Give some thought to how you will contribute to your Thrift Savings Plan – traditional or Roth? Image: Vitalii Vodolazskyi/Shutterstock.com
By: John GrobeDo you want to pay your federal income taxes now or later? “Never” is not an acceptable answer to this question. Many of us would like to put off any payments we make, taxes or otherwise, but this might not always be the best answer. Think of the choice between contributing to the traditional Thrift Savings Plan, or the Roth TSP.
If I contribute to the traditional TSP, I am lowering today’s taxes because all contributions to the traditional TSP are tax deferred. However, when I begin to withdraw from the traditional TSP, everything I take out is taxed at my rate for ordinary income. Not just the contributions are taxed, but the tax deferred earnings are taxed as well
On the other hand, if I contribute to the Roth TSP, I am not getting the benefit of tax deferral on my contributions; I’m paying my taxes today. However, when I withdraw from the Roth TSP, my withdrawals might be free from federal income tax. As long as my withdrawals are qualified, the portion of my withdrawal that came from earnings in the account are tax free; and I’ve already paid the taxes on my contributions back when I made them.
You will note that I said, “as long as your withdrawals are qualified”. If your withdrawals are not qualified, you will owe federal income taxes on the part of your withdrawal that came from earnings. In the TSP, Roth withdrawals are viewed as coming proportionally from contributions and earnings.
What does it mean for a withdrawal to be qualified? You must:
• Have had your Roth TSP account for at least five years (five years from January 1st of the year in which you made your first contribution); and
• Be at least 59 ½ years old.
Because many employees can retire at an age under 59 ½, care should be taken not to take any Roth withdrawals before they become qualified. You are allowed to specify the part of your TSP, Roth or traditional, from which you take your withdrawals.
So, should you pay your taxes now (with Roth contributions), or later (with traditional contributions)? As with many questions, there is no one size fits all answer – unless that answer is “it depends”. What follows are some of the things on which the answer depends.
Think of your own situation when you read these questions:
• What is my tax bracket today, and what will it be when I’m ready to start taking withdrawals from the TSP? It’s possible that I’ll be paying a higher percentage of my income in the future than I am saving today by making tax deferred contributions. Of course, we have no way of knowing what future tax brackets will be.
• How much time do I have for my contributions to grow? The longer they have to grow, the greater the value of tax-free Roth withdrawals will be.
• Will higher income in retirement trigger and “stealth taxes” on my income. Specifically consider the taxation of Social Security and increased Medicare Part B premiums once your income reaches a certain level.
• Will you be leaving TSP monies to your heirs? Your heirs will have to pay the deferred taxes on your traditional TSP when they take money from it. There will be no taxes due on monies they receive from your Roth TSP. Heirs will also need to take required minimum distributions (RMDs) based on the total account balance, traditional + Roth balances combined.
Give some thought to how you will contribute to your Thrift Savings Plan – traditional or Roth?
John Grobe is a retired federal employee and retired retirement educator with over 30 years of experience in helping federal employees understand their retirement.
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