This is one of those things that not many people talk about but that makes a massive difference in your retirement.
It will make a massive difference in how long your TSP lasts and how much you pay in taxes.
I’m not sure why other people aren’t talking about it more.
Training Wheels
This article will save you money and give you more control over your taxes and retirement.
However, there are different levels to this strategy.
If you use the basic strategy you will get results and if you use the advanced strategy you will get better results. Simple as that.
But because I know not everyone will actually use the advanced strategy, I’ll start with the basic one.
Let Roth Ride!
The basic strategy is simple. Don’t touch your Roth (TSP or IRA) first!
There are always some exceptions but as a rule most people should start drawings from their pre-tax (traditional) accounts first. This includes traditional TSP and traditional IRAs.
Here is an example to show why this is.
Let’s say you have 300k in your traditional account and 300k in your Roth account (600k total), you just retired and need to start withdrawing money. But which account should it come from first?
Well if you could pick (and you can pick), which account would you prefer to let grow to 500k?
If you get 200k worth of growth in the traditional side then that entire 200k is taxable when it comes out. If the 200k of growth happens in the Roth side then that entire 200k is tax free!!
And if that wasn’t a big enough reason, where are 3 more good reasons to use the traditional first.
Tax rates are going up
More than likely tax rates are going up in the future. So if you have a bunch of Roth money in the future then you will be set up for success!
Escape RMDs
Traditional accounts are subject to RMDs (required minimum distributions). This means that the government will start requiring you to withdraw money (and pay taxes) from your traditional accounts.
RMDs for most people start between age 73 and 75.
Roth accounts are exempt from RMDs which gives you more control over your money and life.
Make the Kids Happy
If your kids inherit a pre-tax account they need to pay the taxes on that money but if they get a Roth account then it is all tax-free.
The Advanced Strategy
If you are ready to take the training wheels off, here is the advanced strategy.
In a nutshell, since you are planning to use your traditional accounts first, those accounts should be invested more conservatively than your Roth accounts.
To put it differently, you aren’t planning to use your Roth accounts for a while so those accounts should be invested more aggressively.
But as you may know, the TSP doesn’t allow you to invest your Roth and traditional sides differently so this strategy would have to be done in an IRA.
And for those that are familiar with the Bucket Strategy (it’s a strategy about how to invest in retirement and here is a quick video on it if you aren’t familiar), this would make a ton of sense.
Afterall, the job of some of our short-term money is to be safe while the job of our long-term money is to grow.
