Rollover or Retain? Making Smart Decisions When Leaving Federal Service

In 2026, the landscape for the Thrift Savings Plan (TSP) has shifted significantly. With the recent launch of In-Plan Roth Conversions, the decisions facing retirees are more nuanced than ever.

As a financial advisor, I see the TSP as a great wealth-building tool, but it becomes a complex puzzle the moment you stop contributing and start withdrawing. If you don’t understand the DNA of your account, you could leave thousands of dollars on the table for the IRS.

Understanding Your TSP Tax Buckets

Your TSP is rarely just one pile of money. It is usually a blend of four distinct sources, each with its own tax consequences:

Pre-Tax (Traditional): Contributions and earnings are taxed as ordinary income at withdrawal.

Roth: Contributions and earnings are tax-free at withdrawal if qualified.

Non-Taxable (CZTE): Combat zone principal is tax-free and earnings are taxable.

After-Tax (Non-Roth): Earnings are taxable.

The Pro-Rata Problem

One of the biggest reasons clients consider a rollover is the Pro-Rata Rule. Within the TSP, you cannot choose to withdraw only your tax-free Roth money or only your combat zone pay. The TSP requires that any distribution be taken proportionally from all your payroll sources.

If your account is 90% Traditional and 10% Roth, every check you receive will be 90% taxable. This makes it very difficult to manage your tax bracket in retirement.

Pro-Tip: Converting Combat Zone Pay (CZTE)

Here is where we find the most powerful strategy in military finance. If you have Combat Zone Tax-Exempt (CZTE) money sitting in a Traditional TSP, it is in a hybrid state: the principal is tax-free, but the growth is taxable.

As of January 2026, you can use the In-Plan Roth Conversion tool to move that CZTE money into the Roth side of your TSP (or roll it out to a Roth IRA).

Conversion: Because the principal was already tax-exempt, moving it to Roth triggers zero conversion tax.

Payoff: Once it lands in the Roth bucket, the earnings stop being taxable. You have effectively turned a tax-deferred asset into a completely tax-free asset for life.

Because of the Pro-Rata rules mentioned above, you cannot target only the CZTE money if you have other Traditional funds. You have to calculate the taxable versus tax-exempt ratio of your total Traditional balance before pulling the trigger.

Should You Retain or Roll Over in 2026?

Why Stay (Retain):

The G Fund: The G Fund remains one of the only investments that guarantees no loss of principal while offering yields comparable to long-term Treasuries. You cannot get this in an IRA.

The Rule of 55: If you leave service at age 55 or later, you can access your TSP penalty-free. Rolling to an IRA usually locks that money away until age 59½.

Creditor Protection: The TSP has federal protections that are often stronger than state-level IRA protections.

Why Go (Rollover):

Tax Precision: By rolling into separate Traditional and Roth IRAs, you break the Pro-Rata chains. You can choose exactly which bucket to pull from each year to stay in a lower tax bracket.

Investment Freedom: The TSP limits you to five core funds. An IRA gives you access to thousands of ETFs, individual stocks, and sector-specific bonds.

Legacy Planning: Roth IRAs do not have Required Minimum Distributions (RMDs) for the original owner, making them useful vehicles for passing assets to heirs.

The right answer depends on your tax bracket today versus your projected bracket in five years. If you have a large CZTE balance, leaving it in the Traditional TSP is often not the ideal decision because you may continue paying taxes on growth that could otherwise become tax-free.

If you have any questions, or want to have a complimentary consultation to create a financial plan. Please don’t hesitate to reach out.