One of the best options available to Federal employees is often the most misunderstood. With competing philosophies out there, many financial consultants don’t want to admit the TSP has some good features. The Roth TSP is one of the better features of the plan for federal employees. We’ll work through some common misconceptions about the Roth TSP to help you decide if it makes sense for you.
Before we go any further full disclosure – please consult with your financial planner or tax adviser before implementing anything you learn. This article is for educational purposes only to start.
Ok, on with the show!
Misconception #1: “I make too much money to contribute to the ROTH TSP”
Implemented in 2012, the Roth TSP allows Feds to make contributions on an after-tax basis. When assets are held for a period of at least 5 years, all contributions and all growth can be withdrawn tax-free.
There is no income limit on contributing to the Roth TSP like for Roth IRAs. Again, there is NO INCOME LIMIT to be eligible to contribute to the Roth TSP. That means no matter how much you make as a federal employee, you can contribute your full amount to the Roth TSP.
This is most likely the main misconception out there about Roth TSP. Even 12 years after being implemented, I run into Feds weekly that make the comment, “I make too much to contribute.” This is false, and the proper information should be shared with everyone you know!
Misconception #2: “If I contribute to Roth TSP only, I won’t get my matching contributions”
Feds can contribute to the Roth TSP just as they do their regular TSP through salary deferral. They can direct all those funds to the Roth TSP rather than the traditional TSP up to the annual limit each year and still receive the full match.
Often, we hear that Feds are afraid of allocating more of their contributions to the Roth TSP because they will miss out on their match. Healthy fear to have as that’s free money! But fortunately, it’s based on incorrect information.
No matter how much you contribute to the Roth TSP, as long as you have at least 5% per pay period going into to TSP, you will receive your full match. That means you still receive your match if all of your contributions are only going to Roth TSP.
Misconception #3: “It’s too late for me to contribute to Roth”
Even late-career Feds close to retiring or in their highest earning years should consider contributing everything to Roth TSP. Having tax-free income in retirement will provide Feds with tax diversification and allow for a powerful income strategy in retirement. The misconception is that it is too late or someone is too old to contribute to the Roth TSP. Again, this is false. Almost everyone contributing to the Roth TSP will benefit no matter how late in their careers they are.
I can explain with a question: How long do you need money? Until the end of your life, correct?
For many Feds I pose this question to, that means 1-2 years left in their career and their retirement of 20-30 MORE years. If you start the Roth now, you can still let it grow through retirement, thereby continuing to build wealth as you draw down your assets. Then, when the time comes to use the Roth money, it is a built-in inflation hedge. You’ve already paid the taxes in advance, so every dollar that comes out is yours!
Bonus tip: Contributing to the Roth TSP allows Feds to get more money into the TSP. That’s right, we’ll say it again. You can get MORE of your money INTO TSP by using the Roth TSP.
How is this possible? When contributing to the traditional TSP, those dollars go into the TSP on a pre-tax basis. That means they have not been taxed yet, so as the account grows over time, so does that tax liability.
When you reach the age to draw money out, taxes are due at your income rate on the whole distribution. The reason is that your contributions are on a pre-tax basis, and the tax benefit is earned in the year you contribute. So, you have a retirement partner, aka the government, tagging along with you until you draw the money out.
The Roth TSP, on the other hand, deals with that tax partner upfront. As mentioned, Roth contributions are after-tax, so your taxable income in the years you contribute will be higher. Then, when you draw the money out, everything you put in and earned comes tax-free. So, when you do the math of the money the government is contributing to your TSP match, the Roth TSP provides a higher percentage than traditional of what the employee gets.
As you can see, we believe that the Roth TSP is important for federal employees and can provide them with sustainable retirement benefits. If nothing else, contributing to the Roth TSP gives us tax diversification. That means we have another bucket of funds taxed differently than our pension and traditional TSP; this one is tax-free!! So, when taxes go up, and when they go down, we can adjust where we pull retirement income based on the economic climate at the time of withdrawal. That provides additional flexibility to a well-rounded income distribution plan.
Prepare. Plan. Prosper.
James “Wes” Battle is a Financial Planner offering securities through Cetera Advisor Networks LLC, member FINRA/SIPC. Advisory Services offered through Cetera Investment Advisers LLC, a registered investment adviser. Cetera is under separate ownership from any other named entity. 2101 Gaither Rd., Ste 600, Rockville, MD 20850.
The opinions contained in this material are those of the author, and not a recommendation or solicitation to buy or sell investment products. This information is from sources believed to be reliable, but Cetera Advisor Networks LLC cannot guarantee or represent that it is accurate or complete.
For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice.
