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Considerations for Choosing the Traditional TSP or the Roth TSP
Which Thrift Savings Plan (TSP) account option is better suited for your needs? This column discusses some considerations for federal employees in choosing to contribute to the traditional TSP or the Roth TSP. Employees should note that they can contribute to both the traditional and the Roth TSP provided their total contributions to both do not exceed the IRS' elective deferral limit.
Before presenting these considerations, it is important to review the basic differences between the traditional TSP and the Roth TSP, as summarized in the following table.
Here is a list of other factors that employees should consider when choosing to contribute to the traditional or the Roth TSP:
- Contributing to the TSP while living in a high income tax state like California and retiring to an income tax- free state, such as Florida or Nevada, or to a state that has a low income tax state such as Alabama. In that case, an employee who contributes to the traditional TSP will pay less overall in state income taxes.
- "Effective" tax rate versus the "marginal" tax rate at the time of retirement plan withdrawal. When an individual retires and starts receiving their pension income, it is their effective tax rate that matters and not their marginal tax bracket. For example, a single federal employee contributes $10,000 a year to the TSP and plans to withdraw $20,000 a year from the TSP during retirement. At the time of contributing the individual is taxed at a 25 percent tax rate. If the individual expects to be in the same or higher tax bracket at retirement, then the Roth TSP is a good deal. But under the current "progressive tax system," not every dollar of taxable income is taxed at the marginal tax rate.\
- What effect will contributing to the Roth TSP have on one's current taxes? Contributing to the traditional TSP will reduce an employee's adjusted gross income in the year of contribution, resulting in less taxable income and a reduced income tax liability in the current year. A smaller adjusted gross income could also result in the employee being eligible for current year tax credits such as the child credit and educational tax credits, and deductions such as contributions to a traditional IRA. Several tax credits and deductions are not available to individuals whose adjusted gross income is too large. Those employees who contribute to the Roth TSP and therefore have larger adjusted gross incomes could also be more likely subject to the alternative minimum tax
- Roth TSP is favorable for account owners who wish to pass on as much as possible to their heirs. After they retire from federal service, Roth TSP account owners are allowed to rollover their Roth TSP accounts to a Roth IRA. Roth IRAs have no required minimum distribution requirements starting at age 70.5 as do traditional IRAs, 401(k) retirement plans, the traditional TSP, and the Roth TSP. As such, a Roth IRA owner can hold onto the account indefinitely and pass it on tax-free to their beneficiaries upon his or her death.
- Roth TSP is favorable for employees who are ineligible to invest in Roth IRAs because of their large adjusted gross income. See here for the most current Roth IRA contribution limits.
About the Author
Edward A. Zurndorfer is a Certified Financial Planner, Chartered Financial Consultant, Chartered Life Underwriter, Registered Health Underwriter, Registered Employee Benefits Consultant and Enrolled Agent in Silver Spring, MD -- and the owner of EZ Accounting and Financial Services, an accounting, tax preparation and financial planning firm also located in Silver Spring, MD. Zurndorfer is also is an instructor at federal employee retirement seminars throughout the country and writes numerous columns and books on federal employee benefits.