SECURE Act 2.0 Eliminates RMDs on Roth Retirement Plans: What Does It Mean to Roth TSP Participants?
Edward A. Zurndorfer-
If an individual owns a traditional IRA and has reached his or her required beginning date (RBD), he or she is at the age in which a required minimum distribution (RMD) must be taken each year for the remainder of the traditional IRA owner’s life. The amount of the RMD each year is calculated based on the traditional IRA year-end balance from the previous year and a life expectancy factor (determined by one of the IRS’ life expectancy tables). The rationale behind RMDs is that the IRS permitted the traditional IRA owner to delay paying taxes on the traditional IRA accrued earnings (and with deductible traditional IRAs, on the traditional IRA contributions) over decades of time. When the traditional IRA owner reaches his or her RBD (age 70.5, 72, 73 or 75 depending in which year the traditional IRA owner was born) the traditional IRA owner is required to make a minimum required withdrawal and pay the federal and state income taxes due.
If the same individual also owns a Roth IRA, there are no RMDs during the individual’s lifetime. This makes sense because Roth IRA contributions are always made with after-taxed dollars, and the ultimate benefit of a Roth IRA is that any earnings within the account grow tax-free. Since Roth IRAs do not generate any revenue over time for the federal government, there is no reason to require distributions at a certain age. Note, however, that Roth IRA funds cannot remain in the Roth account forever. Non-spousal beneficiaries of Roth IRA accounts do have to deplete the inherited account over a certain period of time, thereby pushing the Roth IRA dollars into circulation and out from under the tax-free umbrella.
If this same traditional and Roth IRA owner is a federal employee and contributes to the Thrift Savings Plan (TSP) the individual, once the employee retires from federal service and reaches his or her RBD, under current rules the retired employee has to take an TSP RMD based on the combined balance of the traditional TSP and Roth TSP accounts.
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The fact that the TSP combines the balance of a TSP participant’s traditional TSP and Roth TSP accounts in calculating the participant’s annual TSP RMD for the year is “unfortunate” for the TSP participant. “Unfortunate” in the sense that it is causing the retired TSP participant to be subject to a larger TSP RMD that in reality does not have to be that large. This is because a retired TSP participant has the option of rolling over (tax-free) all of his or her Roth TSP account to a Roth IRA. Once the Roth TSP is completely rolled over to a Roth IRA, the Roth TSP account balance will be $0. In so doing, the participant’s TSP account balance will consist entirely of the traditional TSP, resulting in an annual TSP RMD. The following example illustrates:
Example. Jason is age 75 and retired from federal service. As of December 31, 2022, Jason had a total TSP balance of $1.2 million. Of the $1.2 million, $900,000 is in Jason’s traditional TSP account and $300,000 is in Jason’s Roth TSP account. Based on Jason’s age of 75 during 2023, Jason will use a factor of 24.6 (from the IRS’ Uniform Lifetime Expectancy Table found in IRS Publication 590-B) to calculate his 2023 TSP RMD:
$1,200,000/24.6 = $48,780.49 (Jason’s 2023 TSP RMD)
The TSP will make sure that Jason receives the entire $48,780.49 2023 TSP RMD by the end of December 2023. According to the TSP Publication “Tax Rules about TSP Payments”, the TSP will withdraw the $48,780.49 pro-rata from Jason’s traditional TSP and Roth TSP accounts according to the balances in each account, using the balances of $900,000 (traditional TSP) and $300,000 (Roth TSP) as of December 31, 2022. This means that of Jason’s $48,780.49 2023 TSP RMD:
$900,000/$1,200,000 times $48,780.49 equals $36,585.37 will be deducted from Jason’s traditional TSP account. The $36,585.37 taxable and be included in Jason’s 2023 income, which it should be.
$300,000/$1,200,000 times $48,780.49 equals $12,195.12 will be deducted from Jason’s Roth TSP account. While the $12,195.12 will not be included in Jason’s 2023 income (assuming the Roth TSP withdrawal is a “qualified distribution”) the $12,195.12 distribution will no longer be Jason’s Roth TSP account and therefore no longer able to potentially grow tax-free.
Jason has the option to notify the TSP and ask that his 2023 TSP RMD amount of $48,780.49 be withdrawn entirely from his traditional TSP account and nothing from his Roth TSP account. In that case, Jason will be including an additional $12,195.12 of income for 2023. This is because had he rolled over his $300,000 Roth TSP account before January 1,2023 into a Roth IRA, his 2023 TSP RMD would have been $36,585.37. The additional $12,195.12 of income could result in Jason: (1) Being pushed into a higher federal or state marginal tax bracket; (2) Being subject to a higher “income tier” for Medicare Part B monthly premium purposes; (3) Being subject to the “net investment income tax” (NIIT) if adjusted gross income exceeds $250,000; and (4) Possibly losing certain tax deductions and tax credits as a result of adjusted gross income exceeding certain limits.
This was the case until the recent passage of SECURE Act 2.0. Effective January 1, 2024, SECURE Act 2.0 eliminates the need to take RMDs on Roth TSP retirement dollars. This makes sense and brings the Roth TSP rules more in line with Roth IRA rules. Beginning January 1,2024 as a result of the SECURE Act 2.0 passage no longer will a rollover of Roth TSP to a Roth IRA be necessary to avoid unwanted TSP RMDs on Roth TSP dollars.
For the year 2023, those Federal annuitants who have reached their required beginning date (age 70.5, if born before July 1,1949 or age 72, if born between July 1,1949 and December 31,1950) and who have Roth TSP accounts will have their 2023 TSP RMDs calculated by the TSP based on their total TSP balances (traditional and Roth), as of December 31, 2022. The year 2023 should be the last year that Roth TSP account balances will be included in the TSP RMD calculation. Those federal employees who are past their RBD and who plan to retire after December 31, 2023, will not have their Roth TSP account balances included in the calculation of their TSP RMD. Their first TSP RMD will have to be taken no later than April 1st following the year they retire from federal service.
Finally, for those federal employees who are in their 50’s and early 60’s, SECURE Act 2.0 allows for enhanced Roth TSP contribution opportunities. Increasing “catch-up” contribution limits, especially for employees aged 60 through 63 should increase Roth TSP account balances for many employees. Many of these employees are not eligible to contribute to Roth IRAs because their adjusted gross incomes are too large. But with no adjusted gross income limitations on Roth TSP contributions, the passage of SECURE Act 2.0 allows federal employees to contribute more to the Roth TSP without affecting the amount of future TSP RMDs, thereby resulting in tax-free withdrawals for Roth TSP participants and their beneficiaries.
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Edward A. Zurndorfer is a CERTIFIED FINANCIAL PLANNER™ professional, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars, located at 833 Bromley Street – Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.