Some Considerations for Choosing the Traditional TSP or the Roth TSP
As of Oct. 1, 2012, all federal employees and members of the Uniformed Services
are eligible to contribute to the Roth Thrift Savings Plan (TSP). Until this
year, all employees and Uniformed Services members could contribute only to the
The question in the minds of many employees and Uniformed Service members is:
Which TSP account is better suited for my needs? This column discusses some
considerations for 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 - $17,000 during 2012 -- and for
employees age 50 and older who are eligible to do "catch-up" contributions -
$5,500 during 2012.
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.
Besides the federal government offering its employees the Roth TSP, there are
some private companies and state and local city governments offering Roth
401(k), Roth 403(b) and Roth 457 retirement plans to their employees.
Participation in Roth retirement plans has been rather slow, however. According
to a survey conducted by some investment companies, nationally less than 10
percent of employees who have access to Roth retirement plans have enrolled.
Part of the reason for the lack of participation in Roth retirement plans has
been that employees are not fully aware or educated about Roth retirement plans.
In particular, which individuals benefit most from Roth retirement plan
A possible reason for the lack of Roth retirement plan participation is the
"cost" of participation -- using after-tax salary dollars to contribute. For
example, an employee who is in a 25 percent tax bracket and who wants to
contribute $17,000 (the IRS elective deferral limit for 2012) to the Roth TSP
during 2012 would have to earn $22,667. This allows for $5,667 in federal income
taxes to be deducted from the $22,667 gross salary resulting in a net of $17,000
to be contributed to the Roth TSP. This example ignores any state income tax
liability, which would be mean an employee living in a state with an income tax
and who wants to contribute to the Roth TSP would to have earn a larger salary
in order to account for state income taxes.
As discussed in a previous column,
those employees who expect to be in a higher marginal tax bracket during
retirement compared to their present marginal bracket will benefit most from the
Here is a list of other factors that employees
should consider when choosing to contribute to the traditional or the Roth
- 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. In this example, if the single individual is receiving during 2012 $20,000
of taxable income, the first $8,700 is taxed at 10 percent and the next $11,300
is taxed at 15 percent, resulting in an effective tax of 12.325 percent.
- 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
- 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. Those employees who file as
single or head of household cannot contribute to a Roth IRA once their adjusted
gross income exceeds $125,000 during 2012. Those employees who file as married
filing jointly cannot fund a Roth RIA once their adjusted gross income exceeds
$183,000 during 2012.
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.