TIP: What about the Roth TSP?

I must admit when the Roth TSP first showed up in 2012, I didn’t pay it much attention. I was really focused on getting those tax breaks that the traditional TSP gives you. That really helped me during my working years, especially when my kids were younger and the joint income from my wife and I were causing taxes to became a bigger issue as time went by. During those years we were able to defer approximately $48,000 from our joint income and that made a big difference in our tax bill!

When I talk about the Roth TSP I am also going to talk a little bit about the Roth IRA. I think people get confused when talking about both of these accounts and they are not the same. The Roth TSP is probably closer to a traditional TSP account than a Roth IRA.

Now I have started to look at the Roth TSP and have noticed some very interesting scenarios that the Roth TSP allows you to do that the traditional TSP doesn’t. For one thing, the Roth TSP can give you a hedge when your taxes are higher and you want to use the Roth to take out some extra money during retirement without putting you in a higher tax bracket.

Also, the Roth seems like a very good investment if you want to leave money to your loved ones when you pass away. Since the tax is already paid, all you have to do is take out an amount, equal to the IRS limit of approximately $14,000 per year per child, and funnel the money to an account in their name. It may take awhile to transfer the money but it could be a very big deal for your family’s future.

The real issue with the Roth TSP is timing. I would say if you are already age 50 and above, the Roth is already too late to be of much use, unless you plan to work all the way to age 62, 65 or 70. If you are age 49 and below, I think you could put some extra money in a Roth TSP and acquire a pretty good nest egg by the time you retire during ages 57 – 62. Then you can alternate the use of the Roth and the traditional TSP, depending on your tax situation for each year.

I say ages 57 – 62 because for the Roth TSP and Roth IRA you have to wait until age 59 ½ before you can access the funds, otherwise you have to pay a 10% penalty. If you retire before age 59 ½, you could use the traditional TSP funds when you first retire and then use the Roth TSP starting at 59 ½ on an “as needed” basis when you need more cash without the tax liability. Waiting to 59 ½ is not a huge hurdle but if you want to retire younger, at ages 50 to 58, you will have to just plan ahead and factor that waiting period into your retirement planning. You also have to have been in the Roth TSP/Roth IRA for 5 years before you can start taking out money.

There is no income restriction for the Roth TSP but there is for the Roth IRA, approximately between $189,000 - $199,000 if you have a joint income tax return and $120,000 – $135,000 for single filers. You can also contribute to both at the same time, if you have available funds that are free to be invested. The Roth TSP does have a Required Minimum Distribution (RMD) starting at age 70 ½ , like the traditional TSP, but the Roth IRA does not have an RMD.

Just for clarity, the RMD is a certain amount, starting at approximately 3.65% of your TSP and slowing increasing, that must be withdrawn every year starting at age 70 ½, so the IRS can start taxing the funds. You don’t have to spend it. You just have to pull the money out so the IRS can get their share. One less thing to worry about if you have a Roth IRA.

If you have a traditional TSP balance and you want to convert to a Roth IRA (you can’t convert a traditional TSP to a Roth TSP), there are some things to consider. Converting a large traditional TSP balance could overwhelm you with taxes if you try to convert the balance all at once. If you are focused and disciplined about converting smaller amounts per year, then the taxes would be much smaller and easier to handle. It would probably be prudent to talk with a tax advisor or accountant if you went the conversion option.

For employees who are just starting their Federal careers, it may be helpful to see if you could fund half to the Roth TSP and half to the traditional TSP, or if you max out the traditional TSP funding at $18,500 for employees under age 50, then try a Roth IRA funding for $5,500, that way at least you get the tax break for the max out amount of $18,500 from the traditional TSP. The type of funds in the TSP are the same for Roth or traditional, so that would not matter. The funding of the traditional TSP and the Roth TSP must total $18,500 combined. You cannot put $18,500 in the traditional TSP and $18,500 in the Roth TSP individually.

The main thing is to be consistent with your TSP funding and keep increasing the contributions to get close to the max out: $18,500 for under age 50 and an additional catch up of $6,000 the year you turn 50 years of age. That way either option you choose, Roth or traditional TSP or half and half, will get you to a comfortable retirement!

Good Luck!