The Thrift Savings Plan (TSP) is a federal retirement plan. More than 6 million people have a TSP, making it the world’s most extensive defined contribution plan. In addition, about 9 out of 10 contributors are either satisfied or extremely satisfied with TSP.

There was formerly one TSP account. But in 2012, a new option was introduced that lets employees choose how they will be taxed on their TSP contributions. You need to decide between the Roth and traditional TSP before investing in a TSP. Both options have their strengths and risks. Which is preferable depends on your retirement location, current and future tax brackets, and whether you want to pay taxes now or later.

What Is the Difference Between a Traditional TSP and a Roth TSP?

What is a Traditional TSP?

A traditional TSP is a type of account you can use to save money. You won’t have to pay taxes on the money you save, but you will have to pay taxes when you withdraw the money during retirement. The traditional TSP will also reduce your taxable income.

Make $150,000 a year and want to save $15,000 in your traditional TSP. The government will reduce your taxable income by the amount you contributed to your traditional MSP. So, in this case, it would only be taxed on $130,000 instead of $150,000.

What is a Roth TSP?

The Roth TSP is a new way to contribute to your TSP introduced in 2012. If you choose this option, you have to pay taxes on the money before you put it in. That means you won’t have to pay any more taxes on the money when you take it out during retirement. It makes the Roth TSP appealing to many federal employees because they consider it an opportunity to have a tax-free income once they retire.

If you put $15,000 of your annual income into a Roth TSP account, you will still have $150,000 per year. The good news is that, upon retirement, you can withdraw all of your money tax-free. You will, however, be required to pay taxes in advance.

The Advantages and Dangers of Traditional TSPs and Roth TSPs

What Are the Advantages and Disadvantages of a Traditional TSP?

One advantage of investing in a TSP is that you do not have to immediately pay taxes on your contributions. It is an excellent way to save money. Another advantage is that the TSP can lower your taxable income. The greater your annual income, the greater the benefits of a standard TSP.

Traditional TSPs do not require contributors to pay capital gains tax on TSP transactions. It allows your money to grow without having to pay taxes on it. It can increase your retirement savings.

The primary danger of selecting a regular TSP is that you cannot forecast the amount of taxes you will owe in retirement. It seems expected that tax rates will increase in the future. There is simply no way to foresee whether your retirement tax bracket would be lower or higher. You must decide if you are willing to take the danger.

What are the Benefits and Risks of Roth TSP?

The main advantage of selecting a Roth TSP is that you won’t have to pay taxes on the amount you withdraw when you retire. It means you can enjoy your total retirement savings, the total amount of contributions you make, and the TSP earnings.

A Roth TSP can benefit young federal employees just starting their careers. They will likely have bigger salaries, which means their taxable income will increase. However, a Roth TSP protects you against future tax increases. Therefore, you have no cause for concern, as taxes were paid before your payments.

The most significant disadvantage of a Roth TSP is that you will not be able to lower your taxable income. It is preventing you from getting into a lower tax bracket. It is because contributions you make to your Roth TSP are not tax-deductible.

To avoid being charged taxes when you take out money from your account, you must be at least 59 years old, and the account must have been open for at least five years.

You must pay taxes if you cannot meet either of these requirements. The earnings on the contributions will be taxed, but the amounts considered part of your contributions would stay tax-free.

Roth TSP vs. Traditional TSP: Which One to Choose

The main difference between a traditional TSP and a Roth TSP is when you need to pay taxes. But before selecting which is better for you, you must consider other factors. Both types of TSP have their advantages and disadvantages. You must consider what would benefit you and choose the one that fits your needs. If it meets your expectations, you will be happy with either type of TSP.

If you want to pay your taxes now instead of later, we suggest you go with a Roth TSP. If you wish to lower your tax bracket, so you will have more monthly money, then a traditional TSP is the best choice.

You can also think about where you want to retire. If you intend to relocate to a state with a high-income tax, it would be better to choose a Roth TSP. But if you are going to stay in a state with low-income tax, then a traditional TSP is ideal.

Whether you choose, both a traditional and Roth TSP are exciting additions to your retirement toolkit. It guarantees that you will have continuous cash flow once you retire, improving your senior years.

 

Deciding Between Traditional and Roth TSP Accounts

If you are a veteran who is leaving the military, you have two options for your retirement fund. You can either leave it in your Thrift Savings Plan or move it into an Individual Retirement Account. Both choices have pros and cons, but in this article, we will focus on how to roll your TSP into an IRA. It can be done in a Roth IRA or traditional IRA account.

TSP Overview

The TSP, or Thrift Savings Program, offers federal employees a retirement savings account. It means that the government contributes money to the account, on top of what employees save. This account provides tax benefits for retirement savings. It differs from a pension and a guaranteed benefit someone receives when they retire.

