The One Big Beautiful Bill Act (OBBBA) extended the lower federal income tax rates that were initially set to expire after 2025. What are the consequences for federal employees and Roth conversion opportunities?
- A stable tax environment to execute Roth conversions.
- The assurance of lower tax rates reduces the time pressure for the urgency of 2025 conversion. This allows for methodical, multi-year conversions, thus avoiding being pushed into higher tax brackets.
- The new act temporarily raises the SALT deduction cap from $10,000 to $40,000 until 2029. The result is lower taxable income and an increased attraction for Roth conversions, especially in the high-tax states. However, this benefit phases out at higher income levels.
- A new $6,000 “senior deduction” for some individuals age 65 or older can help offset conversion income, though it also phases out at higher income levels.
As a defined-benefit plan, your FERS annuity plan provides a predictable, taxable income stream in retirement. By contrast, a Roth IRA and the Roth TSP provide a tax-free income stream, creating tax diversification.
A traditional TSP is a pre-tax account that grows tax-deferred, and withdrawals in retirement are taxed as ordinary income. A Roth IRA, funded with after-tax dollars, provides a tax-free complement, allowing you to draw from whichever account is most advantageous in a given year.
The Roth TSP is another after-tax account available to federal employees, and contributions are not subject to income limits. A Roth IRA provides additional investment flexibility beyond the TSP’s core funds.
Using both taxable and tax-free income streams offers flexibility. For instance, you can use Roth funds to keep your taxable income low, helping to avoid or reduce the impact of income-related surcharges like Medicare Part B premiums.
Roth assets can be inherited tax-free by beneficiaries, and they do not have required minimum distributions for the original owner. This differs from FERS and traditional TSP accounts, which are subject to taxation upon withdrawal.
Strategies to Consider
Some strategies regarding Roth TSPs and IRAs federal employees may consider are:
- Maximize TSP matching contributions: For most federal employees, contributing to the Traditional or Roth TSP to receive the full employer match should be the first step.
- Evaluate Roth conversions: Use the current favorable tax environment to consider converting a portion of your Traditional TSP or IRA to a Roth IRA, especially in years with lower taxable income.
- Consider an in-plan conversion: With in-plan Roth conversions for TSP becoming available in 2026, federal employees will be able to convert their Traditional TSP balance to a Roth TSP without an external rollover.
- Use a Roth IRA for extra savings: If you have maximized your TSP contributions, a Roth IRA can provide an additional avenue for tax-free retirement growth, with greater flexibility for investments.
Always understand that the conversion amount is added to your taxable income in the year of conversion, so it is crucial to plan conversions carefully to avoid pushing into a higher tax bracket. It is recommended to consult a tax advisor to assess how a Roth conversion would affect your personal tax situation.
