Is the Roth TSP Right for Me?

By • March 20, 2012 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 Withdrawals from a Traditional TSP are taxed as ordinary income when withdrawn.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.

Join us for our upcoming webinar Tuesday, September 23rd at 1 PM EST to help you determine if "Phased Retirement" is an option you may want to consider by learning about the benefits, eligibility and other rules. Retirement eligible employees, with approval of an authorized agency official, will be able to submit applications for phased retirement beginning November 6, 2014. If you experience problems registering or cannot participate online but wish to call in (we can provide you with slides to follow), please email Natalie at natalie@franklinplanning.com or call 856-401-1101.

© 2014 Franklin Planning. All rights reserved. This article may not be reproduced without express written consent from Franklin Planning.

Tags:

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 18 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. Contact Carol at (856) 401-1101 or visit FranklinPlanning.com.

Comments

Free Email Updates

Sign up for our free email updates to get our latest news sent directly to your inbox
  • Our top stories sent each business day
  • More news from your FedSmith.com authors
  • The day's closing prices for the TSP funds
  • Videos for the federal workforce