The Thrift Savings Plan (TSP) is a qualified retirement plan, which means the plan meets specific IRS requirements and, as such, receives additional tax benefits and protections. The tax benefits you’ll receive and how your withdrawals will be taxed depends on whether you have a traditional or a roth TSP.
Traditional vs Roth Taxation
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 you make withdrawals.
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.
Note: If you contributed tax-exempt money (combat pay), your contributions would be tax-free when withdrawn, but your earnings will be subject to tax.
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 specific IRS requirements, your withdrawals are tax-free at retirement.
The Roth TSP acts as the opposite of the traditional TSP.
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.
Final Thoughts
Understanding how your TSP is taxed is critical to the longevity of your financial plan in retirement. So, make sure you take the time to plan how your withdrawals will work throughout your retirement. As always, if you would like help developing your financial plan, consult with a qualified financial planner.
