“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.
Retirement planning is a critical step for federal employees, and deciding how to contribute to your Thrift Savings Plan (TSP) is an essential part of that process. This guide explains the differences between traditional and Roth TSP contributions, how taxes affect each option, and strategies to maximize your retirement savings.
What is the Thrift Savings Plan (TSP)?
The TSP is a retirement savings plan for federal employees, similar to a 401(k) in the private sector. Contributions to the TSP grow over time through investments, helping you build a nest egg for retirement. Federal employees can choose between two types of contributions: traditional and Roth.
Traditional TSP vs. Roth TSP
Traditional TSP: Contributions are made before taxes, meaning you don’t pay taxes on the money you contribute until you withdraw it in retirement. However, both the contributions and their earnings will be taxed when you withdraw them.
Roth TSP: Contributions are made after taxes have been taken out, meaning you pay the taxes upfront. The benefit is that your withdrawals during retirement, including earnings, are tax-free if certain conditions are met.
Why Does It Matter Which Option You Choose?
The key difference between traditional and Roth TSP contributions lies in when you pay taxes:
- With traditional TSP contributions, you defer taxes until retirement. This can reduce your taxable income today.
- With Roth TSP contributions, you pay taxes now but avoid paying them later on withdrawals.
Your choice depends on factors such as your current tax rate, expected future tax rates, and overall financial goals.
Future Tax Considerations
Tax laws can change over time, which may impact your decision. For example, the Tax Cuts and Jobs Act of 2017 lowered tax rates for many people, but these cuts are set to expire in 2025. If tax rates increase in the future, having money in a Roth TSP could save you from paying higher taxes on withdrawals later.
By contributing to a Roth TSP now, you lock in today’s lower tax rates on your contributions. This strategy may be especially beneficial if you expect to be in a higher tax bracket during retirement.
Tax Diversification: Why You Need Both
One effective strategy is to use tax diversification by contributing to both traditional and Roth TSP accounts. This approach allows you to balance the tax benefits:
- Traditional contributions lower your taxable income today but are taxed later.
- Roth contributions are taxed now but grow tax-free.
For example:
If all your savings are in a traditional TSP, every withdrawal in retirement will be taxable. This includes withdrawals from other sources like pensions or Social Security.
By having some savings in a Roth TSP, you can withdraw funds tax-free when needed, reducing your overall tax burden.
Should You Contribute 100% to Roth?
While contributing entirely to a Roth TSP sounds appealing, it may not always be the best choice. Switching fully to Roth contributions would increase your taxable income today, potentially pushing you into a higher tax bracket.
A balanced approach might work better for many federal employees. For instance:
- Contribute 90% to a traditional TSP and 10% to a Roth TSP.
This strategy provides both immediate tax savings and long-term flexibility.
Key Takeaways
- Traditional TSP: Contributions are pre-tax but taxed at withdrawal.
- Roth TSP: Contributions are after-tax but grow tax-free.
- Tax Diversification: A mix of both traditional and Roth contributions can provide flexibility in managing taxes during retirement.
- Future Taxes: If tax rates rise, Roth contributions could save money since withdrawals are tax-free.
- Smart Contributions: Consider splitting contributions between traditional and Roth accounts for maximum flexibility.
Conclusion
Choosing between traditional and Roth TSP contributions is an important decision that depends on your current financial situation and future goals. By understanding how each option works and considering strategies like tax diversification, you can create a balanced plan that supports your long-term financial security. If you’re unsure which option is best for you, consulting with a financial advisor who specializes in federal benefits can help.
ABOUT THE AUTHOR
Micah Shilanski, CFP®, is a distinguished financial planner known for his deep commitment to providing exceptional advisory services to his clients. As the founder of Plan Your Federal Retirement, Micah has dedicated his career to helping federal employees understand and optimize their benefits to ensure a secure and prosperous retirement. His expertise is widely recognized in the industry, making him a sought-after speaker and educator on financial planning and retirement strategies.
Micah’s approach is client-centered, focusing on creating personalized strategies that address each individual’s unique needs. His work emphasizes the importance of comprehensive planning, incorporating aspects of tax strategy, investment management, and risk assessment to guide clients toward achieving their financial goals.