Is the Roth TSP Right for Me?

By on March 20, 2012 in Current Events with 20 Comments

Do you want to pay taxes on the seed or the harvest?  The soon to be available Roth TSP may provide you a significant tax reduction on your future income.  Think of the original tax-deferred TSP as paying tax on the harvest.  You get a tax deduction on your contributions, which can grow tax deferred while you are accumulating savings, but at distribution, the harvest (contributions plus earnings) will be subject to tax.  The Roth feature in the TSP will be available during the second quarter of this year, and will allow you to just pay taxes on the seed (your contributions).  Any growth in the account comes out tax free, as long as the Roth account has been established for 5 years and you are 59 1/2 or better.

It is great having choices.  You can now customize TSP for unique and individual situations.  You can contribute to the original tax-deferred TSP, the new after tax Roth TSP, or a combination of both!  The maximum contribution combined for 2012 is $17,000 and if age 50 or better, an additional $5,500. If you contribute to both the Roth TSP and the Traditional TSP, your combined contribution may not exceed the IRS elective deferral limit.  If you are in FERS, the match of up to 5%, will go in the pre-tax TSP.

Get Informed Before Making a Decision

There are several considerations you will need to make when deciding whether to contribute to the Roth TSP or the Traditional TSP. Let’s examine them:

  1. Your net paycheck: Taxes are deferred when you contribute to the Traditional TSP, which means less money is taken out of your paycheck.  Adversely, taxes will be paid up front on contributions to the Roth TSP, which means more money will come out of your paycheck.
  2. Withdrawals from a Traditional TSP are taxed as ordinary income when withdrawn.  In comparison, withdrawals from a Roth TSP will be entirely tax-free if five years have passed since January 1 of the year you made your first Roth TSP contribution, AND you are age 59 1/2 or older.
  3. If you chose to contribute to the Roth TSP be aware:
    • The increased income may affect the taxability of Social Security income, Medicare Part B premiums, income tax deductions, exemptions, and the ability to use tax credits.
    • The increased income may also affect your children’s eligibility for scholarships and financial aid.
  4. Contributing to the Roth TSP will take the uncertainty out of future tax rates and their impact on your retirement income.
  5. A Roth TSP can be rolled over to a Roth IRA and provide an income tax legacy for your children and grandchildren who can stretch distributions over their own life expectancies.

There are similarities and differences between a Roth IRA and a Roth TSP:

Similarities

  • Contributions are made with after-tax dollars and can be withdrawn income tax-free if you are 59 ½ and follow the 5 year rule, which says a Roth has to be established for at least 5 years in order to allow earnings to come out tax-free.
  • Paying the tax in today’s known tax environment may prove to be a valuable tool during the retirement distribution phase.

Differences

  • You are not required to take minimum distributions from a Roth IRA.  You are required to begin taking minimum distributions from the Roth TSP by April 1st following the year you turn age 70 1/2 if you are no longer employed by the federal government.
  • There are income restrictions to contribute to a Roth IRA ($183,000 joint, $125,000 single).  There are no income restrictions on contributions to the Roth TSP.

 

Tax Diversification

On a personal note, I am very excited that the Roth TSP will soon be available. All though there are a lot of personal implications to consider, the opportunity to have tax efficient vehicles for income in retirement is one of the best benefits you now have.

If you wish to learn more about Roth IRA’s and traps to avoid, please email us for our free report: “Roth Re-characterization Traps and How to Avoid Them”.  Please include “Roth” in subject line.

© 2016 Carol Schmidlin. All rights reserved. This article may not be reproduced without express written consent from Carol Schmidlin.

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About the Author

Carol Schmidlin is the President of Franklin Planning and has been advising clients on how to grow and preserve their wealth for 20 years. In addition to her financial planning practice, she is the founder of FedSavvy® Educational Solutions, which provides Financial and Retirement Literacy Programs for Federal Employees. Follow FedSavvy® Educational Solutions on Facebook for the most up to date information. Contact Carol at (856) 401-1101 or visit FranklinPlanning.com.

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  1. Trotski says:

    I turn 70 this year and have been retired since 2006. When I am 70 1/2, can I take the mandatory withdrawals from my TSP account, pay the taxes, then redeposit the balance in a TSP Roth?

