How To Get Your Tax-Exempt TSP Money In To A Roth IRA

The Federal Thrift Savings Plan (TSP) is the “401K” for military and other federally employed physicians.  It is a great retirement plan, with minimal expenses (2-3 basis points total), and 5 great index funds, plus a bunch of Lifecycle funds similar to Vanguard’s Target Retirement funds.  Their G Fund is a unique investment that provides intermediate term treasury yields while taking money market risks.  The TSP even recently implemented a Roth option.

Tax Exempt TSP Money

When deployed to a war zone as a military doctor, you are given the option to contribute money to the TSP above and beyond the $17,500 annual limit.  This money is (mostly) earned tax-free because you’re in a war zone.  When it comes out of the TSP in retirement, it also comes out tax-free, but the earnings from it do not.  It turns out that this acts like a non-deductible IRA, which is really inferior to a taxable account unless you’re going to hold on to it for many decades.  But there is a way to get that tax-exempt money OUT of the TSP, and into a Roth IRA.  All of the research I have done on this indicates it to be completely legal, but you’re not going to get any help from the TSP, the IRS, or a Roth IRA provider like Vanguard on this.  Here are the required steps.

Separating Tax-Exempt TSP Money

First, make sure it actually makes sense to contribute tax-exempt money into the TSP.  If you have better uses for the money, such as regular traditional or Roth TSP contributions, contributions to Roth IRAs, contributions to your spouse’s 401K, high interest debt, or even the Savings Deposit Program (SDP) you probably are better off using the money for that rather than sticking it into the TSP.

Second, get deployed.  You ideally want to max out your TSP contributions for the year PRIOR to deploying or AFTER returning, so that the tax-exempt money is going in to the TSP in addition to the regular contributions.  January to January deployments make this hard.  Go to finance and make sure they’re doing the right thing with your money.  It’ll likely require multiple trips if you’re like most of us.

Third, get out of the military.  You can’t pull TSP money out until after you separate from the military.

Fourth, transfer almost all your TSP money out to a traditional IRA.  If some of it is Roth, then I suppose that portion would go to a Roth IRA. The Roth TSP wasn’t available when I did this.  I left $200 in the TSP.  Keep in mind you can only do a partial TSP withdrawal like this ONCE.

Fifth, transfer an amount equal to your tax-deferred money (your total minus your tax-exempt money) BACK into the TSP.  The TSP DOES NOT permit the transfer of “post-tax money” (such as those tax-exempt deployment contributions) so the only money that goes into the TSP is the tax-deferred money, leaving you a traditional IRA with the basis equal to the value.

Sixth, You then convert this IRA to a Roth.  There should be no tax bill for this.

When all is said and done, you’ve essentially taken the tax-exempt TSP money out of the TSP and put it into a Roth IRA, while leaving the rest of the money inside a great retirement plan.  Now instead of earnings on that money being fully taxable, it is now completely tax-free forever.  My tax-exempt contributions were about $25K.  Over the next 40 years at 8%, that might save me as much as $171K in taxes.

Beware The Step Transaction Doctrine

You should be aware there is some risk that the IRS could consider this illegal due to the step transaction doctrine.  This is the same issue some people have with the backdoor Roth IRA.   Basically, if a series of steps, although all legal by themselves, are simply a means of performing an illegal action, then they’re all illegal.  Frankly, I don’t think anyone at the IRS cares about stuff like this (they’re too busy chasing down Tea Party groups and partying), and even if they did, I could afford it.  I’m also not sure how they’d figure out I did all this from what gets reported on my taxes from the whole process.  It looks very clean on your tax forms.  I haven’t heard of the IRS having any kind of a problem with this, but I confess I’m the only person I know who has ever done it.  Certainly many people have used similar methods to isolate the basis in their 401Ks.

Issues with the Roth TSP

Now that the TSP has a Roth option, most military docs should be using it.  Not only does it allow you to shelter more money ($17,500 after-tax is more than $17,500 pre-tax), but the marginal tax rate for military docs is often comically low, especially in a year with a deployment.  I believe the tax-exempt money is always considered to be put into the tax-deferred portion of the TSP, so even if all your other contributions were Roth, you’d still have fully taxable earnings in the tax-deferred portion.  It would still be worthwhile isolating your basis using this method.  The TSP is still considering allowing in-service conversions, but hasn’t reached a decision yet.

