What Are the Differences Between the Roth TSP and Roth IRA?

November 18, 2020 3:42 PM
View this article online at https://www.fedsmith.com/2020/11/18/what-are-the-differences-between-the-roth-tsp-and-roth-ira/ and visit FedSmith.com to sign up for free news updates

There are many things in life that sound similar but can be quite different. Take cement and concrete for example. Most people think they are the same thing, but don’t say that to a guy that pours concrete all day. Or take jam and jelly. They sound similar but some people take fruit chunks very seriously. 

The same is true for the Roth Thrift Savings Plan (TSP) and a Roth Individual Retirement Account (IRA). They have a number of similarities and I get questions about both of them all the time.

That being said, they have key differences that make a big difference in how the accounts can be used in practice. 

So let’s get into the details…

The Similarities

Tax-Me-Now Accounts

This is often the most well known aspect of a Roth IRA or the Roth TSP. This means that you are only able to contribute after-tax money into these accounts. Unlike the traditional TSP or traditional IRA, you do not get a tax deduction for putting money into a Roth account. 

But down the road in retirement (assuming you follow all the rules), you are then able to take money out of Roth accounts completely tax free, and one of the best parts is that you not only can access what you put in tax free, but you can also get all the money that your contributions had earned while in the account tax free.

For example, let’s say you contribute $100,000 into the Roth TSP over your career and you invest it into the C and F funds. At retirement time, your initial $100,000 contribution has grown to $200,000. You’d be able to access all $200,000 tax free. 

Off Limits For 5 Years

Once you open a Roth IRA or start contributing to a Roth TSP, you have to wait at least 5 years to be able to access the earnings tax free. There are other withdrawal rules as well (like being at least 59 and ½) but this 5 year rule is often that one that gets forgotten. 

For example, let’s say you start a Roth IRA at age 60 while you are still working. You retire at age 62 and are excited to have some tax free money in retirement. Even though you are older than 59 and ½, you’d still have to wait 5 years from the time you opened the account to be able to access your earnings tax free.

The Differences

No RMDs (Required Minimum Distributions)

For those that are 72 and older, you have probably already dealt with RMDs.

For those that haven’t, RMDs require you to take a certain amount of money out of some types of retirement accounts starting at age 72. This is the government’s way of not allowing you to take advantage of tax-advantaged accounts for your entire life. 

If someone does not take a RMD (knowingly or unknowingly), they will have to pay a 50% penalty of whatever amount they didn’t distribute. The government takes this very seriously. 

The good news however, is that Roth IRAs are not subject to RMDs. This gives Roth IRA owners the flexibility to let their money grow tax free for as long as they’d like. They also enjoy the privilege of not worrying about if they have done their RMD correctly or not. 

Roth TSP owners are not so lucky. They, along with traditional TSP, traditional IRA, and 401(k) owners, are required to take RMDs starting at age 72.

Early Retirement Penalties

This difference applies to the traditional sides of the TSP which can affect how we use the Roth side.  

Because of how the FERS retirement system is set up, many federal employees are able to retire before 59 and ½. This is a great thing, but as I mentioned before, there can be penalties when touching retirement accounts before 59 and ½.

The good news is that if you are 55 (50 for special provision FERS) or older in the year that you retire, you are able to access your traditional TSP (not Roth side) without the 10% penalty. However, this rule does not apply to Roth IRAs, traditional IRAs, or the Roth TSP.

For example, let’s say someone retires from federal service at age 56. They would be able to access their traditional TSP without the normal 10% penalty that would normally apply before 59 ½, but if they chose to roll their TSP into a traditional or Roth IRA, they would not be able to escape the 10% penalty before 59 and ½. 

A Few More Things

There are also a couple of other differences that I would be remiss to not mention. 

First, the contribution limit for your TSP (traditional or Roth side) is $19,500 in 2020 and only $6,000 for a Roth IRA. This can make a big difference for those that want to get serious about retirement savings.

Second, when you invest in the TSP,  you receive matching contributions from your agency. There are no matching contributions for a Roth IRA.

Third, once your income is over certain limits, you are no longer able to contribute to a Roth IRA. There are no such limits for a Roth TSP. 

Fourth, the investments in the TSP are relatively simple and easy to understand. When investing in a Roth IRA, there are thousands of investment options and it can be much more difficult to make good investment decisions unless you are familiar with what options are available.

Conclusion

If you have made it this far in the article, you can probably tell by now that neither the Roth TSP or Roth IRA is inherently better than the other, but they are different. Once you understand the key differences, you can make an educated decision on which one will serve you the best throughout your career and retirement. 

© 2020 Dallen Haws. All rights reserved. This article may not be reproduced without express written consent from Dallen Haws.

Tags:

About the Author

Dallen Haws is a Financial Advisor who is dedicated to helping federal employees live their best life and plan an incredible retirement. He hosts a podcast and YouTube channel all about federal benefits and retirement. You can learn more about him at PlanYourFederalBenefits.com.

Top