The TSP (Thrift Savings Plan) is an incredible tool for building wealth for federal employees. But with any great tool, there are often many questions on how to get the most out of it.
One of the most asked (and important) questions that comes up is if a federal employee should use the traditional TSP or the Roth TSP or some combination of both.
This question is often asked in one of the following ways:
-Which is better, the traditional TSP or Roth TSP?
-Is it better to pay the taxes now with the Roth TSP or later with the traditional TSP?
-Is a Roth TSP worth it?
This guide will walk you through the relevant things you need to consider when deciding between the Roth TSP and the traditional TSP.
Table of Contents
What is The Difference Between The Traditional TSP and Roth TSP?
-How Does The Traditional TSP Work?
-How To Make Sure Your Roth TSP Comes Out Tax Free
Other Major Differences/Considerations Between Traditional and Roth TSP
-When You Can Access The Accounts
-Your Traditional TSP Will Affect Other Things
-How Much Money You Need At Once
-Required Minimum Distributions (RMDs)
So Which is Better, Traditional or Roth TSP?
-When The Traditional TSP is Better
-When You Should Have Both: Tax Diversification
-Do my agency matching contributions go into my traditional TSP?
-Do I get matching contributions if I only use the Roth TSP?
-Can I contribute to the Roth TSP and traditional TSP at the same time?
-How much money can I put in my TSP between the traditional and Roth?
-Can I convert my traditional TSP to the Roth TSP?
What is The Difference Between The Traditional TSP and Roth TSP?
The main difference between these two types of accounts is when you pay taxes. Now or later.
Note: There are many other differences/considerations as well which we’ll dig into later in this article.
How Does The Traditional TSP Work?
When you contribute money into the traditional TSP you get a tax deduction in the year that you make the contribution. In other words, you don’t pay taxes on any money you put in.
As a simplified example, if you have a taxable income of $100,000 and you put $15,000 into the traditional TSP then your taxable income will go down to $85,000. So by using the traditional TSP you save taxes while you are working.
However, when you take the money out of the account in retirement that is when you pay taxes. So if you contributed $100,000 into the TSP over your career and it grew to $150,000 then you’d pay taxes on the full $150,000 when you take it out.
How Does The Roth TSP Work?
The Roth TSP is exactly the opposite. You don’t get a tax deduction when you contribute but the money comes out completely tax free in retirement (assuming you follow the rules a couple paragraphs down from here).
For example, if you again have a taxable income of $100,000 and you put $15,000 into the Roth TSP then your taxable income will still be $100,000. But in retirement anything that you contributed to the Roth TSP and the growth can be taken out tax free.
How To Make Sure Your Roth TSP Comes Out Tax Free
There are two main rules that you must follow in order to take money out of your Roth TSP tax free.
Be at least 59 and ½.
Have had money in the account for at least 5 years.
If either of these two criteria are not met then you will have to pay income taxes on your earnings. Whenever you withdraw money from your Roth TSP the withdrawal is split pro rata between your contributions (money you put in) and your earnings on your contributions.
The part of your withdrawal that can be attributed to your contributions will never be subject to taxes or a penalty but the portion that comes from your earnings can be if you don’t follow the two rules from above.
Other Major Differences/Considerations Between Traditional and Roth TSP
While taxes is the most obvious difference between these two accounts, here are some miscellaneous considerations to consider as well.
What State You Retire To
Because these accounts can determine when you pay taxes, a major consideration is where you are going to live when you retire.
For example, if you know you are going to move to a state with high income tax (i.e. California) for retirement then you may want to use the Roth TSP to pay taxes before you move there.
On the other hand, if you are going to retire to a state that has little or no income tax (i.e. Florida) then you may want to use the traditional TSP to delay taxes until retirement.
Passing Money To Heirs
For some, leaving money behind for kids or others is a major factor to consider.
When you leave a traditional pre-tax account behind then your heirs will be on the hook for the tax bill as they distribute it. However, if you leave behind a Roth account then your heirs will enjoy the great blessing of tax-free withdrawals.
When You Can Access The Accounts
Generally, as long as you retire in the year that you turn 55 or later then you can access your traditional TSP and Roth TSP with the normal 10% penalty that would apply but you generally have to wait until age 59 1/2 to get tax free distributions from the earnings portion of your Roth TSP.
Note: If you are a special provisions employee (air traffic controller, fire fighter, law enforcement) then you can access your TSP without penalty as long as you retire in the year you turn 50 or later.