Those separating from the military with tax-exempt money in the TSP should consider isolating the basis to convert that tax-exempt money to Roth money.

What do you think?  Have you isolated basis before?  Do you have tax-exempt TSP money?  Comment below!


How To Get Your Tax-Exempt TSP Money In To A Roth IRA — 24 Comments

  1. Hi,

    As a self employed 1099 independent contractor hospitalist, do you have any ideas on how can I maximize my pretax tax deferred retirement accounts and THEN convert them to a stealth self directed Roth IRA? Do you know all the possible tax deferred accounts that can be opened? My wife has a full time employed position as a nurse and has a regular employee 403b plan with Fidelity. Advice much appreciated as usual.

    • You can use a SEP-IRA and do a Roth conversion every year. If you have sufficient income to get $51K into it, you could do that plus $5.5K for you and $5.5K for your wife into a Roths. Your wife, as an employee, may have a Roth 403B option to explore.

      Keep in mind that just because you can do this, doesn’t mean you should. In peak earnings years it is probably wiser to use traditional tax-deferred retirement accounts over Roths when possible.

  2. I just returned from a deployment and actually addressed this topic with the folks at the TSP. The Roth TSP is absolutely the way to go when deployed because the tax-exempt contributions AND earnings will both be tax-free on withdrawal. Not so with the traditional TSP, where only the tax-exempt contributions during the deployment will be tax-free but the earnings (which after 20-30 years will be considerably higher than the contributions) will be fully taxable.

    If you have a two-income household and/or can afford it, you can contribute up to $51,000 to the TSP during deployment (though I believe the Roth TSP contributions max out at $17,500 even during deployment – apparently Uncle Sam’s generosity has limits).

    But I have to ask, why on earth would you want to transfer money out of the TSP to another 401K or IRA? With an incomparably low ER of 0.027% and a performance as good as the Vanguard 2040 fund in my separate IRA, why transfer the money, even after I ETS? That outside 401K better offer some truly outstanding managed funds to make up the difference for the TSPs solid performance and ridiculously low ER. I’m curious what WCI and his prior service readers think – is it really worth it?

    • First, I agree that the Roth TSP is the way to go when deployed, and probably even when not deployed. I haven’t seen anything definitive on how they treat tax-exempt contributions now that the Roth TSP is in place. Are the earnings still considered tax-deferred? If you have a definitive source, I’d like to see it.

      Second, there are at least two good reasons to transfer money out of the TSP- to get additional investing options (like TIPS and REITS and Small Value stocks) and to get better distribution options than the TSP offers. That said, I’ve held my TSP assets in the TSP since separation, aside from the tax-exempt money I wanted to convert to a Roth.

      • WCI, I emailed directly with an administrator at the TSP regarding the Roth contributions and earnings. I can share her email with you offline if you’d like. But by my LES, obviously all income was tax-free. The “tax-exempt contributions”, Roth contributions/earnings are all tracked separately from regular (traditional TSP) contributions on my monthly TSP statements. But yes, it looks like both Roth contributions and earnings are tax-free.

          • From the email:

            “The traditional tax-exempt contributions will not be taxed when you
            withdraw them. However, the earnings on those contributions will
            always be taxable. This differs from the TSP Roth option, as the
            earnings on Roth TSP contributions have the potential to become

            That pretty much settles it. Even with the Roth TSP, you still would want to isolate this basis and convert it. The email doesn’t, however, address whether you can do an in-service Roth conversion on that money. Anyone want to send the TSP another email? According to this:


            it wasn’t allowed as of January 2013.

  3. Did something similar to this when I changed jobs a while back, albeit not with tax-free money.

    A few months after leaving company A, rolled over to company B’s 401k, which at the time did not have a Roth option. So only the taxable portion could be rolled over.

    Immediately withdrew the rest from Company A and paid off a big chunk of debt.

  4. so I’m new to this and totally confused…I have a regular TSP. I am a military doc. I will consider opening a Roth TSP…but why would it be more beneficial than a regular TSP?

  5. I am currently on step 3….e.g. waiting to get out. Have a countdown on my phone to working full time in civ ED’s :) In addition to my regular roth ira, I am maximizing my roth tsp this year and next (my 1/2 military year and 1/2 civ year) as those will prob be the last year I am able to use a regular roth.

