With all the talk about the TSP possibly opening up a mutual fund window and expanding withdrawal options, you may have forgotten that the TSP also offers a Roth option, which began in 2012. The Roth TSP combines the after-tax (no upfront tax deduction) option with the existing benefits of the TSP, which are the universally renowned low administrative costs.
There are three options to choose from when allocating your TSP contribution:
- Contribute 100% to your traditional TSP account
- Contribute 100% to your Roth TSP account or
- Allocate any percentage of your contribution to either of these two accounts
As you’re probably aware, your contributions to the traditional TSP are withheld from your pay and not included in your income for income tax purposes. But it’s easy to forget that once you start withdrawing from your TSP account, every penny will be taxed, both the contributions and the earnings. Taxes aren’t eliminated with your TSP account, they are just deferred. However, studies show that tax-deferred growth is much better for the investor than being taxed upfront upon receipt.
When you contribute to your Roth TSP, those contributions are still included in your income and taxed in the year earned. But when you or your designated beneficiary withdraw the money from the account, it will not be taxed again. Even more importantly, the earnings in the account will never be taxed. But remember, this great deal only applies if five years have passed since January 1st of the year you made your first contribution to the Roth TSP account, and you are either age 59½ or older, permanently disabled, deceased, or a first-time homebuyer.
Now, there’s one curious but unfortunate little aspect of the Roth TSP that you should be aware of: government matching, which can be up to 5% of your salary, is put into your traditional TSP account.
It’s also important to remember that contributing to the Roth TSP instead of the traditional TSP will result in lower take-home pay. The money is withheld from your pay and is also taxed. However, if you are in a low tax bracket and feel that time will serve you well in terms of your earnings, you may want to pay the taxes now in exchange for tax-free distributions once you retire.
So, if you believe overall tax rates will increase significantly in the future and want to hedge against that possibility, or if you are likely to be in a higher tax bracket in your retirement years, you may want to consider starting a Roth TSP account. Just remember to speak with a federal benefits specialist to discuss your options first.
John Stohlman has been serving clients in the DC metro area since 1983. He is a frequent keynote speaker throughout the DC area and co-author of Navigating Your Federal Retirement Benefits. For more information visit FederalNavigators.com.