Step 5 to Crush the Thrift Savings Plan – Roth vs Traditional
We’ve talked about steps 1, 2, 3, and 4 to crush the Thrift Savings Plan (TSP). Now we’re on to step 5, deciding between the Roth vs traditional TSP. Let’s take a look at the difference between the two and help you to decide which is the right choice for you.
The Traditional TSP
The traditional TSP is the first of two potential tax treatments for your TSP contributions. If you elect it, you defer paying taxes on your contributions and their earnings until you withdraw them.
If you are in a combat zone making tax-free contributions, your contributions will be tax-free at withdrawal but your earnings will be subject to tax.
The Roth TSP
The Roth TSP is the second of two potential tax treatments for your TSP contributions. If you contribute to it, you pay taxes on your contributions now and your earnings are tax-free at withdrawal.
The Roth TSP is similar to a Roth 401(k) that a civilian would have, not a Roth IRA. There are no income limits for Roth TSP contributions. You can contribute to both your Roth TSP and a Roth IRA without contributions to one affecting how much you can contribute to the other. For example, in 2018 you can contribute the full $18,500 to your Roth TSP and $5,500 to your Roth IRA.
Which One is Best for You?
Here’s a table that compares the two options from the TSP website:
|The Treatment of…||Traditional TSP||Roth TSP|
|Your Paycheck||Taxes are deferred*, so less money is taken out of your paycheck.||Taxes are paid up front*, so more money comes out of your paycheck.|
|Transfers In||Transfers allowed from eligible employer plans and traditional IRAs||Transfers allowed from Roth 401(k)s, Roth 403(b)s, and Roth 457(b)s|
|Transfers Out||Transfers allowed to eligible employer plans, traditional IRAs, and Roth IRAs2||Transfers allowed to Roth 401(k)s, Roth 403(b)s, Roth 457(b)s, and Roth IRAs3|
|Withdrawals||Taxable when withdrawn||Tax-free earnings if five years have passed since January 1 of the year you made your first Roth contribution, AND you are age 59½ or older, permanently disabled, or deceased|
The issue of whether Roth is a good option for you was discussed in this TSP Highlights called Is Roth For You?
If you are more of a visual learner, you might enjoy this video from the TSP called “Is Roth Right for Me?”
If you like interactive calculators, this one from Betterment is pretty good.
If you don’t trust anything I say and want to read what someone else thinks, I don’t blame you. Here’s a good article from Money.
The decision really boils down to whether you’d like to pay taxes now (Roth) or later (traditional) and how your current tax rate compares to your likely future tax rate during retirement. While predicting the future is not easy, if you are young or early in your career, your earnings and tax rate are likely to rise in the future, so you should probably lean toward the Roth option. If you are in your peak earning years and you expect your tax rate to fall in retirement, you should probably lean toward the traditional and defer taxes to a future date.
If you are not sure which option to choose, many people recommend you diversify your retirement accounts and simply split the Roth and traditional 50/50. That way in the future you’ll have options depending on how future tax rates and your financial situation changes.
What do I do? I can afford the taxes now and want as much tax-free money available to me as I can get, so I put all the money in the Roth TSP that I can. That said, the first part of my career I didn’t have a Roth option, so a large percentage of my TSP balance is in the traditional TSP as well.
Some Rules to Be Aware Of
The TSP keeps your traditional and Roth money in separate “buckets” in your TSP account. However, you cannot just tap one or the other balance when you request transactions such as contribution allocation changes, interfund transfers, loans, and withdrawals. All transactions will include a proportional amount from each balance.
You cannot convert any portion of your existing traditional TSP balance to a Roth balance.
You can make both traditional and Roth contributions if you want. You can contribute in any percentages or amounts you choose and can change your election at any time.
If you are getting government contributions (perhaps because you are in the Blended Retirement System), they are deposited into your traditional TSP.
The Bottom Line
Use the resources above to decide if you want to invest in the traditional TSP, the Roth TSP, or some combination of the two. If you’re not sure what to do, I’d just split it 50/50 so you have options in the future.
Keep your eye out for the next step to crush the TSP, rebalancing…coming soon.