  2. Isle90 says:

    Wish they would have started this the same time as the L Funds, I’d jumped in for sure, but I am planning on retiring at the end of 2012 and therefore will do me no good……

  3. White Rabbit says:

    CSRS employees can set up and contribute to an, after tax, interest earning, Voluntary Contribution Account with OPM.  Upon retiring I understand we have the option to move these funds into a non-government, institutional Roth IRA in lieu of taking a supplemental annuity.  Will we have the option of moving these VCA funds in the Roth TSP?  

  4. RZW says:

    Isn’t it also the case that one can withdraw the principle contributed to a ROTH IRA can be withdrawn without penalty at any time?

  5. Marty says:

    Doesn’t look like a good option for me.  It would increase the taxes I pay while reducing the amount of money that goes into my retirement account.  There would be less investment to grow, as Uncle Sam would be getting his share up front.  Maybe some diversity is worth looking at though.

    • Kris says:

      its all a matter of %. If “Uncle Sam” takes 20% now and you average say 5% growth for the next 10 years you will end up with roughly the same as if you had put your full 100% in up fron then had the 20% taken out at the end (assuming the same 5% growth). The benifit is if you retire and want to buy something big, you can do it with your ROTH to avoid getting bumped into a higher tax bracket for that one year with extra expenses.

  6. EImperati says:

    How are Roth TSP (or IRA) taxed before reaching 59 1/2 years old?

  7. RetiredFERS says:

    If you are under age 59 1/2 then EACH TSP “conversion” to a ROTH has it’s own 5 year clock that once met allows you to withdraw those conversions penalty free while under age 59 1/2.  Any earnings on contributions or conversions taken before 59 1/2 will trigger a tax and penalty.  Earnings are the last ROTH funds to be withdrawn according to ROTH withdrawal rules.  This is one reason I chose to monthly convert TSP into a non-TSP ROTH.  I also don’t like the trade limitations in the TSP which my Scottrade account doesn’t have.  If under 59 1/2 you can also pull money out of a ROTH penalty free if used for college.  The limitations on a TSP ROTH are a negative in my view.

  8. Nighthawk_skye says:

    What affect will there be to the offset annuity for under 65?

    • RetiredFERS says:

      If you are talking about the FERS offset annuity then the TSP ROTH should have no affect on it.  Keep in mind that the FERS offset annuity is only payable up to age 62 (not 65).  Also be aware that congress is proposing to do-away with the FERS offset annuity starting Jan 1st 2013 for anyone retiring on/after that date.

  9. NumbersGuy001 says:

    One comment that I have not heard made on the Roth is this.  If the income tax were to be replaced with a value-added (VAT) tax, as has been advocated in Congress and has happened in other countires, holders of Roth-type savings accounts would be very unhappy as they watched their tax advantage disappear into thin air.  I think that it could happen.  In fact, as the Roth vehicles become more popular, the conspiracy theorist in me thinks that it is becoming more likely! 

    • The Master says:

      This country is not looking at a VAT as a replacement for income tax. Rather the politicians are looking at it as additional revenue. Most who advocate for the VAT are not calling for elimination of income tax, just a reduction.

      • NumbersGuy001 says:

        Reduction or elimination based on a VAT or any of the “flat tax” proposals all have huge implications for a holder of a sizable ROTH.  I’m just suggesting that it is worth thinking long and hard before jumping on the bandwagon. 
         

        • BB says:

          It would not have an effect on people that have already contributed.  If(that’s a ginormous if) that were to happen would they make anything retroactive??  NO.  Do you think people that contributed to a traditional IRA wouldn’t have to pay any taxes on the $$ they put in it and Congress would suddenly say they can take $$ out tax free?  I would say you need to be more realistic.

    • Black_Diamond_Bob says:

      what quatifiable data do you have that this will happen? The GOP opposes all taxes so this will NOT happen

      • Retired, but not stupid says:

        It won’t happen.
        Republicans love new highways in THEIR states, military bases in THEIR states, government offices in THEIR states, Post Offices in THEIR states, and purchases of expensive weapons from factories owned by their friends.  Just try to close a military base or government office in their district, and see what names they call you.Republicans just aren’t HONEST enough to admit that those things cost money, and they are so greedy they aren’t even willing to pay taxes for the highway, bridge, etc. being built in their own state!  Get a clue about what America is all about. 

        • Republicans2 says:

          Yes Retired, get a clue. MWhilenyou are at it, try to start to think for yourself and quit spitting out nonsense that is told to you. Time to grow up!

      • Fresno says:

        What do you think a flat tax is? All Rebulican’ts march out the post card income tax form every year. You need to get a clue.

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