Most TSP Participants Should Switch To the Roth TSP

My friend Austin asked me about the Roth TSP. TSP is Thrift Savings Plan. It’s the equivalent to a 401k plan for federal government employees and members of the military.

Until now, TSP only accepts pre-tax contributions, like a Traditional 401k. TSP announced that it will add the Roth feature soon. I heard April 1, 2012 as the likely start date.

If you are in the TSP now, should you switch some or all of your contributions to the Roth TSP?

Federal civilian employees receive a full match if they contribute 5% of their pay. As a result, many just contribute 5% to get the full match. If they still contribute 5% but switch some or all of the contributions from pre-tax to Roth, because the Roth contributions and the earnings won’t be taxed after 59-1/2, these participants will have a higher retirement income after tax.

Switching to Roth sounds good then. But wait, a higher retirement income can also be achieved by simply increasing the contribution rate, from 5% to say 7%. So should you do 7% to traditional or 5% to Roth?

Private sector employees faced this question for some time now. Many employers added a Roth 401k feature to their 401k plan. The employees had the choice of switching to Roth 401k or bumping up their contributions to the Traditional 401k, because the impact on the take-home pay would be the same.

Like traditional 401k versus Roth 401k for the private sector employees, whether the Traditional TSP is better than the Roth TSP depends on the tax bracket now and the tax bracket in the future, which is unknown. In my previous post  The Case Against Roth 401(k), I argued that most people should stay with Traditional 401k, except those who have a pension and already contribute the maximum.

However, for TSP participants, I say that most should switch to the Roth TSP.

Why the difference between private sector 401k and TSP? One word: pension.

Federal civilian employees do get a pension. The FERS program pays 1.1% of highest average pay during any consecutive 3 years for each year of service if you retire after 62 with 20 or more years of service (1% of high-3 average per year of service if under 62 or fewer than 20 years of service). For a 30-year service, that’s 33% of the pre-retirement income, covered. Social Security will cover another 1/3 of the pre-retirement income. Both FERS pension and Social Security are adjusted for inflation.

At retirement, withdrawals from the TSP will be taxed at the marginal rate, on top of pension and Social Security. For those who already contribute the maximum $17,000 a year to TSP, switching to the Roth TSP will effectively put more money into the TSP. You should lean toward doing the Roth TSP unless:

  1. You will not work long enough to qualify for a pension; or
  2. You have substantial income from other sources now (spouse, outside employment), which puts you in a high tax bracket; or
  3. You will retire early, but postpone drawing from your pension (use TSP withdrawals for gap years); or
  4. You live in a state with high state income tax but you will retire to a state with no or low state income tax; or
  5. an increase in Adjusted Gross Income will make you lose some other tax benefits (child tax credit, American Opportunity Credit, etc.)

Members of the military get a pension only if they stay in the military for 20 years. For those who will stay long enough to get the pension, the case for the Roth TSP would be the same as the one for civilian employees.

Military members who don’t stay 20 years won’t get a pension. I would still do the Roth TSP because the income in the military isn’t that high. After leaving the military, you will likely get a job in the private sector that pays much more. It makes sense to do the Roth TSP now when your tax rate is low.

With some exceptions, most TSP participants should switch to the Roth TSP.

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  1. dd says

    Good analysis for individuals who have pensions. Roth 401Ks are good decisions for someone starting out with a lower salary (pension or not). Switching to a traditional 401K can be done when one makes more money and wants to have an impact on lowering taxes.

  2. qatman says

    Are TSP matching contributions to a Roth TSP also treated as Roth? If so then it seems like a no-brainer to choose the Roth unless other factors weigh heavily against it.

    Example: Salary = $100,000, matching amount = $5000, current tax rate = 30% (for argument’s sake), retirement tax rate = 30%

    If regular TSP, you will get $5000 now and ultimately have to pay taxes of 30% on $5000 = $1500, for a net gain of $3500 after tax.
    If Roth TSP, you will get $5000 now and never have to pay taxes on it, for a net gain of $5000 after tax.

