ROTH IRA Contribution or Conversion?

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I watched the very helpful video on ROTH IRA conversions. I will be retiring by the end of 2022 and I do not have any funds in the Roth TSP, but all funds have been in the traditional TSP. In hindsight, that was probably not a good idea. I am now wondering if there is any upside to having all or some of my 2022 contributions placed in the Roth TSP. Also, if I do this can these funds now be TRANSFERRED to a Roth IRA when I retire.” – Deborah.

As a Federal Employee under FERS, your retirement is often referred to us as a three-legged stool.  When you’re eligible to retire, you will receive your pension.  When you’re eligible for Social Security Benefits.  Once you’re age 59 ½ you are eligible to start withdrawing money from your Thrift Savings Plan (TSP). 

FERS Pension

Social Security

Thrift Savings Plan

Your Thrift Savings Plan is one of the investment vehicles that you have to contribute towards your retirement and while you are working is an Employer-sponsored plan.  

The Thrift Savings Plan allows for you as a Federal Employee to have 2 types of contributions: tax-deferred or tax-free.  Your Employers contributions are always made as tax-deferred.

The benefit of having your contributions go in as tax-deferred means that you get to realize tax savings today, during your working years when your taxes may be at their highest.  Tax is deferred until later when you make a withdrawal. At the time that you make a withdrawal from a tax-deferred account, the monies that are withdrawn are subject to ordinary income tax (the worst kind of tax!). Your distributions from the tax-deferred portion of your TSP are not taxed as capital gains but as ordinary income. 

Whenever we sit down with our Federal Employee clients, we like to draw out a 10 year tax plan for their retirement.  

We do not know what tax laws may be in effect in 1 or 10 years from now but we know what they are today.  By knowing what they are today, we are able to make decisions based on what those rules are now.  This does not mean that we will never go back and make adjustments later but we aren’t going to spend an exhaustive amount of time trying to guess what Congress passes into law which we have zero direct control over. We don’t recommend that you do either.

Types of Taxes

If Deborah was meeting with one of our Federal Employee Financial Advisors, we would start by discussing the types of taxes that Deborah (and everyone in the United States) is subject to. There are four types of taxes.

Ordinary Income Tax

Ordinary income tax is the worst type of tax. Income that is subject to ordinary income tax can include things like wages, salaries, tips, bonuses, commissions, rents, and TSP distributions.

The reason that Ordinary Income Tax is so awful is that it can range between 0% and 37% PLUS state income tax if you live in a state that taxes income.

Tax Deferred

We really like the tax deferred bucket because it allows us to receive income today and defer it until later.

This can be really advantageous during working years when we may be at our highest earning potential.

Capital Gains

The next tax bucket is your long term capital gains.

Short term capital gains are taxed as ordinary income but long term capital gains are taxed differently.

A capital gains tax is like a levy that is placed on an investment, when that investment is sold for a profit.


Our favorite bucket and we hope yours too!

Tax free is just that – tax free. When you make a contribution to your tax-free account, like a ROTH, you will pay taxes today at whatever tax rate is applicable to you.

However, when you go to withdraw those funds in the future, it is tax free. Yes, even the earnings are tax free providing you meet the rules. The rules are that the account must be opened for 5 years or more and you have to be age 59 ½ before you take money out of the account.

The ROTH, whether it is an Individual Retirement Arrangement ROTH (ROTH IRA) or the ROTH component of the TSP are phenomenal investment tools to add to your retirement toolbox. You just have to understand how they work, like all tools.

Now you can see why we LOVE the tax-free bucket.

When to contribute to the TSP ROTH

For Deborah, contributing to the ROTH TSP during the last year of employment probably doesn’t make a ton of financial sense.

Rather, Deborah could make sure that she has an Individual Retirement Arrangement ROTH (ROTH IRA) open to start the clock on the 5 year rule. Often times, depending what your Financial Advisor requires, you can make as little a contribution as $25 to open an account and get started, and put up to the maximum allowable each year.

Once you have retired, you can work with your Financial Advisor (just make sure that they specialize in Federal Benefits) to look at potential ROTH conversions from your TSP. This is a powerful planning step when designing your retirement plan if done correctly.

For others, we almost always recommend starting a ROTH contribution as soon as possible. How much you defer into your ROTH account, IRA or TSP depends on your threshold for tax tolerance. Remember, your contributions to a ROTH are taxed today at your applicable tax rate. Your withdraws later, providing that you meet the rules of eligibility, are tax free.

One of the reasons that we love employer sponsored retirement plan’s having a ROTH contribution allowance is that it will allow for much higher contribution levels than a ROTH IRA does each year. You can have both a TSP ROTH account and a ROTH IRA; you will just want to make sure that you’re balancing the contrition’s so that you do not have an unexpected income tax liability in April.

Make sure that when you are designing your 10-year tax plan, you have calculated and set aside funds to pay for taxes if you are planning to do a conversion. The beautiful part of planning this out is that you can really adjust the amount you want to convert based on important financial factors such as: your tax tolerance, your current tax bracket, anticipated income, down turns in markets, and more.

If you would like a little one on one help designing a tax plan that works for you, you can schedule a consultation with one of our financial advisors here.

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