And as we discussed above, to avoid taxes on your Roth TSP earnings you will have to have the account open for 5 years and be at least 59 and ½.
Your Traditional TSP Will Affect Other Things
Because traditional TSP withdrawals affect your income from a tax perspective it may just increase the price you pay for other things in retirement.
For example, Medicare part B premiums go up as your income increases. You can find the cost of Medicare part B here.
So if you are close to an income threshold then taking money out of your traditional TSP could not only cost you more in taxes but also cost you more in Medicare part B premiums.
The same is true with Social Security. As your income increases, so does the % of your Social Security that is subject to taxes. You can find out more about taxes on your Social Security income here.
How Much Money You Need At Once
If someone needs a large chunk of their TSP at once then using their Roth TSP has a major advantage because it won’t cause a spike in taxable income which might push you into a higher tax bracket.
Whenever someone needs to make a large withdrawal/purchase from their traditional TSP in retirement the tax consequences are not appealing.
This withdrawal often causes a large spike in income and taxes.
For example, if you take out $100,000 from your Traditional TSP to buy a RV then that withdrawal may push you from the 12% tax bracket to the 24% tax bracket. As a result, it may end up costing you a lot more money than you anticipated.
Required Minimum Distributions (RMDs)
In the past, both the Traditional and Roth TSP were subject to RMDs but that changed in 2022. Currently, the traditional TSP is subject to RMD’s but the Roth TSP is not. RMDs start between age 73 and 75 depending on when you were born.
So Which is Better, Traditional or Roth TSP?
As you know by now, there are lots of things to consider when making this decision but there are certain situations that tend to be better suited for one over the other.
When the Roth TSP Is Better
The Roth TSP is a great tool when you project that your taxes will be higher in the future.
This is often the case when someone is young in their career and their salary is relatively low compared to what it will be.
Also, because most people agree that tax rates are most likely going to increase in the future, many people like to use the Roth TSP to pay taxes before that happens.
And some people simply prefer to pay the taxes now in efforts to not have to worry about it later.
Bonus Tip: For high earners, the Roth TSP may be one of the only ways to save any money after tax. This is because there is an earnings limit on putting money into a Roth IRA. You can find the earnings limits here.
When The Traditional TSP is Better
The traditional TSP is a great way to keep your taxes during your career especially if you are a high earner.
And because you lower your AGI (adjusted gross income) by using the traditional TSP it may also keep you within the threshold to qualify for certain tax credits and perks like Child Tax Credits and IRA Contribution Limits.
It can be especially helpful for those that are nearing the end of their career because their income is probably as high as it will ever be.
Source: Kitces.com
When You Should Have Both: Tax Diversification
There are many situations where there is a distinct advantage to using only the Roth TSP or only the traditional. But there are also many situations in between that are not as clean cut.
Because as you know by now, to figure out exactly what type of account will be the best for you you’d have to know exactly what your income, tax rates, and other factors will be in the future.
And because no one has a crystal ball it can often make sense to use both the traditional and Roth TSP to get some of the benefits of both.
This way as things do change you have the flexibility of both accounts.
For example, you can withdraw more from your Roth TSP in years when you’d like to keep your taxes down and then use more of your traditional TSP when you may have more wiggle room in your tax bracket.
Common Questions
Do my agency matching contributions go into my traditional TSP?
Yes, your agency’s matching contributions will always go into your traditional account regardless of if you are contributing to your Roth or Traditional accounts.
Update: As of December 2022, a new law made it possible to put your agency’s matching contributions into your Roth TSP however as of 4/24/23 this new capability has not been implemented.
Do I get matching contributions if I only use the Roth TSP?
Yes, even if you contribute 100% into the Roth TSP you will still get your agency’s match. However, your agency’s match will always go into the traditional side.
Can I contribute to the Roth TSP and traditional TSP at the same time?
Yes, you can use both of them in any combination as long as you don’t contribute more than the annual limit between both accounts. For 2023, the annual limit is $22,500 or $30,000 if you are age 50 or older. So if you are 48 you can put up to $22,500 into your TSP every year and you can split that $22,500 however you’d like between the traditional and Roth.
How much money can I put in my TSP between the traditional and Roth?
For 2023, the annual limit is $22,500 or $30,000 if you are age 50 or older. So if you are 52 you can put up to $30,000 into your TSP every year and you can split that $30,000 however you’d like between the traditional and Roth.
Can I convert my traditional TSP to the Roth TSP?
The short answer is no, you can’t. But if you want the long answer then check out this article.