    This would seem to be a pretty big bonus to pass up, unless I am misinterpreting the rules.

  3. Andrew says

    Interesting, I’ve been wondering about this since I read your prior article. I used to be a federal employee but am now a state employee. My pension is better but I have no matching in my 457b.
    You said “For those who already contribute the maximum $17,000 a year to TSP, switching to the Roth TSP will effectively put more money into the TSP”
    So since I’m not contributing the max at the moment because of financial reasons…does it mean it is less beneficial to switch to the Roth 457b?

    “You have substantial income from other sources now (spouse, outside employment), which puts you in a high tax bracket”
    What is considered substantial?
    Also, I thought the rule was that if you think you’re going to be in a higher tax bracket when you retire, you should contribute to Roth.
    With the federal employee, lets say he makes $100,000 which means his pension will be approximately $33,000. Even with the TSP…wouldn’t he be in a lower tax bracket. So should he still go for the Roth?

  4. Tim says

    I’m sticking with the traditiona TSP for a few reasons. One, the deduction keeps me in the 15% tax bracket. I doubt I’ll be in a higher tax bracket when I retire (and things will change greatly by then–I’m only 32.) Secondly, at my age, I don’t have faith that the pension will be around when I retire. Thirdly, I’m not sure I’ll stick around as a Fed until I retire. Fourth, I have an outside Roth that I (and wife) max out each year.

    I contribute 6% of my pay and am nowhere near the limits for the TSP.

    I have thought about this a lot, and while you make a good argument, I think I’ll stick with the traditional TSP.

    At 32, I don’t think a public pension or SS should be in my retirement equation.

  5. Bob G says

    Hi Feds:

    Stay away from the Roth for now…. Why? Everyone is talking about lowering tax rates and “broadening” the base. Both repubs and Dems are talking about this so it’s going to happen… Keep putting into the traditional and let’s wait and see what kind of tax rates we have from tax reform… It then may be worth it since the rates are going so low…

  6. Alison says

    I think it will be helpful if you clarify this sentence: “The FERS program pays 1.1% of highest average pay during any consecutive 3 years for each year of service.” FERS employees only get 1.1% of high 3 ONCE THEY ARE 62. Below age 62, FERS employees retire with only 1% of high 3.

    That’s why many of us remain working until 62….

  7. Pam says

    I am a fed contributing 7% to tsp and am planning on retiring at 62. I am 59 1/2 now. Can I switch my traditional to a Roth?

  8. Harry Sit says

    Pam – Yes, you can switch your future contributions to Roth TSP but you can’t convert the money you already contributed to the traditional TSP to Roth TSP.

  9. Harry Sit says

    Alison – Thank you. Corrected. There’s also a 20 years of service requirement for 1.1% of high-3 average per year of service.

  10. Jay says

    Can you still keep your ROTH IRA (personal one) if you switch your TSP to ROTH TSP? Can you contribute to both ROTH IRA and ROTH TSP?

  11. Harry Sit says

    Jay – You can still contribute to Roth IRA when you switch to Roth TSP, unless your income happens to sit on the borderline where a lower income due to traditional TSP contributions would qualify you for a Roth IRA but a higher income when you contribute to Roth TSP would not.

  12. Jay says

    Thanks Harry. One more question, is the interest earn in ROTH TSP is tax-free as well? I believe that’s how personal ROTH IRA is. The interest you earn/compound is NOT tax even when you take it out at retirement. Correct me if I’m wrong. Thanks again.

  13. Ron Elmer says

    My thoughts are that NOBODY should use the Roth 401k. Here’s an example of why. Let’s take an employee who contributes $15,000 per year to a Roth 401k who is also in a marginal tax bracket of 33% (state & federal). This person is paying an extra $5,000 in taxes.

    What if this person instead, contributed to the Traditional 401k, then take the $5,000 saved in taxes and put it into a Roth IRA. So, for the same cost (or same take-home pay) the employee either has $15,000 in a Roth 401k or have $15,000 in a Traditional 401k AND $5,000 in a Roth IRA.

