Which Thrift Savings Plan Is Right For You? Roth Vs. Traditional

Having the choice of contributing to a Traditional TSP or a Roth TSP provides you with a significant tax planning option—but it does force you to make another financial planning decision. Many people find making this decision a challenge because there’s no one right answer for everyone, and it depends upon several factors.

What’s Not Different

First, what’s not different: The TSP contribution limit applies to both accounts. In 2020 you can contribute up to $19,500, not including employer matching dollars. Individuals 50 or older get to contribute an extra $6,500, for a total of a $26,000 maximum employee annual contribution. Additionally, you can contribute to both accounts, as long as your total contribution doesn’t exceed the annual limit.

Traditional Vs. Roth TSP Benefits

The Traditional TSP (referred to as TSP for simplicity) and Roth TSP provide different tax treatment options for your employee contributions and distributions. The key differences are as follows:

Traditional TSP (tax me later):

The traditional TSP allows you to make your contributions before taxes are taken out of your pay, reducing your taxable income and your current overall tax bill. This pre-tax contribution provides an upfront tax benefit by deferring taxation until your funds are distributed.

While your TSP contributions and earnings will grow tax-deferred, your distributions from the TSP are fully taxable at ordinary tax rates.

The Traditional TSP allows you to postpone your tax payment until you withdraw your funds.

The significant benefit of the TSP is the current tax savings, which will lower your gross income and may make you eligible for additional tax deductions and tax credits that have adjusted gross income “phase-outs.”

Lastly, those who may have started saving late in their career and are approaching retirement may find the TSP more flexible than a Roth, due to the Roth’s five-year rule: Which requires the Roth account to have been held for five years for distributions to be qualified even if age 59½.

Note: If you contributed tax-exempt money (combat pay), your contributions would be tax-free when withdrawn, but your earnings will be subject to tax.

Is the Traditional TSP Right for You?

If you are reasonably sure that you will be in a lower overall tax bracket in retirement, contributing to a TSP may be advantageous. The reasoning is that the TSP’s income tax deferral benefits those expecting to be in a lower tax bracket when they plan on making withdrawals. Meaning you’re expecting to pay lower income taxes on your TSP withdrawals in retirement because you postponed paying taxes during your working years when you were in a higher income tax bracket.

Roth TSP (tax me now)

Roths allow after-tax contributions and tax-free withdrawals. You pay taxes upfront contributing to your Roth with money that has already been taxed. Once in your Roth, your contributions grow tax-sheltered, and as long as you meet certain IRS requirements, your withdrawals are tax-free at retirement.

The Roth TSP acts as the opposite of the traditional TSP.

Keep in mind that the Roth TSP is not a Roth IRA and there are no income restrictions. So, if you’re eligible to contribute to TSP, you can contribute to the Roth TSP regardless of your income level.

Another key advantage of the Roth TSP is that you can roll it over to a Roth IRA when approaching retirement (keeping in mind the 5-year rule). This option is significant because although both the Traditional and Roth TSP are subject to required minimum distributions (RMDs) at age 72 when you roll your Roth TSP to a Roth IRA, you can avoid the RMDs and perhaps pass that money on to heirs.

Note: If you contributed tax-exempt money (combat pay) to your TSP, once you are eligible for withdrawals, you can receive tax-free income and tax-free contributions and earnings from your Roth. In other words, your investment is completely tax-free.

Is the Roth TSP Right for You?

The Roth TSP strategy is based on the assumption that you will be in a higher tax bracket in retirement. Therefore, paying your taxes today and receiving tax-free withdrawals in retirement will be the most advantageous option.

Hence, if you’re in a low-income tax bracket now — for instance, if you’re early in your career and think you’ll be in a higher tax bracket in retirement, a Roth can make a lot of sense. After all, it doesn’t take a genius to realize that paying taxes upfront if the tax bill is small is a good thing.

Which Should You Choose?

The general rule is that if you expect to be in a higher tax bracket when you retire, then a Roth may be your best option. However, if you believe that your income will drop once you retire, perhaps you began saving for retirement later in your career, then a Traditional TSP may be the most advantageous.

While some Federal employees may be in a lower tax bracket when they retire, many of them end up in a higher tax bracket because of the amount of their retirement income. Their retirement income includes their FERS pension, TSP (or/and IRA) distributions, Social Security, and other pensions such as military a pension. Another factor that’s worth considering is how Required Minimum Distributions (RMD) may substantially increase your taxable income.

Rather than making an affirmative decision, why not contribute to both? Remember that you can contribute to both accounts simultaneously, or you can switch back and forth throughout your career.

Just as you should diversify your TSP and other portfolios, there’s a strong case for diversifying your tax exposure in retirement.

By using both a Roth and a Traditional TSP, you’d lower at least a portion of your current taxable income, maintain a diversified retirement plan, and give yourself a hedge if future tax rates change.

It is also worth noting that your agency/service matching contributions are based on the total amount of money (traditional and Roth) that you contribute each pay period. All agency/service contributions are deposited into a traditional TSP. Therefore, if you contribute to a Roth, you will have a Traditional TSP accumulating your agency/service match.

Lastly, your personal financial circumstances will dictate which option is best for you. The decision can be complex, and ideally, you’ll determine which option is best for you by building a financial plan. You can also find some additional resources on the TSP website. This article is solely for informational purposes and if you do not feel confident in making the decision alone, you should consult with a qualified financial planner.

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The SECURE ACT 2.0 passed and impacted many of the articles on this website. While the articles were correct when written, it’s impossible to re-write every article. Please consult a qualified professional (i.e., CFP®, CPA, or attorney) before implementing any strategy.

Author: Jose Armenta, MsBA, CFP®, ChFC®, EA

Hi, I’m Jose Armenta, a Certified Financial Planner practitioner. For over 14 years, I have worked with or among federal employees, from serving in the Marine Corps to my stint as a police dispatcher and now as a financial planner specializing in helping FERS federal employees. In that time, I have spoken to hundreds of federal employees about their benefits and retirement. Helping federal employees maximize their benefits, reduce taxes, and live confidently is a passion of mine. When I am not perfecting financial plans, you’ll find me at the shooting range, playing the drums, or breaching blanket forts with my three little ones.