If you’re a federal employee with everything in the TSP, consider building Roth and taxable brokerage accounts over time. Tax diversification is one that you will not regret in the future. Image: dee karen/Shutterstock.com
By: Brad Bobb, CFP®As the year draws to a close, it’s the perfect time for federal employees to think about tax planning. Yes, we advisors live and breathe this stuff—but every federal employee and retiree can benefit from it.
My philosophy is simple: control what you can control. That means proactively managing your taxes so you keep more of your hard-earned money today and pass more to your loved ones tomorrow.
Here are some of the most powerful tax-planning strategies available to federal employees and retirees.
1. Tax Diversification (a.k.a. Asset Location)
Everyone understands investment diversification, but tax diversification is often ignored—and it’s available to both employees and retirees.
Tax diversification means holding money in accounts that are taxed differently. This gives you some flexibility and control over your taxable income in retirement.
Here’s how the major account types are taxed:
- TSP and Traditional IRAs – Tax-deferred; 100% taxable as ordinary income when withdrawn.
- Roth TSP and Roth IRAs – Growth and qualified withdrawals are completely income tax-free. Your contributions have already been taxed.
- Taxable Brokerage Accounts – Contributions are after-tax; dividends, interest and realized gains are taxed, but you control the timing of the gains.
- Health Savings Accounts (HSAs) – Triple tax-advantaged (deductible contribution, tax-free growth, tax-free withdrawal for qualified medical expenses)—only available with a high-deductible health plan.
Why does this matter? Because when every dollar is taxed the same way, you lose options.
Example 1 – Joe & Betty (No Diversification) They retire with $65,000 of taxable income (FERS annuity + Social Security, after the standard deduction). They need an extra $36,000 per year and have $1 million entirely in the TSP. To net $36,000 after federal tax, they must withdraw approximately $43,500 pushing them into the 22% bracket (plus possible state tax). Every additional dollar from the TSP is fully taxable, leaving them with little to no control. Higher TSP distributions mean higher income which can trigger higher IRMAA surcharges, increased taxation of Social Security, and push capital gains into the 15% bracket.
Example 2 – Robert & Mary (Diversified) Same income need, same $1 million total, but their assets are split:
TSP: $600,000
Roth IRA: $200,000
Taxable brokerage: $200,000
This couple has choices. They can stay in the 12% bracket by pulling from the Roth or brokerage account first, or by using a combination of withdrawals from the three accounts. Staying in the 12% tax bracket means 0% federal long-term capital gains tax instead of 15%, and they avoid many of the “tax torpedoes” Joe and Betty face.
Bottom line: Tax diversification = options and more control in retirement.
2. Roth Conversions
This is a strategy that financial advisors talk about all the time and for good reason. Nobody ever wants to pay more tax than they have to, but there are times when it makes sense to pay taxes today in return for income tax free money in the future. There are a ton of questions to consider when deciding if you should do Roth conversions.
- What is your current tax bracket?
- What will your future tax bracket be?
- What are your priorities?
- Will you spend all the income that your investments will produce?
- Do you have a desire to leave assets to heirs?
- Will you pay IRMAA surcharges?
- Is the widow’s penalty a concern?
- What will your effective tax be if you do a conversion?
- How will you pay tax on the conversion?
- What will my RMD be if I don’t take any distributions until I’m forced to?
The answers to these questions will either lead you to doing a Roth conversion or deciding not to. If you will be in the same tax bracket or lower when you take distributions as you’re in now, and a couple of the other answers line up then conversions could be a great fit. Roth conversions are a great planning tool that can be evaluated annually, especially in retirement.
3. Qualified Charitable Distributions (QCDs)
The most underutilized tool in financial planning is called a Qualified Charitable Deduction (QCD).
Once you reach age 70½, you can direct up to $108,000 (2025, indexed for inflation) per person directly from your IRA to a qualified charity. The distribution:
Is excluded from your taxable income (huge plus if you don’t itemize)
Counts toward your Required Minimum Distribution (RMD)
Lowers future RMDs by reducing your IRA balance
While most feds aren’t going to give 100k to charity in a year, I know of many that give anywhere from $2,000 to $30,000. If you give to charity anyway, a QCD is almost always better than writing a personal check.
One note on QCDs is that TSP does not allow them.
4. Gifting Appreciated Assets
The 2017 Tax Cut and Jobs Act (TCJA) raised the standard deduction so high that far fewer people itemize. That eliminated the charitable deduction for many. A solution to still get a tax benefit from charitable contributions is to donate appreciated stocks or funds held more than one year instead of cash. You (and the charity) avoid capital gains tax on the growth, and the charity receives the full fair-market value.
Example: Donate shares bought for $1,000 now worth $4,000 → no capital gains tax on the $3,000 gain.
5. Tax-Loss & Tax-Gain Harvesting (in Taxable Accounts)
This is something that people have been doing for years with their taxable brokerage accounts.
- Tax-Loss Harvesting: Sell positions at a loss to offset gains or up to $3,000 of ordinary income; carry forward unused losses indefinitely. (Watch the 30-day wash-sale rule.)
- Tax-Gain Harvesting: If your taxable income keeps you in the 12% federal bracket or below, long-term capital gains are taxed at 0%. Sell winners, pay zero federal tax, reset your cost basis higher by buying the same or similar position immediately.
Final Thoughts
Two big themes emerge:
- Your current and future tax brackets are two essential variables in retirement planning.
- Having money in differently taxed accounts gives you flexibility and often saves thousands (or tens of thousands) in lifetime taxes.
If you’re a federal employee with everything in the TSP, consider building Roth and taxable brokerage accounts over time. Tax diversification is one that you will not regret in the future.
Brad Bobb is a CERTIFIED FINANCIAL PLANNER™ professional specializing in planning for federal employees and retirees. You can learn more at bobbbfinancial.com.
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See also,
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