Roth TSP ; image: man at chalkboard doing math

Learn why the Roth TSP can be a great choice for younger feds.

FEDZONE Ed Zurndorfer
Traditional qualified retirement plans (including the traditional Thrift Savings Plan or TSP) were built and established in the 1980s on a simple idea. An employee sets aside a portion of his or her paycheck to save for the future and receives a current year tax break. But over the last 18 years, employees have another option available to them in order to save for their future in a tax-favored way; namely, forgo the current tax break and get the tax break in the future.

The latter arrangement is the premise of the Roth retirement plan, including the Roth TSP. The Roth TSP has been around since 2012 and is funded with after-taxed salary contributions and grows tax-free over time. The Roth TSP is similar in many ways to the Roth IRA. However, these are two important differences between the Roth TSP and the Roth IRA. The first difference is that a federal employee is eligible to contribute more to the Roth TSP than to a Roth IRA in any year. The second difference is that Roth IRA contributions are subject to adjusted gross income (AGI) limitations. If an employee’s AGI is too large in any given year, the employee is not allowed to contribute to the Roth IRA. On the other hand, the Roth TSP has no income limitation as far as contributions are concerned.

In spite of the complexity the Roth TSP has introduced, the Roth TSP creates the opportunity for some federal employees to reduce life-time tax bills and leave more money for themselves and for their beneficiaries.

It is important for employees and retirees to understand that tax-free qualified Roth TSP withdrawals can be used to supplement taxable income (such as CSRS and FERS annuity payments, Social Security monthly benefits, and traditional TSP withdrawals) when federal retirees could be pushed into higher federal and state income brackets. Starting January 1, 2024, Roth TSP accounts will be exempt from required minimum distributions (RMD) that the traditional TSP is subject to. That means the Roth TSP can be left intact for beneficiaries who do not have to pay taxes on the withdrawals. Non-spousal TSP beneficiaries must withdraw inherited Roth accounts within 10 years following the death of the Roth TSP participant.

When to Contribute to the Traditional TSP?

Contributing to the traditional TSP is often a better choice for federal employees who are in their peak earning years. For example, those employees who are in a 35 percent or 37 percent federal income tax marginal tax bracket. These employees need the tax savings currently when they contribute to the TSP, not when they withdraw from the TSP.

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However, these high earning federal employees are advised to look for other ways to get money into Roth accounts (Roth IRAs) if they move into a lower federal marginal tax bracket. For example, if a federal employee retires at age 60 or at their minimum retirement age (MRA) (age 56 to age 57 depending on when the FERS employee was born) and taxable income then decreases, that point of time can present an opportunity to directly transfer traditional TSP to a traditional IRA and then convert the traditional IRA to a Roth IRA. This can result in overall tax savings as a result of the retiree’s current lower federal tax bracket.

When to Contribute to the Roth TSP?

The following are some reasons for federal employees to consider contributing to the Roth TSP:

An employee’s tax rate (combined federal and state) is likely to stay the same in retirement. While the best candidate for contributing to the Roth TSP is an employee whose combined federal and state tax rate is likely to rise in retirement, the flexibility of the Roth TSP can make the strategy of a winner even if the employee’s combined federal and state tax bracket says the same in retirement.

An employee thinks his or her combined federal and state tax bracket is headed higher in retirement. With respect to federal tax rates, the tax cuts that Congress enacted in 2017 (under the Tax Cuts and Jobs Act of 2017 or TCJA) lowers individual tax rates to the lowest ever in the history of individual tax rates. However, these tax cuts are scheduled to expire as of December 31, 2025 and revert back to what the tax rates were pre-TCJA, inflation adjusted. This could mean that some federal retirees could end up in a higher federal marginal tax bracket when they retire after December 31, 2025.

An employee wants to leave their entire Roth TSP to heirs. Since starting January 1, 2024, the Roth TSP will be exempt from required minimum distribution (RMDs) to which traditional TSP and traditional IRAs are subject to. The Roth TSP can be passed on “intact” to beneficiaries.

To protect one’s spouse. For married couples, the argument for contributing to the Roth TSP is more intense. This is because the traditional TSP can be directly rolled over tax-free to a traditional IRA. IRAs can be directly rolled over tax-free to a spouse. Traditional TSP and traditional IRAs are subject to RMDs once a surviving spouse reaches his or her required beginning date (currently, age 72; age 73 starting in 2024). At that time, the surviving spouse will likely be filing his or her taxes as single and likely in a higher federal marginal tax bracket. The surviving spouse will likely be paying more in federal income tax. Starting January 1, 2024, the Roth TSP will not be subject to RMDs.

When to Contribute to Both the Traditional TSP and the Roth TSP?

Financial professionals say that putting a portion of TSP contributions into the Roth TSP can help federal employees hedge their bets if they are not sure what their future combined federal and state tax rates will be. Congress will soon require those federal employees aged 50 and older, and whose Social Security wages exceed $145,000, to contribute only to the Roth TSP. The regular contributions can go to either the traditional TSP or to the Roth TSP. This law takes effect on January 1, 2026.

*Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Additionally, each converted amount may be subject to its own five-year holding period. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion.

Edward A. Zurndorfer is a CERTIFIED FINANCIAL PLANNER™ professional, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars, located at 833 Bromley Street - Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.

Roth TSP ; image: man at chalkboard doing math

Younger Feds and the Roth TSP