Getting money into your TSP is the easy part, but getting it out without getting killed in taxes is much harder. Today, we’re going to look at how one federal employee saved over $184,000 in taxes—not through magic, but by simply knowing how to manage their TSP in a way that made sense for them. While this specific strategy won’t be a perfect fit for everyone, it highlights how taking control of your investments can help you get the most out of what you’ve worked so hard to save.
The Structural Flaw of the TSP
The reason so many feds struggle with tax efficiency in retirement comes down to a structural flaw within the TSP: it forces both your Traditional and Roth money into the exact same investments. However you invest your Traditional balance is exactly how your Roth balance will be invested. For example, if you put your money 50% in the C Fund and 50% in the G Fund, your Roth money is forced into that identical allocation. You cannot break them apart.
This causes a significant problem when it comes to taxes. As you likely know, all the growth that happens in your Traditional TSP is fully taxable when you withdraw it. Conversely, all the growth in your Roth TSP comes out completely tax-free. If you have $500,000 in Traditional and $500,000 in Roth, and they both grow to $1 million, the entire $1 million from the Roth is tax-free, while the entire $1 million from the Traditional is taxable. That difference is the key to maximizing your tax savings.
The Power of Asset Location
To fix this structural flaw, we use a strategy called “asset location”—putting the growth where the taxes can’t touch it. What if you could take your Traditional money and invest it mostly in safer, more conservative funds, while focusing your Roth money entirely on aggressive growth? Overall, your portfolio might still have the same balance of conservative and aggressive investments, but *where* those investments sit makes all the difference.
Let’s look at an example. Assume you have $1 million total, split evenly between Traditional and Roth. (If you don’t have that much in Roth yet, don’t worry—Roth conversions and other strategies can help build that balance over time.) Let’s assume your aggressive investments earn 10% a year (roughly the historical average of the stock market), your conservative investments earn 4% a year, and a 50/50 split earns 7% a year. We’ll also assume a 20-year retirement and an effective tax rate of 22%.
The Cost of the Default Approach
If you leave your money in the TSP and invest it 50/50, both your Traditional and Roth balances are forced to grow at that 7% rate. Over 20 years, both halves will grow to about $2 million. The $2 million in the Roth comes out completely tax-free, which is fantastic. However, the $2 million in the Traditional account will cost you over $400,000 in taxes when withdrawn, and it will be subject to Required Minimum Distributions (RMDs).
The Asset Location Advantage
Now, let’s apply the asset location strategy. What if we took the Roth money out of the G Fund and put it entirely into something like the C Fund, where it could grow at 10% a year? And what if we focused the Traditional money on the G and F Funds to keep it stable? You are still investing your overall portfolio 50% aggressively and 50% conservatively, but you’ve changed *where* that growth happens.
After 20 years, your Roth balance would grow to more than $3 million—all completely tax-free. Meanwhile, your Traditional balance would grow to about $1 million. The total amount of growth across your portfolio was the same, but because you directed the aggressive growth into the tax-free account, you only pay about $240,000 in taxes on the Traditional side instead of over $400,000.
Long story short, this strategy saves you about $184,000 in taxes and leaves you with over $700,000 in additional tax-free wealth over time. You didn’t have to take on any more risk; you simply strategized the money you already had.
How to Implement This Strategy
If the TSP doesn’t allow you to separate your investments, how do you actually do this? The answer is moving your money to an IRA. To do this, you must be either separated from federal service or at least 59½ years old. Once you meet one of those criteria, you can roll your Traditional TSP into a Traditional IRA and your Roth TSP into a Roth IRA.
Once your money is in IRAs, the accounts are naturally separate. You now have the control to invest your Traditional IRA conservatively and your Roth IRA aggressively. You can put the investments that actually make sense into the type of account they belong in. After all, you want your Roth money to grow as much as possible!
While this specific strategy may not make sense for everyone, exactly how you manage your money makes a massive difference in the wealth you experience over time. If you want help maximizing your investments and creating a great tax strategy for your federal retirement, our firm offers free 50-minute strategy sessions to see if we’re a good fit to help you get the most out of what you’ve worked so hard to save.