When I’m talking with people about their federal retirement, they often say to me, “I only have a year or two until I retire, and the bulk of my retirement money is in a traditional TSP. Should I move all or some of that to a Roth TSP? Or have I waited too long?”
It’s a great question: When is it “too late” to start a Roth TSP?
First, let’s correct a misconception.
Many, if not most of the folks asking me this question see retirement as the goalpost. They reason, “Since I’m planning to leave the workforce next year, I’m guessing it’s too late to try to move money into a more tax-friendly Roth TSP.”
I would argue that the goalpost isn’t the age at which you retire. The real goalpost is the age at which the government requires you to begin taking required minimum distributions (RMDs) from your TSP. For a long time, that’s been age 72; however, the SECURE Act 2.0 that went into effect in early 2023, raised the RMD age to 73. (It will eventually increase to age 75.)
Here’s why that matters to you. Yes, you owe taxes on all the money in your traditional TSP. And once you start taking distributions from that account, you’ll have to pay taxes on every dollar you withdraw…at whatever the going tax rate is at the time you withdraw it.
But suppose you don’t need to take distributions from your traditional TSP right away. In that case, you don’t have to start paying taxes until the IRS forces you to start taking required minimum distributions (RMDs).
This is why I say the goalpost isn’t the age at which you retire…it’s when your RMDs begin.
In short, if you’re 66, let’s say, and you don’t need that traditional TSP money right away to live on, you have at least seven years to take advantage of Roth TSP conversions.
Second, let’s see if Roth TSP makes sense for you.
Here’s how to tell if Roth conversions (from your traditional TSP) make sense for you…
Look at your tax returns
Get out your tax returns from last year and check your taxable income (after all your write-offs).
Determine your tax bracket
Next, visit the IRS website and check the tax brackets for whatever year you’re in (because they are always changing). At your income level, where do you fall?
A lot of federal employees that we talk to are either in the 22% or 24% brackets. (NOTE: These brackets are different depending on if you’re filing single or filing jointly.)
Do some math
Now, look to see how much room you have left on your current bracket. Subtract your income from the highest allowable income in your tax bracket. This will determine if you can shift some money from your traditional TSP over to a Roth TSP and remain in your current bracket without raising your tax rate. (Remember: Any money you convert is considered taxable income for the year in which you move it.)
Ask and answer some questions
My question for clients is, “Can you Roth convert and stay in either the 22% or the 24% bracket?”
In most cases, we’ve concluded that if you CAN Roth convert and stay within the 22% bracket, then this may be a good move for you, and even if doing a Roth conversion bumps you up from 22% to the 24% bracket, a lot of times that still could make good financial sense.
But suppose you look at your tax return and determine you’re already in the 32% tax bracket (or higher). In that case, it may not make sense to do Roth conversions (or at least do them this fiscal year). Will you always be in that tax bracket? What about when you retire?
Most of our clients will likely be in either the 22 or the 24% bracket once they retire. If that’s true for you, and you’re in the 32% tax bracket or higher right now, it probably doesn’t make sense to do Roth conversions now. You may want to wait until you’re at that lower tax bracket to move money into your Roth account.
But if you’re working, and you’re comfortably in the 22% or 24% bracket, it may be smart to convert some of your traditional TSP money to Roth, and even contribute new money to your Roth account.
As always, the goal is to use your tax bracket to your best advantage.
Solicit professional advice
I’m talking in generalities here, and because every situation is different, you want to talk with a tax professional or financial advisor to make sure that you’re doing what’s best for your situation. If you don’t have a financial advisor who understands all these matters, feel free to set up a consultation with one of our Christy Capital advisors.
Third, let’s think about future tax rates.
Since no one has a crystal ball, no one can say for sure what tax rates will be in the future.
However, here’s what some industry professionals have said on this topic.
“The U.S. will have little choice but to raise taxes in the coming years to offset its mounting liabilities and debt. The national debt, health care liabilities, and pension liabilities have to result in higher taxes since defaulting is not an option.”
Ray Dalio, Co-chairman of Bridgewater Associates, best-selling author
“Our government will soon need huge infusions of cash to meet its commitments, and it will have no choice but to raise taxes on those who have worked hard, sacrificed, saved, and played by the rules. Those who have saved the most diligently, though, will soon realize that a substantial chunk of those tax deferred retirement savings are sitting ducks for a revenue hungry Uncle Sam.”
Ed Slott, CPA and “America’s IRA expert”
Here we have two experts pointing out that our country is facing a serious “math problem” and that higher taxes are the only way to make the math work.
Hopefully, you now have clarity on three things:
- What tax bracket you’re in
- What tax bracket you’re likely to be in when you retire
- What you think future tax rates will be
These three factors should be enough to let you know whether you need to start moving money from your traditional account into a Roth account so that you can pay taxes at today’s rates instead of waiting for future, likely higher, tax rates.
Fourth, let’s make this practical.
Let’s say you’re 60 years old right now.
- Do you agree that the goalpost isn’t the age at which you plan to retire—it’s the age at which you will be required to take RMDs (i.e., age 72-75)?
- Do you think today’s tax rates are likely lower than what they’ll be 13+ years from now?
If so, you may want to start doing some Roth conversions. Again, this is where you take money from your traditional TSP, pay taxes on it now, and move it into a tax-free Roth account.
However, you cannot move money directly from your traditional TSP into a Roth account. If you’re 60 years old, you can move TSP money into a traditional IRA. From that traditional IRA, you can then move the money into a Roth account.
Fifth, final considerations…
Remember, whether you’re shifting traditional TSP money to a Roth account OR contributing to Roth, you need to keep an eye on your tax bracket.
When you switch from traditional contributions (which are tax-deferred) to Roth contributions (which are taxable), your taxable income increases. The same is true when you start doing Roth conversions. Both of these actions will increase your taxable income. Therefore, it’s important to monitor what these changes will do to your tax and tax bracket situation.
The goal is to convert as much money as you can, as efficiently as possible without bumping yourself up into a higher tax bracket.
All this is why when I’m asked, “Am I too late to move my traditional TSP money into a Roth TSP?” my answer is usually “no.”
Again, the goal post is your RMD age, not your retirement age. This means most people have 5-10 years to convert their traditional money—and it usually takes several years to do so in a tax-efficient manner.
The fact is, you can’t do it all in one year and be efficient on the taxes. The good news is you have until age 73 (at least) before the RMD deadline kicks in.
There is one other “deadline” of sorts that I need to bring to your attention. It’s the age 65 “deadline.”
Here’s what I mean: At age 65, you can start Medicare—if you want to. Because federal retirees have federal health care, they don’t have to start Medicare, but a lot of people choose to do so at age 65.
Why is that an issue? Because, as we’ve noted, Roth conversions—i.e., shifting traditional money to a Roth account—do increase your taxable income, and if your taxable income gets high enough, it can cause your Medicare premiums to go up. So, while I say the goalpost is age 73, some people will argue that the goalpost is actually age 65.
If you’re in this latter camp, you may want to convert your traditional money before age 65. In that case, instead of looking at this from the vantage point of, “Am I too late?”, you should view it as, “I need to get busy!”
