Thrift Savings Plan (TSP) Roth Option
An increasing number of employers—including the federal government—now offer employees a relatively new workplace savings choice—a Roth retirement savings option. With a Roth, employees are able to make after-tax contributions to their retirement savings account that will be tax-free when withdrawn.
The TSP began making the Roth option available to servicemembers in May 2012. Agencies and service branches have been phasing in the Roth option over time, as they modify payroll systems to accommodate contributions. As of October 1, 2012, the following groups are able to participate in the Roth TSP:
- active military members of the Army, Navy and Air Force;
- active duty and Reserve members of the Marine Corps and Coast Guard; and
- Uniformed Members of the NOAA and USPHS Corps;
- federal civilian employees.
In the words of Greg Long, TSP's Executive Director, "the Roth TSP option offers an important new tool for federal civilian employees and uniformed servicemembers in managing their retirement income by providing greater flexibility in the tax treatment of contributions now and in the future."
According to the TSP, with the introduction of Roth, employees will potentially have two types of balances in their TSP account: a traditional TSP balance and a Roth TSP balance. Money already in your account when you begin making Roth contributions may not be converted to a Roth and will remain part of your traditional balance. Matching contributions, which are not currently offered by any of the services but are available to DoD civilian employees, go into and will always be a part of your traditional balance. However, you may designate your own contributions any way you like—to Roth TSP, traditional TSP or a combination of the two—and participate in any TSP investment option, regardless of how you chose to allocate your savings.
Comparing Your Options
Both the traditional TSP and Roth TSP feature tax-deferred compounding of contributions that are made to the account. However, tax treatment of contributions and withdrawals differ between the two options:
|Traditional TSP||Roth TSP|
|Contributions||Come from pre-tax income, reducing gross income reported to IRS||Come from taxable income, not reducing gross income reported to IRS|
|Withdrawals||Taxed at your ordinary income tax rate||Tax-free, provided account is open at least five years and you are either at least 59½ or permanently disabled. In the event of death, withdrawals by heirs are tax-free.|
Tax treatments aside, both the traditional and Roth TSPs require minimum distributions after you turn 70½ in most cases. In addition, both can be rolled over to an IRA or other retirement savings plans such as a 403(b) or when you retire or leave your job for any reason.
Your total contribution can’t be more than the annual limit the IRS sets for an employer-sponsored retirement plan. With an employer-sponsored Roth, as well as a traditional option, there are no income restrictions limiting who can participate. The only requirement is being eligible to participate in your employer’s plan.
Which Is Right for You?
There is no one-size-fits-all answer. Instead, the right answer for you will depend on your current tax situation and whether your tax rate is likely to be higher or lower in retirement.
Since you don’t pay any taxes on Roth withdrawals, the higher your tax bracket in retirement, the more advantageous a Roth is likely to be. Strong savers—including those who contribute the maximum amount allowed by the IRS each year—are good Roth candidates because they are likely to have a bigger nest egg in retirement that can benefit from Roth’s tax-free withdrawals.
On the other hand, if you’re in a low tax bracket today, you might consider a Roth now, when a lowering of your gross income will not be as significant a tax benefit as it might be later on, if you find yourself in a higher bracket.
Because it comes right out of your paycheck, a Roth contribution is likely to reduce your take home pay by more than a similar contribution to the traditional option, which is made using pre-tax dollars. If you want to save—and take home as much money as possible—allocating to the traditional TSP option is perhaps the way to go.
Finally, since no one knows what tax rates will be in the future, diversifying with contributions to both a traditional and Roth TSP account might be a way to hedge your tax bets with your retirement savings.
To learn more about the TSP’s Roth option, visit the TSP website: www.tsp.gov.