Many people have heard of a Roth IRA but what is a Roth TSP and how is it different from the regular TSP? Let’s get into it.
The main difference between the regular TSP and the Roth TSP is when you pay taxes. For the regular TSP, your contributions are tax deductible and you don’t pay any taxes until you pull the money out (usually during retirement). For the Roth TSP, your contributions are not tax-deductible but you will never pay taxes on that money again (assuming you don’t pull out money when you aren’t supposed to).
For example, if you invest $100 into your normal TSP, the $100 would come straight out of your paycheck and you would not pay taxes on it right now. But come retirement time, let’s say that $100 has turned to $300 because it was invested. You would pay taxes on the the full $300.
Let’s use the same example but with a Roth TSP. Would would pay taxes on the $100 in the year that you made it. But come retirement, you would be able to take out the entire $300 without paying a penny in taxes.
Now, the million dollar question. Which is better?!? It depends. Most people believe that they will be in a lower tax bracket while in retirement so they’d like to push their taxes (use the regular TSP) until they pull their money out. What I have seen, is that most federal employees are not in a lower tax bracket in retirement because nearly all of their pension income, TSP distributions, and social security count as taxable income.
For most people it makes sense to use both the regular TSP and the Roth TSP. Let me explain why. It is almost impossible to predict what taxes will be like in retirement. Tax rates can change and your personal situation can change from year to year. Having both the regular TSP and Roth TSP gives you the flexibility to adjust year by year. If you have a year with higher income than expected, you can withdraw from the Roth TSP to limit your taxable income that year. Furthermore, if taxes decrease or you have less income one year, you can withdraw from the regular TSP.
Having both the regular TSP and Roth TSP gives you the tools to be flexible in retirement and take advantage of opportunities that arise along the way. Because only ¼ of all federal employees use the Roth TSP account, this could be an easy change that could give you more options in retirement and put you one step closer to financial freedom.
