TSP

While a good deal for savers, Roth contributions are taxable up-front, giving the government its tax money right away. Image: bangoland/Shutterstock.com

How is Congress like Bobby Darin?  Darin sung about multiplication in his 1961 hit Multiplication (#1 in the UK, but not quite as successful this side of the pond), and Congress endorsed Rothification in recent legislation, including SECURE 2.0.  I can’t quite picture Mike McCarthy and Chuck Schumer forming a duet and crooning, “Rothification, it’s the name of the game”, but Congress has expressed support for encouraging savings in the Roth versions of both IRAs and employer plans, sometimes at the expense of their traditional versions.

A few examples of the push toward the Roth version of retirement savings are:

· Beginning this year, employer plans (such as the TSP) will be allowed, but not required, to make their matching contributions on a Roth basis.  Don’t hold your breath waiting for the TSP to act on this immediately because there are a few tax issues about it but do expect it to be implemented sometime in the future.

· Beginning next year, required minimum distributions will no longer need to be taken from the Roth portion of employer plans, this will make the Roth TSP option more attractive.

· Highly compensated workers (over $145,000, adjusted annually for inflation) who make catch-up contributions to an employer sponsored plan will have to make them as Roth contributions.

Why this interest in the Roth approach to retirement savings over the traditional approach?  Tax revenue – plain and simple.  Roth contributions are taxable up-front, giving the government its tax money right away.  And Roth earnings do not always escape taxes, only earnings taken in qualified withdrawals do.  In order for the earnings portion of Roth withdrawals to be tax free, the account owner must have had a Roth account for at least five years and must be at least 59 ½.

This interest in getting taxes upfront isn’t new, it was evident in the early proposals for 2017’s Tax Cut and Jobs Act.  Early versions of the legislation would have reduced the dollar amount of retirement contributions that could be from pre-tax dollars.  It would not have lowered the amount that was allowed to be contributed overall, but it would have limited the pre-tax portion.

Given the fact that employer plans now have the ability to make matching contributions on a Roth basis, we can expect most of them to offer it voluntarily at some time in the future.  Because Roth contributions are after taxes, the employee who is receiving the matching contributions will be required to pay the income taxes on the employer’s matching contributions.  That’ll delay implementation as it will require some adjustment to the record-keeping system of most plans.

Did You Know that the early withdrawal penalty that is assessed for withdrawals of pre-tax money from an IRA prior to age 59 ½, does not apply to TSP withdrawals by participants who separate from federal service in the year in which they reach age 55 or later?  Special category employees can avoid the penalty if they separate in the year in which they reach age 50 or reach 25 years of qualifying special category service.

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