Federal TSP – Roth conversion
I have a very large sum in my TSP as I enter 2010. (Luckily I moved my S&P TSP election to the Government instruments (G) fund just before the market dive last spring, so this means I have a lot in the G fund.) I have not converted my regular IRAs to Roth IRAs previously because I exceeded the $100k AGI conversion limit. That means the Roth 5-year rule for taking distributions as not commenced. Presently I am embarking on a total restructuring of estate planning. That has brought the 2010 Roth conversion option and the TSP front and center. For as far ahead as I can see, I shall not require distributions from the TSP for living once age 70.5 compels distributions per my life expectancy. Neither will my wife if she outlives me. I am 68 now. Converting the TSP to a Roth IRA in 2010 and spreading the tax hit between 2011 and 2012 is attractive theoretically, but the tax hit will be very substantial. In both years I suspect converting the TSP to a Roth IRA could well drive me to the 35% tax bracket. Doing a Roth conversion and making my grandchildren or children designated beneficiaries is an attractive option because of the eventual stretch possibilites, but the federal tax hit both years might well exceed $100k per year. Add Virginia taxes. I am loathe to fork this over now. This is an awkwardness of riches, I realize, but I posit that many federal retirees are facing a similar situation now that 2010 is here. What are my alternatives to reduce the immediate (2011 and 2012) tax bite?
Permalink Submitted by Alan Spross on Wed, 2010-01-20 21:22
A very basic response to your main question is that you need to have an analysis done to determine how much you should convert without paying a higher tax rate on the conversion than your expected tax rate in retirement. For those in the 35% bracket who expect to see that bracket return to 39.6 and to apply to them in retirement the conversion decision is somewhat easier.
A nice feature of Roth conversions is that you can reverse them in part or in full by Oct 15th of the year following your conversion. This provides the benefit of hindsight after your conversion year tax bill is known and your initial investment returns on the conversion are evident. This means you get another crack if things change or it you feel you made a mistake in the amount of your conversion.
While it can pay to convert in retirement in certain situations, the main benefits may go to to your heirs unless you live for several years after making the conversion. I would not worry about the 5 year rule to qualify your Roth IRA since that only applies to earnings and earnings would not be distributed until your entire conversion was distributed. Barring a calamity, the 5 years would be attained long before you got even close to having to consider Roth distributions of that amount. And since you are over 59.5, there is no 5 year holding requirement for your converted amount because you are past the age for early withdrawal penalties.
These are very general guidelines. To drill down to specifics, you would have to complete an extensive analysis of just about every facet of your family financial situation and estate goals.