Should I Be Contributing to the ROTH TSP? - United Benefits

Some of the most common questions about the Thrift Savings Plan involve the ROTH option. Federal employees want to know if it could be a good option for their retirement dollars and how it differs from the Traditional TSP. In this post, we’ll explore the differences between the two and where each fits according to your career stage.

Choosing Tax Treatments.

The decision involves choosing when you pay income tax on your TSP contributions and earnings. You can pay taxes either when you earn and contribute the money or when you withdraw it. With traditional TSPs, your contributions go into the TSP before tax withholding, which can potentially lower your current income tax rate. But when you withdraw money from your traditional TSP, you’ll pay taxes on both your contributions and earnings at the income tax rate of the year you make the withdrawal.

Conversely, the ROTH allows you to pay the income taxes upfront. Withdrawals from the ROTH are tax-free in retirement as long as you have met the basic conditions to be considered “qualified.” Earnings are considered qualified after both Internal Revenue Code (IRC) requirements are met: 5 years have passed since January 1 of the calendar year when you made your first Roth TSP contribution, and you are at least age 59½, permanently disabled, or deceased.

So which option is best?

There is no “best” option as the decision somewhat involves predicting the future of tax rates. A Roth makes sense if you believe you will have a higher income in retirement than you do now. If you expect your income (and tax rate) to be higher at present and lower in retirement, the Traditional TSP may be a better place for your contributions. The Roth may be more appropriate for an employee just starting their career or one who has not fully recognized their full earning potential.

A Blended Approach

Instead of choosing one or the other, you may find contributing to both the Roth and the Traditional advantageous. You can hedge your bets on taxes and have two places to pull money from in retirement. Any matching dollars you receive will automatically go into the Traditional side and cannot be converted to Roth inside the TSP. So, an excellent way to begin would be to contribute 5% to the Roth and let the 5% match go into the Traditional.

A Tax-free Inheritance

What about those who don’t plan on taking income from the TSP but want to leave it to their beneficiaries? When the participant passes away with a Traditional account, the spouse can continue the account in their own name and can take distributions based on their age. However, if the beneficiary is not the original owner’s spouse, they would have ten years to distribute the account’s entire balance. This could cause a high tax rate on the distributions, particularly if the recipient is a high-income earner.

On the other hand, taxes on Roth accounts have already been paid by the original owner when they funded the account. If someone inherits a Roth retirement account, they still have to fully distribute the account within ten years, but the distributions are tax-free for that entire ten years. Also, a Roth balance isn’t subject to IRS-required minimum distributions (RMDs), which means the original owner can keep more in the account to pass along at death.

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