This is an excellent question and I'm sure many people have thought about this as well. The short answer is yes. You would need to first rollover the funds into a Traditional IRA and then do what is called a Roth conversion. You will pay taxes in the year you convert but as long as you withdraw according to IRS rules, you will not pay any taxes on the growth you see in this account nor will you be subject to Required Minimum Distributions. The conversion must be completed in the calendar year, not by the tax filing deadline of the following year. So, if you want it for 2016, you have until December 31st or the deadline your financial institution sets in order to have the rollover completed and then converted. As with all tax laws, I am speaking as they are today but the government could change it at any time.
Before you make your decision, I would like for you to consider some advantages to leaving the money in the TSP.
1) The TSP has very low fees on their investment options but have fewer choices than what is available on the marketplace. However, more choices do not always mean better choices.
2) Possibility of penalty free withdrawals at age 55. According to www.tsp.gov, if you separate from service during or after the year you reach age 55, then the 10% early withdrawal penalty does not apply. If you leave money in your TSP, you could possibly have access to it penalty for free several years earlier than what is possible with an IRA or Roth IRA. Please reference TSP-536 for additional information.
3) If you get a federal civil service job, there could be automatic and/or matching contributions to new additions you put into your TSP.
4) You may be able to borrow against the TSP; you can't do that with a Traditional or Roth IRA.
5) The TSP may offer enhanced creditor protection versus an IRA.
With all that in mind, here are you options.
1) Leave 100% of the funds within the TSP account.
2) Rollover some or all of the funds to an IRA or another employer sponsored plan. You can always roll back into TSP if you leave the minimum balance required.
3) Take a cash withdrawal from the TSP. This is highly discouraged due to penalties and taxes!!
I suggest speaking with a financial advisor at USAA and your tax advisor to discuss your current financial situation so that you can better understand your options and you can make the best financial decision. If you decide to rollover the TSP, I suggest a direct rollover instead of taking it as a distribution and then re-investing in order to take the 60 day rollover rule out of play and avoid any possible income tax withholding and/or penalties.
I welcome any questions or comments anyone might have.