Another Retirement Option? Roth IRA's and the Federal Employee
By Ralph Smith
Thursday, November 30, 2006
In a recent article, we highlighted several possible changes to your Thrift Savings Plan (TSP) program. The article was widely read and a number of readers raised questions, particularly with regard to the portion of the article referring to Roth Individual Retirement Accounts.
The Roth IRA is a retirement investment vehicle that is a good option for some people. But, as a federal employee, you cannot currently use this investment vehicle within your TSP. The big advantage: An investor can put after tax money into a Roth IRA.
This can be an advantage because when you withdraw the money from the account after retirement, often many years later, you do not pay taxes on the withdrawal. That should be an advantage for many investors. But, until Congress changes the law to allow this option within the TSP, it is not open to federal employees.
Several readers wrote to ask about investing in a Roth IRA outside of the Thrift Savings Plan and asked if that is an option for federal employees.
To ensure accuracy, I discussed this subject at length with George Varchetta, a financial advisor with the Smith Barney office in Huntsville, Alabama.
In a word, the answer is "yes," you can invest in a Roth IRA outside the Thrift Savings Plan if you are otherwise qualified to do so. There are restrictions on a Roth IRA. You will first need to see if you meet the qualifications for this investment. If you qualify, you will need to determine if a Roth IRA is an appropriate investment choice for you.
Is the Roth IRA an Appropriate Choice for You?
Since the passage of the Taxpayer Relief Act of 1997, individual retirement accounts (IRAs) have become a popular way of saving for future financial needs. As the name implies, an IRA is one way of saving for retirement. It can also be used for other long-term goals such as first-time home ownership or meeting college expenses.
Income Restrictions
The Taxpayer Relief Act also created the Roth IRA. As noted above, Roth IRA distributions are free of any additional taxes or penalties., if specific requirements are met.
There are restrictions on who can invest. Contributions are phased out for single readers with an adjusted gross income (AGI) between $95,000 and $110,000. For married couples, contributions are phased out where their adjusted gross income is between $150,000 and $160,000.
Funds in your Roth IRA grow without having to pay taxes on the gains. The tax and penalty status of distributions depends on how long ago you made the first contribution to your Roth IRA, your age, and how you will be the money you withdraw from you account.
Potential Taxes and Penalties
If you withdraw the funds after age 59½ and the first contribution was made five years before your withdrawal, you will avoid paying taxes or penalties. If you withdraw funds prior to age 59½, and those funds are used for the purchase of a first home, all withdrawals up to $10,000 are tax- and penalty-free, as long as they were held in the Roth IRA for at least five years from the date of the first contribution.
Funds used for college expenses for yourself or your immediate family will be penalty-free. However, you will income taxes on the accumulated earnings.
Finally, if money is withdrawn before five years from the date of the first contribution, and you are under the age of 59½, the earnings on these funds will be subject to regular income taxes and will be assessed a penalty of 10%.
In 2006, the maximum annual contribution to a Roth IRA is $4,000 or 100% of earned income, whichever is less. The Roth IRA also permits a $1,000 "catch-up" contribution for individuals who are 50 or older.
In order to find out if a Roth IRA makes sense for you, you should contact your financial or tax advisor.
In effect, as a federal employee you have the ability to invest in a Thrift Savings Plan which has the lowest expense rate you will find anywhere. Most federal employees can also invest in a Roth IRA if you wish to do so. For many, this approach will make sense and make your future retirement more enjoyable with a more secure—and less taxing—financial future.
© 2009 FedSmith Inc. All rights reserved. This article may not be reproduced without express written consent of FedSmith Inc.
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