    Now, that being said here is something tsp told me recently: According to TSP- I have to contribute 1% to regular tsp to keep the roth allotment going. Well that is not much- only $60/month

    And one question: I deployed prior to roth tsp being rolled out. Tried to put as much as possible into tsp- about 27k I think. I now have a mix of tax deferred, tax exempt, and roth. I understand the steps 4-6, but really is it just moving money around. Some here, some there etc. Or is it the way it works is to pay the taxes now during the tsp move, and place already taxed money into the account so it grows tax free.

    One other question: after step 6, does it make sense to keep tsp open with a small chunk of money. I also heard once you fully leave, you can’t get tsp back and is it worth it to have as an option. The reason I ask is my financial advisor eventually wants me to leave tsp- mind you he gets more money the more I invest with him. (i know i should be with an advisor that is flat fee, but I do like this guy)


    • I still have my TSP and plan on keeping it indefinitely. So you want to keep at least a little money in there so it doesn’t close on you.

      I’m not exactly sure how this scheme will work now that the Roth TSP is in place. You may be able to do a conversion simply within the TSP, or you may still have to isolate basis by rolling out all the tax-deferred and tax-exempt money, then rolling the tax deferred money back in. Or perhaps rolling out all the tax-deferred, tax-exempt, and Roth money (except a few bucks) and then rolling the tax-deferred and Roth back in.

  6. I know this is a late post but while trying to find information on how to get my tax exempt balance out of my account, I came across this article. I have found one minor flaw in your plan.

    It wold appear that when TSP distributes the money for the transfer (your fourth step) it first distributes only tax deferred funds (this is the only type of distribution that is not pro rata). The last funds to be distributed are the tax exempt ones, meaning the 200 you left in TSP was 200 in tax exempt funds. 200 of the funds that were coverted to a Roth in step 6 were taxable. Not a huge amount but wanted to share the information. (Special note on page 5

  7. WCI, thanks for this article – very informative. I’m slated for deployment for 6 months starting in mid-2015, with a goal to maximize my TSP contribution for 2015, with the CZTE in mind. From what you wrote before, I have been trying to come up with a strategy. Does it make sense to maximize traditional TSP contribution of $18K prior to deployment, and then put $18K in Roth TSP while deployed, plus an additional $17K traditional while deployed, to bring the total up to the annual addition limit of $53K? Thanks in advance for any advice you may have time to give!

  8. Agree with the WCI completely. And the $10K in the SDP is simply a no-brainer. Guaranteed 10% annual return. A 6 month deployment with earn you $750. It’s a little paperwork up front, but complete visibility thru MyPay and then you’ll just cash-out thru MyPay. Oh, and one more note – leave the money in for 90 days when you re-deploy. If you’ve invested $10K you’ll accrue $500 in interest over the 6 month tour but an additional $250 for 90 days after you re-deploy. Too easy.

  9. Another late comment/question – hoping that someone reads this in the next few days as I have a bonus payment coming up on July 1.

    I am currently in a combat zone and will be until October. I’ve contributed about $10K to my Roth TSP so far this year; I currently have my TSP contributions set up so that the bonus that I will receive on July 1 will fully fund my Roth TSP.

    I have already deposited $10K into the SDP and have fully funded a Roth IRA, don’t have any debts except a mortgage, so my next goal is to put my CZTE money into my Traditional TSP. I am assuming, but can’t find anything in writing, that the amount I can put in per month is limited by the monthly CZTE cap on tax-exempt income which is currently about $8100. Is this true?

    What I would like to do would be to use my bonus to put the remaining $8K into the Roth TSP, and then put another ~$30K from the bonus into the traditional TSP but by my read of the rules this is not possible and I will have to put in $8100 monthly; also, will DFAS’s antiquated system allow me to contribute $8K to the Roth TSP in July and add another $8100 in tax exempt traditional contributions in the same month?

    • Yes, that’s true.

      DFAS will probably screw it up, if my experience is any guide. But after a few trips to finance, you should be able to do all that. If you can’t get money into the Roth TSP before October, just use your income from November/December to max it out.

  10. Thank you for this information. I have been wondering about all of the retirees out there who have FERS TSP accounts and maintain a traditional uniformed services TSP having only CZTE contributions and only a small amount of taxable earnings. I see nothing illegal about rolling the CZTE contributions into a traditional
    IRA then converting to Roth. I have read everything, and the one thing I wonder is whether Vanguard or USAA will accept CZTE rollovers. The TSP website alluded to it, albeit not very clearly.

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