TSPs can be either traditional or Roth, depending on the investor’s tax situation. Individuals may choose between a regular and a Roth TSP. Every dollar you put into a standard TSP reduces your current taxable income. Roth TSPs, on the other hand, provide a tax advantage later. You don’t immediately benefit from putting money into a traditional TSP. However, every dollar you take out after age 59 1/2 is exempt from taxes.

Service members who leave the military are not required to close their TSP accounts. Instead, the federal government lets you keep your account open and use money as you see fit. This approach makes sense for many service personnel for two reasons:

  • Low expense ratios: The TSP’s investment fund alternatives offer extremely low expense ratios (the amount you pay to hold the funds).
  • There is no account fee: You also do not have to pay administrative costs to the government to keep your account open.

IRA Overview

IRAs are different from other types of retirement savings plans. They are not employer-sponsored plans. You, the individual, can open an IRA and save money for retirement. It differs from other retirement plans, which have a guaranteed employer contribution.

IRAs and TSPs are similar in that they are both tax-advantaged retirement savings vehicles. If you open a traditional IRA, you can receive a tax break for every dollar you contribute, up to a yearly maximum. At certain income levels, this benefit is phased out. Alternatively, you can start a Roth IRA and benefit from a tax cut in the future. It means you won’t have to pay taxes on the money when you withdraw it in retirement, as long as you’re 59 ½ or older.

The Benefits of Rolling TSP Funds into an IRA

There are a few advantages to preserving your earnings for retirement in a TSP account after you have left the military. But there are also some significant advantages to rolling those funds into an IRA. If any of the below benefits resonate with your unique situation, moving your TSP funds into an IRA may make sense.

Advantage 1: Investment Options

The TSP has low expense ratios, but it also has limited investment options. There are just five individual funds and several life-cycle funds to choose from. Suppose you want to invest in individual stocks, exchange-traded funds, or other standard investment options. In that case, you cannot do so in a TSP.

You can invest in a lot of different things with an IRA. You are limited to what the account custodian lets you invest in. But for more sophisticated investors, IRAs let them be more flexible with their investments. Some investors also use retirement funds to invest in alternative assets (like real estate or precious metals). But you can’t do this with a TSP or regular IRA. You can do this with a self-directed IRA.

Advantage 2: Simplicity

As people get older, they may try to simplify their financial life. It may mean having fewer open retirement accounts. Suppose you have served in the military, worked a civilian job, and started an IRA. In that case, you might have three retirement accounts. You might also have an account from your spouse.

Rather than keep track of all these separate accounts, some retirees prefer the simplicity of a single charge. Rolling your TSP and 401k funds into an IRA will help you get there.

Advantage 3: Continued Contributions

You can’t make direct retirement contributions to your TSP account when you leave the military. You can transfer money from other retirement accounts into your TSP, which creates more paperwork. And as stated above, moving money back into a TSP limits your investment options.

You can also choose to put your TSP funds into an IRA. This way, you can select the investment options you want and keep making contributions to the IRA each year.

Advantage 4: Potential Tax Benefits (Roth-specific)

You may consider converting your standard TSP into a Roth IRA, depending on your circumstances. Roth TSP donations are after-tax, whereas traditional TSP contributions are made before taxes. Therefore, you will be responsible for paying taxes on the entire amount if you transfer money from a traditional TSP to a Roth IRA.

If you enter a lower tax bracket when you leave the service, this strategy could save you a lot of money. For example, say you have $100,000 in your traditional TSP when you separate. If you move those funds into a Roth IRA, you’ll need to pay income taxes on the entire $100,000. But, once it’s in the Roth IRA, you can withdraw that money and all of the earnings tax-free once you reach retirement age.

Let’s say that you and your spouse choose to travel or go back to school for a year during your first year as civilians. It would mean that you have very little income and would fall into one of the lower IRS tax brackets. That way, you would only have to pay a 10% or 12% tax rate on $100,000 (as opposed to 22% to 37% for people with higher incomes). Plus, you can withdraw the money from your retirement account without paying taxes. Alternatively, when you have to withdraw traditional TSP funds from your retirement account during required minimum distributions, you could end up in a much higher tax bracket.

Suppose you convert your traditional TSP balance into a Roth IRA when you separate. In that case, the TSP administrators will not withhold taxes for you. It means that you must plan to pay taxes on the entire conversion amount when you file your annual taxes.

Making the Decision

The benefits of transferring your balance into a TSP outweigh the low expenses. In that case, you may want to consider transferring your balance into an IRA. Traditional IRAs and Roth IRAs are the two primary forms of IRAs. We will explain both in the following two sections.

TSP to Traditional IRA Rollover

The TSP administrators make it easy to close your account. You can log in to their website, go to the “Withdrawals and Changes to Installment Payments” option, and then use the online withdrawal wizard. This wizard will help you through the entire process of withdrawing your money. When you choose the “Full Withdrawal” option, the wizard automatically generates a form called TSP-70, Request for Full Withdrawal.

