Breaking Down The Roth TSP
Beginning in 2012, federal workers were given the option of making after-tax contributions to the Roth Thrift Savings Plan (TSP). On top of agency matching, the Roth TSP allows you the distinct advantage of tax-free withdrawals in retirement. While the Roth TSP could be an attractive addition to your retirement portfolio, it may not fit into everyone’s investment strategy. It’s important to understand the advantages and disadvantages before you dive into the Roth TSP.
Contributions To The Roth TSP Are After-Tax Earnings
When you contribute to a 401(k) or traditional TSP, those contributions are pre-tax. This helps to lower your tax burden by potentially moving you to a lower income tax bracket, but in retirement, you’ll pay taxes on any distributions from these tax-advantaged accounts. Since contributions to a Roth TSP are post-tax, you won’t feel immediate relief from your tax burden, but it’s important to remember that distributions from your Roth TSP in retirement are tax-free. If you fear that your retirement income may result in a “tax bomb,” a Roth TSP could be a solution.
High Earners May Prefer Tax-advantaged Accounts
High earners often prioritize the immediate tax savings provided by pre-tax contributions over the future tax-free withdrawals of Roth accounts. Contributions to traditional retirement accounts reduce your taxable income in the year you make them. For individuals in higher tax brackets, this can lead to substantial tax savings, as the contributions lower your overall tax liability in the short term.
Benefits Of The Roth TSP
Unlike the traditional TSP, Roth TSPs do not require minimum distributions at age 73. This means you can leave your money in the account to grow tax-free. If the Trump tax cuts are allowed to expire, you might be facing much higher tax rates in the future. A Roth TSP gives you protections not offered by a traditional TSP. It’s important to note that to withdraw earnings (not contributions) from your Roth TSP without penalty, you must be 59.5 and the account must have been open for at least 5 years.
Having both pre-tax and post-tax retirement accounts can give you flexibility in managing your tax liability in retirement. To develop a strategy that aligns with your financial goals, contact an FRC® trained advisor.
