IRS lets you go back in time. If you contribute to your very first Roth IRA, or make your very first Roth TSP contribution in December 2025, your clock actually starts January 1^, 2025.

With Roth IRAs you’re actually allowed to time travel even more, since you can contribute to an IRA up to the tax filing deadline for that year. So if you were to make your first Roth IRA contribution on April 15, 2025, but the contribution was for tax year 2024, your five-year clock would start 1/1/2024. In this scenario, you would satisfy the five year rule on 1/1/2029, meaning your five-year clock would actually be more like three years and eight months.

#1 – Whose clock is it anyway?

Question: If I transfer my Roth TSP to my Roth IRA, does the five-year clock required for qualified Roth distributions carry over from my TSP to my IRA? Or does the clock reset?

Answer: The five-year period for your Roth IRA is what matters. The number of years that have passed since you first contributed to your Roth TSP are irrelevant once the money lands in the Roth IRA. That period of time does not transfer to your Roth IRA. Here’s the direct quote from TSP BK26: “When you rollover your TSP Roth balance to a Roth IRA, the starting date for satisfying the five-year rule for qualified distributions does not carry over. Instead, you count from January 1^st of the first year you contribute to any Roth IRA.” 

Question: Will I “taint” my Roth IRA clock by moving in Roth TSP funds that didn’t meet the five-year rule within the TSP?

Answer: No. You will not ruin your Roth IRA clock by transferring in Roth TSP dollars that didn’t meet the five-year rule within the TSP.

How could this battle of the two clocks (TSP vs IRA) become an issue?

Let’s say you first funded your Roth TSP at least five years ago and therefore have satisfied the five-year clock for your Roth TSP. You then retire and transfer your Roth TSP into your Roth IRA. However, you did not fund your very first Roth IRA at least five tax years ago. If you distribute any earnings from this Roth IRA, they won’t be qualified and therefore will be taxable. Why? Prong #1 of the two-prong Roth IRA test: It has not been five years since January 1^st of the year you first contributed to any Roth IRA.

It’s important to note that Roth IRAs have ordering rules when it comes to distributions. Roth IRA distributions come from contributions first. Then, once all of your contributions have been distributed, you tap into the conversions bucket (if you have any), and last, the earnings/growth bucket is distributed once all contributions and conversions are gone.

In the scenario above where the five-year rule wasn’t satisfied with the Roth IRA, any earnings distributed would be subject to income tax, and if you’re under age 59 ½, a 10% penalty. However, you’d only be tapping into that earnings bucket if you had depleted all of the post-tax contributions and conversions. Which brings us to the next thing you must know.

#2 – Contributions only

Question: If I transfer my Roth TSP to my Roth IRA, can I withdraw contributions only?

Answer: Yes. While TSP does not allow you to withdraw just contributions, you can withdraw just contributions with a Roth IRA. With transferred money from an employer plan to an IRA, this removal of contributions can play out two different ways.

Scenario #1: Transfer from Roth TSP to Roth IRA (non-qualified dollars)

Let’s say you can’t satisfy both prongs for qualified Roth TSP distributions. Maybe you separated from federal service prior to age 59 ½ or maybe you didn’t first fund your Roth TSP five tax years ago. This means you have not-yet qualified Roth TSP money.

When you transfer this not-yet qualified Roth TSP money to a Roth IRA, the dollars maintain their same characteristics; contributions remain contributions, earnings remain earnings. If you transfer $100,000 Roth TSP money to a Roth IRA, consisting of $40,000 post-tax Roth TSP contributions and $60,000 Roth TSP earnings, you now have $40,000 additional post-tax contributions that can be withdrawn tax and penalty free from your Roth IRA. With a Roth IRA, contributions can always come out tax and penalty free at any time, at any age, for any reason.

