ROTH TSP is great, and it’s getting better for Feds.
One of the more interesting investment options available to Federal employees is often the most misunderstood. With competing philosophies out there, many financial consultants don’t want to admit the Thrift Savings Plan (TSP) has some good features. The ROTH TSP is a noteworthy feature of the TSP for Federal Employees. And it’s getting better. This year, TSP now offers the option of In-Plan conversions. In this three-part series we’ll work through some common misconceptions about the ROTH TSP and how the in-plan Roth conversion feature works and where it may fit in with your retirement planning.
What is the ROTH TSP
Implemented in 2012, ROTH TSP allows Feds to make contributions on an after-tax basis. When you contribute to the Traditional TSP, we typically receive a tax deduction in the same year. When you contribute to a ROTH TSP, you are taxed on that money first, then it goes into the TSP. Doesn’t seem like a benefit, so why would one do this? The trade-off is the long-term benefit: when the ROTH funds reach a 5-year holding period, everything that has been contributed and everything that’s been earned can be withdrawn tax-free. This is powerful, let me say it again; all the money comes out tax-free!
Common Misconceptions about ROTH TSP
Jumping in, our first point of misconception: there is no income limit on contributing to the ROTH TSP, unlike ROTH IRAs. 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 TSP. Even 13 years after being made available, we weekly run into Feds that make the comment “I make too much to contribute” or, just as commonly, “Is this a new feature? I’ve never heard of it.” Let’s get this good news out and share it with everyone you know!
On to our second misconception: we often hear that Feds are afraid to allocate more contributions to a Roth TSP because they fear they will miss out on their matching. In reality, all contributions can be directed to the ROTH TSP, with none of our contributions going to the traditional TSP, and still receive the full match. No matter how much you contribute to the ROTH TSP, as long as you have at least 5% per pay period going into TSP, either Traditional or ROTH TSP, you will receive your full match. That means if all of your contributions go only to the Roth TSP, you still receive your match.
Misconception number three is that it’s too late in the career or that someone is too old to contribute to the ROTH TSP. Even late-career Feds who are close to retiring or in their highest-earning years should consider contributing all to a ROTH TSP. Having tax-free income in retirement will provide Feds with tax diversification and enable a powerful income strategy. I can explain with a question: How long do you plan on needing 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, then 20-30 MORE years in retirement. That means if you start the ROTH TSP now, it can grow through retirement, continuing to build wealth as you draw down your assets. When the time comes to use the ROTH money, these funds have a built-in inflation hedge. You’ve already paid the taxes, so every dollar is yours!
Benefits of ROTH TSP
Contributing to the ROTH TSP allows Feds to get more of their money into the TSP. That’s right, we’ll say it again. You can put more of your money into the TSP by using a ROTH TSP. How is this possible? When contributing to the traditional TSP, those dollars are contributed on a pre-tax basis. That means they have not been taxed yet. As the account grows over time, so does the tax liability. When you reach the age to draw money out, taxes are due at your income rate on the whole distribution. 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 are contributing will be higher. Then, when you withdraw the money, everything you put in and everything it earned comes out tax-free. So, when you do the math, of the money the Fed is contributing to your TSP match, the ROTH TSP provides a higher percentage than traditional of what the employee gets.
One of the most significant changes from the SECURE 2.0 Act is that Roth TSP accounts are no longer subject to Required Minimum Distributions. Prior to this change, even though Roth IRA owners were exempt from RMDs, Roth TSP participants were still required to take distributions starting at age 73, undermining one of the core advantages of Roth savings. This means that dollars you convert into your Roth TSP can sit and grow tax-free for as long as you choose, giving you complete control over whether and when you pull from that account. This creates a powerful opportunity to let those funds compound undisturbed while drawing from other sources first, potentially passing a larger, tax-free balance on to heirs, providing more money for late-life health care, and providing an inflation hedge.
As you can see, we believe the ROTH TSP is important for Federal Employees and can provide sustainable benefits to Feds in retirement. If nothing else, contributing to the ROTH TSP provides us with tax diversification. That means we have another bucket of funds that are taxed differently from our pension and traditional TSP. So, when taxes go up…and when they go down, we are able to adjust where we pull retirement income based on the climate at the time of withdrawal. That provides additional flexibility to a well-rounded income distribution plan.
See you for Part 2!
Prepare. Plan. Prosper
Wes Battle CFP®, ChFEBC℠, AIF®, RICP® proudly hails from a Fed family. Beginning with his grandfather, their service to the country reaches back 70 years. Wes brings nearly two decades of financial experience to his service to federal employees and works to treat them as family.
James "Wes" Battle is a Financial Planner - Securities offered through Cetera Wealth Services, 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 Wealth Services, 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 Wealth Services, LLC nor any of its representatives may give legal or tax advice.
All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful. Converting from a traditional account to a Roth account is a taxable event. A Roth account offers tax free withdrawals on taxable contributions. To qualify for the tax-free and penalty-free withdrawal or earnings, a Roth IRA must be in place for at least five tax years, and the distribution must take place after age 59 ½ or due to death, disability, or a first-time home purchase (up to a $10,000 lifetime maximum). Depending on state law, Roth IRA distributions may be subject to state taxes. A diversified portfolio does not assure a profit or protect against loss in a declining market. Tax Free - Income may be subject to local, state and/or the alternative minimum tax.