    I think using a plan of Traditional 401k combined with investing the tax savings into a Roth IRA would probably be better no matter which tax bracket you are in now or in the future. Plus, you end up with some money in each type of savings account. So, you can tap which ever one makes sense in retirement in order to minimize taxes in retirement.

    For example, retire at 59.5 and withdraw funds from your Traditional 401k since you won’t be drawing Social Security until perhaps 67. Once you begin drawing Social Security, then you tap your Roth IRA to keep your taxes low. It’s possible you can avoid paying ANY income taxes in retirement until you are 70.5 years old and are forced to take Required Minimum Distributions from your 401k while also drawing Social Security.

    What does everyone think of this?

  14. Jay says

    I thought you can only get either ROTH IRA or Traditional IRA. Also, isn’t there also a cap ($5k or $7k) for IRA contribution?

  15. Tim says

    Ron, there are a lot of us in the lowest tax brackets who use the TSP. Switching to the ROTH TSP can make sense in this instance. Yes, if you are in higher tax brackets and using the regular TSP brings you down a bracket or reduces your taxable income in that higher bracket, then yes the traditional TSP is likely better.

    Let’s not forget here, too, that the original post is about the TSP, which is only available to Federal employees. Rules may be different.

  16. DC_fed says

    I know this is an old thread but not sure I follow Ron Elmer’s comment of “What if this person instead, contributed to the Traditional 401k, then take the $5,000 saved in taxes and put it into a Roth IRA. So, for the same cost (or same take-home pay) the employee either has $15,000 in a Roth 401k or have $15,000 in a Traditional 401k AND $5,000 in a Roth IRA.” If you are in the higher 33% tax bracket why would you not go ahead and max out out the traditional TSP contribution ($17,500 right now) and get even more tax savings before putting money into the Roth TSP?

    Also, if you did max out a traditional TSP but are 50+ so eligible to make catch-up contributions, is there any reasoning that says it’s better put the catch-up in a Roth TSP rather than the traditional TSP? Or is the thinking still the same, it’s all about what tax bracket you assume yourself to be in upon retirement?

  17. Trevor Fells says

    The highest marginal tax rate for earners eligible to contribute to Roth IRA is 28%. Even taxpayers that are in the phase out range are still well within the 28% tax bracket.

  18. AL Light says

    Sir, I am in the military with 8 more years before retirement (20 years). I am currently contributing 20% of my base for sometime now. Just received my contribution balance today and I currently have $80,000 balance. I wanted to switch to Roth TSP but can’t get a better advice. I am currently 40 years old . Is it better for me to switch now? I deployed in 2012-2013 and just came back from deployment Dec 2014.

    • Ron says

      My opinion is that the Roth 401k is not good for anyone. By contributing to a regular 401k you pay less income tax NOW. By contributing to a Roth 401k you pay more income tax now in an effort to pay no tax in retirement. However most people are in a higher tax bracket while working than in retirement. Why pay a lot more tax NOW in order to save a little tax 20-30 years from now? It makes no sense. I wish they never invented the Roth 401k.

    • Cody says

      It’s a bit late, but please don’t listen to Ron. His math from his previous comments is wrong and misrepresents the Roth vs Traditional argument.

      Switching to a Roth can be a good idea, especially for military members. A significant enough portion of your income is nontaxable (BAH, BAS, Clothing Allowance), making your tax footprint artificially smaller. Assuming that you are a single E-6 with 12 years TIS, your annual base pay would be 42780. After a standard deduction this still leaves you in the 15% marginal tax bracket. If you believe that you will exceed the 15% tax bracket in retirement (from pension, traditional withdrawals, eventually social security and capital gains on taxable investments), a Roth would be a better option. If you expect to be in the 15% marginal tax bracket in retirement, Roth and Traditional break even. These numbers favor contributing to a Roth more if you are married or itemize your deductions.

      If you are an officer (or are higher than an E-6), you should throw your numbers in to determine if you should make the switch.

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