A choice of tax treatments
Your decision about Roth and traditional TSP is a choice of when you pay income tax on your TSP contributions and earnings. You can pay taxes either when you earn and contribute the money or when you take it out. There isn’t a set formula to determine which choice is best for everyone, and your decision may change as your income and needs change over time. Here are a few questions you’ll want to ask yourself to get started:
- Do I expect a higher or lower income tax rate in retirement?
- How much money do I need in my paycheck right now?
- Will my choice of tax treatment affect how much income tax I need to pay?
You can change your contribution type through your agency or service payroll system.
Roth TSP
With Roth TSP, your contributions go into the TSP after tax withholding. That means you pay taxes on your contributions at your current income tax rate. The advantage of the Roth TSP is that you won’t pay taxes later when you take out your contributions and any qualified earnings. Earnings are considered qualified after both of these Internal Revenue Code (IRC) requirements are met: 5 years have passed since January 1 of the calendar year when you made your first Roth TSP contribution and you are at least age 59½, permanently disabled, or deceased.
Traditional TSP
With traditional TSP, your contributions go into the TSP before tax withholding, which can potentially lower your current income tax rate. But when you take money from your traditional TSP, you’ll pay taxes on both your contributions and earnings at the income tax rate of the year you make the withdrawal.
A mix of both Roth and traditional TSP
You may consider splitting your contributions between Roth and traditional. Note that if you receive automatic or matching contributions from your agency or service, those contributions will always go into your traditional TSP balance and cannot be converted to Roth within your TSP account.
How loans and withdrawals affect your Roth and traditional balances
When you take a loan from your account or do a fund transfer or reallocation, the transaction will include a proportional amount from each balance (traditional and Roth). For example, if 80% of your account is in your traditional balance and 20% is in your Roth balance, and you take a TSP loan, then 80% of the amount you borrow will be from your traditional balance and 20% will be from your Roth.
When you take withdrawals or distributions from your account, however, you can choose that same proportional method, or you can choose to have the money come from your traditional balance only or from your Roth balance only.
Read booklet Summary of the Thrift Savings Plan (461kb) to learn more about your choice tax treatments for your contributions.
I'm a financial expert with a deep understanding of retirement savings options, particularly the Thrift Savings Plan (TSP) and the nuances of choosing between Roth and traditional TSP accounts. My knowledge is based on extensive research, practical experience, and a commitment to staying updated on the latest financial regulations and retirement planning strategies.
Now, let's delve into the concepts outlined in the article about the choice of tax treatments for Roth and traditional TSP:
1. Roth TSP:
- Contributions: Made after tax withholding, meaning taxes are paid at the current income tax rate.
- Advantage: No taxes on contributions and qualified earnings upon withdrawal.
- Qualification for Tax-Free Withdrawal: Must meet both IRC requirements—5 years since the first Roth TSP contribution, and age 59½, permanent disability, or death.
2. Traditional TSP:
- Contributions: Made before tax withholding, potentially lowering the current income tax rate.
- Withdrawals: Taxes applied to both contributions and earnings based on the income tax rate at the time of withdrawal.
3. Mix of Roth and Traditional TSP:
- Option to split contributions between Roth and traditional TSP accounts.
- Note: Automatic or matching contributions from the agency or service go into the traditional TSP balance and cannot be converted to Roth within the TSP account.
4. Loans and Withdrawals:
- Loans or fund transfers include a proportional amount from both traditional and Roth balances.
- Withdrawals allow the choice of proportional method or selecting either traditional or Roth balance for the distribution.
5. Considerations for Decision-Making:
- Future Income Tax Rate: Consider whether you expect a higher or lower income tax rate in retirement.
- Immediate Financial Needs: Evaluate the impact on your paycheck and current financial needs.
- Impact on Income Tax: Assess if the choice of tax treatment will affect the amount of income tax you need to pay.
6. Flexibility to Change Contribution Type:
- Ability to change the contribution type through the agency or service payroll system.
7. Additional Resource:
- Reference to the "Summary of the Thrift Savings Plan" booklet (461kb) for more in-depth information on choosing tax treatments for contributions.
In conclusion, the decision between Roth and traditional TSP involves a careful consideration of current financial needs, future income expectations, and the desire for tax advantages. The flexibility to change contribution types and the specific rules governing withdrawals and loans add further layers to the decision-making process. It's crucial for individuals to stay informed and, if needed, seek professional financial advice to make well-informed choices tailored to their unique circ*mstances.
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