Federal employees aged 50 and older (and therefore eligible to make “catch-up” contributions to the Thrift Savings Plan) may not be aware that effective January 1, 2024, some of these employees can make their catch-up contributions only to the Roth TSP and not to the traditional TSP.
One of the provisions of SECURE Act 2.0 (passed into law on December 30, 2022) restricts employees aged 50 and over who are participating in a qualified retirement as to the type of account (traditional or Roth) that they can make catch-up contributions. Qualified retirement plans that offer the Roth option (such as 401(k) plans and 403(b) plans) and the TSP are affected by this provision of SECURE Act 2.0.
In particular, the provision will not allow federal employees eligible to make any catch-up contributions to the traditional TSP if their Social Security wages exceeded $145,000 during 2023. Social Security wages appear in Box 3 of an employee’s annual W-2 statement and, for most employees, differ from an employee’s taxable wages which appears in Box 1 of an employee’s annual W-2 statement.
During 2023, all employees can contribute a maximum of $22,500 (the IRS’ elective deferral limit) to the traditional TSP, to the Roth TSP, or to a combination of both accounts provided that the total contributions do not exceed $22,500. Employees who will be over age 49 as of December 31, 2023 (that is, employees born before January 1, 1974) can also contribute a maximum $7,500 in catch-up contributions to the traditional TSP, to the Roth TSP, or to a combination of both accounts provided the total catch-up” contributions do not exceed $7,500.
But effective January 1, 2024, those employees whose Social Security wages exceeded $145,000 during 2023 (the $145,000 wage amount will be indexed to inflation in future years) will be allowed to make catch-up contributions only to their Roth TSP accounts.
Affected employees aged 50 and older should note that any or all of the regular contributions ($22,500 contribution limit during 2023) can continue to be made to the traditional TSP or to the Roth TSP or a combination of both accounts provided the total contributions do not exceed the IRS’ elective deferral limit for that year.
How Will the Roth TSP Only Catch-Up Provision Affect Employees?
Roth TSP contributions are not tax deductible. This means that an employee who contributes to the Roth TSP will not reap any current year federal (and in most states with a state income tax) and state income tax savings.
As many of these employees aged 50 and older are in their peak earning years, putting after-taxed dollars into a Roth TSP account could result in higher federal and state income liabilities in the current year. This additional current year tax liability could reduce and even erase the benefit of future tax-free payouts from the Roth TSP account.
But there are some positives resulting from this change in the law. In the long run, those federal employees who will be required to put their TSP catch-up contributions into the Roth TSP may come out ahead.
The following are some reasons:
• Many high earning federal employees are not eligible to contribute to Roth IRAs because their adjusted gross income (AGI) is too high.
These high-earning employees also do not perform “backdoor” Roth IRA contributions because the process is too complex and may be partially taxable. On the other hand, unlike the Roth IRA, there are no income limitations for contributing to the Roth TSP. During 2023, Roth IRA contributions are also limited to $6,500 plus $1,000 more for individuals aged 50 and older. But Roth TSP contributions are limited during 2023 to $22,500 for employees younger than 50 during 2023, and $30,000 for employees aged 50 and older.
• Qualified Roth TSP withdrawals are not included in income.
In addition to not being subject to federal and state income taxes, qualified Roth TSP withdrawals do not leave federal annuitants more susceptible to means-tested Medicare Part B surcharges (called Income Related Monthly Adjustment Amounts or IRMAA resulting in higher Medicare Part B monthly premiums), or the 3.8 percent Net Investment Income Tax (NITT) applicable to interest, dividend, and capital gain income generated from a non-retirement account. This means that a high-income federal employee’s putting more after-taxed salary into the Roth TSP could lead to additional savings in retirement.
• Contributing to the Roth TSP may be better than contributing to taxable brokerage accounts.
As an alternative to making catch-up contributions to the Roth TSP, a high-income federal employee can contribute to a taxable brokerage investment account. Capital gains, dividends and most interest income generated within the brokerage account are taxed annually, while qualified Roth TSP withdrawals are tax-free. If an individual sells asset in an investment account before death, the net gain is taxable, unlike qualified Roth TSP withdrawals. For example, a federal annuitant may have to make withdrawals sometime during his or her retirement to pay for long-term care expenses. Liquidating a brokerage account consisting of stocks at a time that the stock market is on a down-cycle may not be financially prudent.
• Effective January 1, 2024, the Roth TSP account balance will not be included in the calculation of a TSP participant’s TSP required minimum distribution (RMD).
When a federal annuitant reaches his or her required beginning date (RBD) (April 1st following the year he or she becomes age 72, 73, or 75, depending on when he or she was born), the federal annuitant must start taking RMDs from his or her TSP account. In calculating the federal annuitant’s annual TSP RMD, the TSP uses the annuitant’s combined traditional TSP and Roth TSP account balances, thereby resulting in a larger TSP RMD. But effective January 1, 2024, the TSP will not use the Roth TSP account balance in the calculation of the annual TSP RMD, thereby resulting in smaller TSP RMDs and less federal and state income tax a TSP participant will be paying.
• A Roth TSP account can be better for beneficiaries.
A non-spouse beneficiary of a TSP account must withdraw his or her inherited TSP account within five years of the death of the TSP participant. While the beneficiary is allowed to request a transfer of the inherited TSP account to an inherited (“death”) IRA (traditional TSP can directly transferred to an inherited traditional IRA, Roth TSP can be transferred to an inherited Roth IRA), effective for inherited IRA accounts created after January 1, 2020, all inherited IRA accounts must be withdrawn within 10 years of the creation of the inherited IRA. Inherited traditional IRAs are fully table when withdrawn while inherited Roth IRAs are tax-free when withdrawn.
Edward A. Zurndorfer is a CERTIFIED FINANCIAL PLANNER®, Chartered Life Underwriter, Chartered Financial Consultant, Registered Health Underwriter and Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, located at 833 Bromley Street Suite A, Silver Spring, MD 20902-3019