Back in the spring of 2012, federal workers were able to start making after-tax contributions to the Roth Thrift Savings Plan (TSP). In addition to getting the agency match, the biggest advantage of these accounts is tax-free withdrawals in retirement. Although there are several reasons why the Roth TSP may be a good retirement savings strategy, it may not be ideal for everyone. It’s important to explore the advantages and disadvantages before you add the Roth TSP to your retirement plan.
The Roth TSP Is Funded With After-Tax Earnings
Contributions to a Roth TSP are deducted from after-tax earnings which means you’re paying taxes on your contributions now at your current income tax rate. As a result, distributions made in retirement are tax free. However, if you’re still raising a family and cash flow is tight, you might want to make pre-tax contributions to the traditional TSP to lower your tax burden. If you expect to be in a lower tax bracket when you retire, your taxes on withdrawals from your traditional TSP will be lower than they are today.
“Also consider that the Trump-era income tax cuts will expire on December 31, 2025.”
High Earners May Not Benefit From The Roth TSP
If you and your spouse have a high household income, you may be better off making pre-tax contributions to the traditional TSP during your working years. Since dual-income families are often in the higher tax brackets, the tax advantages of the traditional TSP may make more sense. Also consider that the Trump-era income tax cuts will expire on December 31, 2025. If Congress doesn’t extend the tax cuts, high earners might want to reconsider making after-tax contributions to the Roth TSP in the years before they retire.
The Roth TSP May Not Make Sense If You’re Close To Retirement
According to the latest available data, only around 20% of TSP participants are making contributions to the Roth TSP. Of those who have a Roth TSP, their average balance is considerably lower than their average traditional TSP balance. If you’re only a few years away from retirement, you’ve likely hit your highest earning years, and paying taxes on your Roth TSP contributions doesn’t make sense. Making tax-deferred contributions and catch-up contributions to the traditional TSP lowers your tax burden considerably when you’re close to retirement.
As you can see, if you’re in a lower tax bracket in retirement, the Roth TSP may not be a good strategy for you. To estimate your projected tax liability, connect with an FRC® trained advisor who can help you crunch the numbers.