You’ll need some information about your account to withdraw money from your traditional IRA. It includes the number of your account and the name of the company that is holding it. If you have had this account for a long time, you can use it. If not, you can open a new account and put the money in there from your old account. It’s easy to open an IRA at many companies, and you can do it online.

After you finish the online withdrawal wizard, print and sign the form; if your spouse is a beneficiary, have their signature notarized too. Once that’s completed, there are a few ways to submit the form:

  • Option 1: Submit the signed TSP-70 to your new IRA account custodian. 
  • They will process it for you, and eventually, the TSP will mail a check to your new custodian. They will then notify you that your cash has been received.
  • Option 2: Send the signed TSP-70 form to the TSP. The TSP will then send you a withdrawal check. You must forward this check to your new IRA custodian to avoid paying taxes and getting penalized for withdrawing early from your TSP account.

TSP into a Roth IRA Conversion

Converting a traditional TSP account to a Roth IRA is similar to the steps you would take to roll over your account. You will use the same withdrawal wizard and have the option of having someone else handle the process for you or doing it yourself.

The Roth IRA conversion differs from the traditional TSP in terms of taxes. When you move funds from a traditional TSP to a Roth IRA, you have to pay income taxes on the whole amount. Because the TSP does not withdraw any money for taxes, you must budget for the total tax obligation. Instead, the TSP will give you a 1099-R in January of the year following the withdrawal.

This form, also given to the IRS, shows how much money you earned from your Roth IRA conversion. If you transferred your whole $100,000 traditional TSP balance to a Roth IRA, your 1099-R would state that you made an additional $100,000 due to the change.

However, you don’t have to pay a lot of taxes in one year if you convert all of your traditional TSP balance into a Roth IRA. You can instead do it over several years. To do this, first, roll over your traditional TSP account into a traditional IRA. It won’t cost any extra money. Then, depending on your overall financial situation, choose to convert $25,000 per year for four years. It will help you reduce your annual tax bill.

If you do a traditional to Roth conversion, you don’t have to worry about the annual contribution limits for IRAs. But if you make direct contributions to an IRA, you can only contribute a certain amount each year.

Tax-Exempt TSP Contributions

If you made TSP contributions while serving in a combat zone, you would have a tax-exempt balance in your TSP account. These are funds that you will never have to pay taxes on. As a result, you must ensure that this money is not incorporated into a regular IRA by mistake. You’ll find a box asking if you want to withdraw your money when you fill out the TSP withdrawal wizard:

  • Do not select this option for a standard TSP-to-IRA rollover.
  • Check this box if you complete a traditional TSP to Roth IRA conversion.

You can take the tax-exempt money as soon as you separate from the military. Still, you can get a double benefit if you contribute it to a Roth IRA. Once you withdraw, you won’t have to pay taxes on them, and you will not have to pay taxes on them when you deposit them.

Final Thoughts

When you leave the military, you can choose to keep your TSP balance in that account. If you want low expenses and easy investment options, it makes sense to do this. However, suppose you want more flexibility with your investments. In that case, you can roll over your TSP balance into a traditional or Roth IRA. It will give you more choices for what to invest in. And depending on how you do the rollover, you could get some great tax benefits in the future.

Frequently Asked Questions About Traditional VS Roth TSP

Is a Roth TSP Better Than a Traditional TSP?

The Roth TSP is a type of account where you pay taxes on your contributions, but then when you take the money out, you don’t have to pay taxes on it. That means you won’t have to pay taxes on the money you make from the account either.

Is It Better to Invest in TSP or Roth IRA?

The Traditional IRA is better if you think your taxes will be lower in retirement. You can use the deduction now when you have a high tax rate. The Roth IRA is better if you are far away from retirement.

How Much Should I Put in Roth TSP?

To contribute the most you can to your 401k, you must contribute around 28% of your income. If you are 50 or older, you can contribute an extra $6,500 per year. It brings the maximum contribution up to $27,000 per year or $2,250 per month.

Can I Convert My Traditional TSP to a Roth TSP?

No, you cannot convert a regular TSP to a Roth TSP. Nor can you directly convert a TSP to a Roth IRA. However, you can roll over your TSP into an IRA and then convert it to a Roth IRA.

Does Traditional TSP Reduce Taxable Income?

Contributing to the traditional TSP lowers your taxable salary, which decreases your AGI and saves you money on taxes this year. Distributing money from a traditional deductible IRA or TSP is fully taxed at regular rates.

When Should I Switch From Roth to Traditional?

There are two good occasions to convert to a Roth IRA when your income is low, or the stock market is down. This way, you can pay fewer taxes on the money you convert. In the past, it was possible to change your mind and return to a traditional IRA if you didn’t like what you did.

What Is the Downside of a Roth IRA?

Roth IRA contributions are made with after-tax money, meaning you don’t get a tax deduction when you contribute. Another drawback is that you can’t withdraw account earnings until at least five years have passed since the first contribution.

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