Taxation of Rollover from Thrift Savings Plan
The federal Thrift Savings Plan (TSP) is a qualified, 401(k)-type defined contribution plan.
Numerous threads have discussed the taxation of rollovers from qualified plans: direct rollovers include a pro rata share of basis whereas 60-day rollovers follow a basis last rule.
The TSP allows for direct rollovers. However, if the successor plan will not accept basis, “the tax-exempt amount will be paid directly to you.” – Tax Notice. Important Tax Information About Payments From Your TSP Account, December 2010.
Query 1. Is the tax-exempt amount, which arises from a contribution of tax-exempt combat pay to the TSP, in anyway different from the basis which would result from an after-tax contribution to another qualified plan? I see no reason why the tax-exempt amount should be treated differently from basis.
Query 2. Does the TSP procedure segregate basis; that is, is the amount paid to the participant tax free?
Notice 2009-68 says that “If you do a direct rollover of only a portion of the amount paid from the Plan and a portion is paid to you, each of the payments will include an allocable portion of the after-tax contributions.” I conclude that the TSP procedure does not segregate basis and that the amount paid to the participant includes both taxable and tax free income.
Query 3. Does the TSP Notice misrepresent actual TSP procedures? It is possible that TSP issues two checks to the participant, for example, with instructions to deposit the “taxable” check with the new custodian within 60 days. If this is the actual procedure, the “tax-exempt” check would be tax free.
Permalink Submitted by Alan Spross on Mon, 2011-11-07 19:10
Query 1. Is the tax-exempt amount, which arises from a contribution of tax-exempt combat pay to the TSP, in anyway different from the basis which would result from an after-tax contribution to another qualified plan? I see no reason why the tax-exempt amount should be treated differently from basis.
Peter, I agree. The TSP should treat these contributions as any other after tax contributions.
Query 2. Does the TSP procedure segregate basis; that is, is the amount paid to the participant tax free?
Notice 2009-68 says that “If you do a direct rollover of only a portion of the amount paid from the Plan and a portion is paid to you, each of the payments will include an allocable portion of the after-tax contributions.” I conclude that the TSP procedure does not segregate basis and that the amount paid to the participant includes both taxable and tax free income.
Correct, the pro rate rules should apply to distributions to the employee. If the employee wants to “isolate basis”, this brings up the same issues as for any other QRP. 2009-68 expresses the IRS’ intent of requiring pro rating the basis for direct rollovers. However, the employee could still request that the entire lump sum (less 20% withholding of the pre tax amount) be distributed, from which the employee could first do a rollover of the pre tax amount to a TIRA, and then roll the after tax amount to a Roth IRA, replacing the 20% as necessary to complete these rollovers. This ordering of rollover money only applies when distributions are made to the employee and employee does indirect 60 day rollovers of the proceeds. While isolating the basis is more beneficial, the employee could also do a direct rollover to a TIRA of the full amount and file an 8606 for the after tax amount; or could do a direct Roth conversion of which part of the conversion would be tax free.
Query 3. Does the TSP Notice misrepresent actual TSP procedures? It is possible that TSP issues two checks to the participant, for example, with instructions to deposit the “taxable” check with the new custodian within 60 days. If this is the actual procedure, the “tax-exempt” check would be tax free.
This is the tough question, because the IRS did not follow through with their pro rate ruling in 2009-68 with instructions for plan administrators for 1099R reporting. Plans are therefore still reporting these rollovers just like they used even before EGTRRA, when the after tax money could not be rolled over to an IRA. The employee then received an after tax check, but now the employee can roll that money over if they wish. They will still get a separate tax free 1099R because the other 1099R with the G (Direct rollover code) code will only show the pre tax money, and will not show any after tax basis on it. This has presented employees that do not want to keep the money with the opportunity to push the envelope by depositing that cash in a Roth IRA within 60 days as an indirect rollover. The IRS is still reacting to the 1099R forms as issued, so people are getting away with something here that the IRS did not intend, and the 2011 1099R Inst still do not make any changes. Of course this opportunity could close at any time, but I don’t see how this happens without revamping the 1099R Instructions. And I don’t see any chance of it happening retroactively.
Note: I do not know if the TSP has special provisions for in-service distributions like many 401k plans, where only after tax money and the earnings on that money are eligible for distribution. If it does, then any pro rating should be limited to only the funds that are eligible for distribution, and should not include the rest of the pre tax contributions or matching contributions that are not eligible for in service distribution.