TSP Transfer to Self-Directed IRA (SDIRA)

Updated: May 28, 2021
In this Article

    For military members, the TSP offers an outstanding retirement savings vehicle. But, the TSP also has relatively few investment options. On the other hand, self-directed IRAs allow account holders to use their retirement savings to invest in alternative asset classes (e.g. real estate, cryptocurrency, precious metals, etc.). As such, we’ll use this article to explain the considerations behind a TSP transfer to self-directed IRA (SDIRA).

    Specifically, we’ll discuss the following:

    • SDIRA Overview
    • Alternative Asset Class Benefits of an SDIRA
    • How to Transfer a TSP to an SDIRA
    • SDIRA Risks and Considerations
    • Final Thoughts

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    SDIRA Overview

    A self-directed individual retirement account, or SDIRA, is a unique type of IRA. Unlike their IRA counterparts, SDIRAs allow account holders to invest in a far broader range of asset classes (which we’ll discuss in the next section). This represents the primary practical difference between normal IRAs and SDIRAs. And, due to this additional complexity, most IRA custodians do not offer SDIRAs. Rather, if interested in this route, you’ll need to find an IRA custodian that focuses solely on self-directed IRAs.

    Like normal IRAs, SDIRAs serve as a form of tax-advantaged retirement account. More precisely, investors can choose between a traditional or Roth version, both of which offer unique tax benefits. With a traditional SDIRA, investors contribute pre-tax funds, which reduces your current taxable income. However, when you withdraw funds from your SDIRA in retirement, you’ll need to pay income taxes.

    Alternatively, you can opt for a Roth SDIRA. With these, you contribute post-tax funds. This means you don’t receive a current tax benefit, but you have the advantage of withdrawing tax-free funds in retirement.

    Alternative Asset Class Benefits of an SDIRA

    With normal IRAs, investors have access to a standard range of investments: stocks, bonds, mutual funds, and exchange-traded funds (ETFs). Investors have access to even fewer options in their TSP accounts. While TSPs offer the advantage of low fees, they also only allow a handful of investment choices. For people looking to more eclectically invest their retirement funds, TSPs just don’t provide much flexibility.

    On the other hand, with SDIRAs, you can still invest in the more traditional options offered in IRAs, but account holders can also choose from a far wider variety of alternative asset classes. While not a comprehensive list, some of the more popular alternative investments held in SDIRAs include:

    • Real estate
    • Precious metals
    • Closely-held companies
    • Real estate tax liens
    • Cryptocurrencies (e.g. Bitcoin, Ethereum, etc.)
    • Private loans

    Some of these alternative assets have significantly more risk than more traditional investments, which is why only experienced investors should consider SDIRAs. But, if interested in A) investing in any of the above asset classes, and B) receiving the tax advantages of a retirement account, transferring your TSP to an SDIRA may make sense.

    How to Transfer a TSP to an SDIRA

    Step 1: Identify an SDIRA Custodian

    As discussed, most IRA custodians do not also serve as SDIRA custodians. Consequently, you first need to find a designated SDIRA custodian. But, due to the complexity of different alternative assets offered in these retirement accounts, you should also find a custodian that specializes in your desired asset class. For instance, if you want to use your SDIRA to invest in real estate, you can – and should – find a custodian that focuses its services on real estate.

    Step 2: Conduct the TSP to SDIRA Transfer

    Once you’ve identified your account custodian, you need to actually fund the SDIRA. Before making any requests of the TSP, alert your new SDIRA custodian that you will be completing a direct rollover from your TSP account. While you can conduct an indirect transfer, which sends you a check that you then forward to the SDIRA custodian, this poses far more risk of making a mistake that could trigger taxes and penalties. Instead, a direct transfer sends the check directly from your TSP to the new SDIRA custodian.

    Once you’ve alerted your SDIRA of the impending rollover, you can begin the transfer process with the TSP. Fortunately, the TSP website makes transferring your funds a relatively straightforward process. When you log into your TSP account online, there’s an option for a full withdrawal. The website will walk you through its withdrawal wizard, which will ask you a few questions and use your responses to automatically complete Form TSP-70, Request for Full Withdrawal. Of note, if married, you’ll need to notarize this form, as well.

    After you’ve completed the Form TSP-70, you can send the form directly to your SDIRA custodian. Then, this new custodian can directly handle the TSP to SDIRA rollover on your behalf. This limits the likelihood of mistakes. Alternatively, you can submit the form directly (the TSP website lets you upload it). Regardless of which path you choose, the TSP will eventually acknowledge that A) it received your withdrawal request, and B) has completed the associated account transfer to your SDIRA.

    NOTE: If rolling over your traditional TSP to a traditional SDIRA, you will not trigger a taxable event. But, if you choose to convert your traditional TSP into a Roth IRA, you will need to pay the associated income taxes, as all of your prior TSP contributions and investment growth have been with pre-tax funds. When you complete this conversion, the TSP will issue you a 1099-R, which will clearly indicate the taxable funds moved into your new SDIRA for tax filing purposes.

    Step 3: Choose Your Investments

    Once your SDIRA custodian receives the TSP funds, you need to actually choose your investments. And, from a compliance perspective, it’s important to understand that all investments will be made in the name of the SDIRA – not the account holder. More precisely, the IRS considers SDIRAs separate legal and taxable entities from the individual account holder. This means that you need to pay all investment-related expenses from the SDIRA, and you must receive all investment income into the account.

    SDIRA Risks and Considerations

    While SDIRAs provide investors a wider range of possible investments, they also come with significant risks and considerations. Prior to transferring your TSP funds into an SDIRA, account holders should consider the below factors.

    Due Diligence

    By law, SDIRA custodians cannot provide account holders investment advice. Accordingly, the onus for research and investment due diligence rests solely with the account holder. If you do not have the investment analysis experience in your desired alternative asset class to support this responsibility, you may want to reconsider your TSP to SDIRA transfer. For example, if you want to use SDIRA funds to invest in cryptocurrency but have never held any cryptocurrency assets, an SDIRA likely doesn’t make sense.

    Prohibited Transactions

    Additionally, the IRS has strict rules for what you cannot do with an SDIRA. Known as prohibited transactions, the IRS outlines a series of rules outlining what account holders are forbidden from doing with SDIRA investments.

    For instance, you cannot engage in a transaction with a “disqualified person,” including yourself (recall, the IRS views your SDIRA as a separate entity from you as an individual). While the list of prohibited transactions is long, the important takeaway is that these rules exist. Prior to engaging in any SDIRA transactions, make sure you’ve consulted a tax or finance professional to verify IRS compliance.

    Fee Structures

    Due to their additional complexity, SDIRAs impose more administrative requirements on account custodians. Consequently, these custodians usually charge far more extensive fees than you would experience with a normal IRA. These fees can include initial set-up fees, annual fees, renewal fees, and fees related to investment bill pay. Prior to transferring your TSP funds into an SDIRA, read the fine print regarding your new custodian’s fee structure. If you don’t, you could end up with significant fees biting into your investment returns.

    Final Thoughts

    For some investors, the TSP just doesn’t offer enough investment options. As an alternative, military members and veterans can transfer their TSP funds into an SDIRA. While these retirement accounts provide access to a wider range of alternative asset classes, SDIRAs also come with more risk and compliance requirements. Prior to completing a transfer, make sure you have weighed these costs against SDIRA benefits.

    About The AuthorMaurice “Chipp” Naylon spent nine years as an infantry officer in the Marine Corps. He is currently a licensed CPA specializing in real estate development and accounting.

    Written by Veteran.com Team