What are the Tax Differences Between Traditional and ROTH TSP Accounts?
One of the differences between a Traditional TSP account and a ROTH TSP account is in the taxation of contributions and withdrawals. For a ROTH account, you have to pay taxes on your contributions but the account can grow tax free and after age 59 ½ you can make withdrawals from the account tax free. For a Traditional account, you don’t have to pay taxes on your contributions and the account can grow tax free, but after age 59 ½ you must pay taxes on any funds you withdraw from your account.
Should I Contribute Funds to a Traditional or ROTH TSP Account?
The TSP allows you to allocate 100% of your contributions to a Traditional account, 100% to a ROTH account, or mix your contributions in any ratio between the accounts. The only restriction is that the sum of your contributions cannot exceed the yearly contribution limit set by the Internal Revenue Service ($23,000 in 2024 plus another $7500 for those age 50 or older). In general, you should allocate more to your ROTH account in any year that you think you will be in a higher tax bracket during retirement than in the year of the contributions. Conversely, you should allocate more to your Traditional account in any year that you think you will be in a lower tax bracket during retirement than in the year of the contributions. You can make that decision each year based on your tax situation which you can use to your advantage. For example, let’s assume you have higher than normal income in a particular year that places you in a higher tax bracket than normal. For that year, it might make sense to contribute more to your Traditional account than to your ROTH account.
Should I Withdraw Funds from my Traditional account or my ROTH Account During Retirement?
After age 59 ½, the withdrawals from your ROTH account are not taxed while the withdrawals from your Traditional account are taxed. Since you can decide how much to withdraw from each account, you can allocate your withdrawals to minimize your taxes. For example, let’s assume you have lower than normal income in a particular year that places you in a lower tax bracket than normal. For that year, it might make sense to withdraw more from your Traditional account than from your ROTH account to take advantage of your lower tax rate.
Use Both a ROTH account and a Traditional Account to Provide Yourself Flexibility
It is almost always advantageous to have and use both a ROTH account and a Traditional account. The goal is to look at your tax situation each year and to make contribution and withdrawal decisions that will leave you the most money after taxes over the course of your life. If you only use one type of account, you lose flexibility that will probably end up costing you more taxes and leaving less money to spend and/or give to your heirs.
TSP ROTH Accounts Are not Subject to Required Minimum Distributions (RMDs)
Once you reach age 72 or 73, you are required to take RMDs from your Traditional TSP accounts each year. This can force you to take more from your account than you need or desire. One of the benefits of the ROTH accounts is that you are not required to take RMDs. This can be very helpful in your tax and estate planning.
Use Both Traditional and ROTH Accounts
The bottom line is that it is generally advantageous to contribute funds to both a Traditional account and to a ROTH account while you are working. Having both types of accounts can give you a lot of flexibility to minimize your tax liability from a lifetime perspective and will give you flexibility in regards to Required Minimum Distributions (RMDs) and estate planning. You should find a financial planner that can help you maximize the use of your ROTH and Traditional accounts in regards to taxes, RMDs, and estate planning based on your circumstances.