What if you distributed the entire $40,000 worth of contributions and started tapping into the $60,000 earnings bucket? You would then go back to the two-prong test for qualified Roth IRA distributions:

• Did you first fund any Roth IRA at least five tax years ago?
• Are you at least:
  • 59 ½,
  • disabled,
  • deceased, or
  • withdrawing up to $10,000 (lifetime limit) under the first-time homebuyer exception?

If you can answer yes to #1 and either a, b, c, or d of #2, your earnings are qualified and therefore tax and penalty free.

Scenario #2: Transfer from Roth TSP to Roth IRA (qualified dollars)

Let’s say you can satisfy both prongs for qualified Roth TSP distributions. You first funded your Roth TSP at least five years ago and you’re either 59 ½, disabled or deceased. This means you have qualified Roth TSP money that you can access tax and penalty free.

If you choose to transfer this qualified money from Roth TSP to Roth IRA, the entire amount lands in the Roth IRA as if it were an original Roth IRA contribution. Using the same scenario above with $60,000 contributions and $40,000 earnings, if your Roth TSP is qualified, the entire $100,000 would land in your Roth IRA as if it were an original contribution (also referred to as “basis”).

Be careful with this. While $100,000 of qualified Roth TSP money arrives in the Roth IRA as if it were a contribution, the two-prong test for qualified Roth IRA distributions still applies. So if you did this transfer, but hadn’t yet satisfied both prongs of the Roth IRA qualified test, any earnings on top of that $100,000 could be subject to tax and penalty. Remember, the qualified rules of the account the money is coming out of is what matters.

#3 – The Rule of 55

Many people have heard of the “Rule of 55”, which is slightly misleading since it can also be used by Special Category Employee (SCE) retirees at age 50, or any age with 25-years of service. The Rule of 55 is one of many exceptions to the 10% early-withdrawal penalty usually imposed on distributions from retirement accounts prior to age 59 ½.

The Rule of 55 says that if you separate from service in the year that you turn 55 or later, the 10% early-withdrawal penalty will not apply to traditional TSP dollars. For the SCEs, also known as Qualified Public Safety Employees (QPSE), they must actually be age 50 when they separate from service, unless they cross the threshold of 25-years of SCE/QPSE service.

Notice that only traditional TSP is being mentioned when talking about the Rule of 55.

Roth TSP dollars do not qualify for the Rule of 55 exception. SCE/QPSEs can also not use their “Rule of 50” / “Rule of any age with 25 years of service” to access Roth TSP dollars tax and penalty free.

What do you need to know in terms of rollovers/transfers and the Rule of 55?

The Rule of 55 only applies to employer plans like the TSP. There is no Rule of 55 for an IRA. If you move traditional TSP money into a traditional IRA, you will not be able to use the Rule of 55 to avoid a 10% penalty on IRA distributions.

Also, the Rule of 55 only applies to the plan of the employer you are separating from. So if you separate from federal service, get a new job, and transfer your TSP into your new 401(k), you can no longer access those TSP dollars penalty free under this exception. In order to use the Rule of 55, the dollars must come from the employer plan of the employer you are separating from.

Summary

Tax-free Roth money is something that we don’t want to mess up. Unfortunately, that can happen when executing rollovers from TSP to an IRA. Knowing the rules can save you a lot of frustration and unnecessary tax. Know which five-year clock you’re working with. If the money goes from TSP to an IRA, the IRA five-year clock is what matters. Remember that contributions were already taxed and can be withdrawn tax and penalty free from a Roth IRA at any time for any reason. TSP does not allow you to withdraw just Roth TSP contributions; instead they are mixed together with earning and distributed proportionately. Finally, don’t let the Rule of 55 trip you up. If you want penalty-free access to your money prior to 59 ½, it may be worthwhile to leave it in the TSP. Once that money moves to an IRA, the Rule of 55 vanishes.

Tyler Weerden is a fee-only financial planner and the owner of Layered Financial, a registered investment advisory firm based in Arlington, Virginia.

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