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Traditional vs. Roth TSP: Key Differences

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traditional vs roth tsp

If you’re a government worker with a Thrift Savings Plan (TSP) from your employer, congratulations! With low management fees to matching contributions, you have one of the best investing tools available. You can prepare well for a comfortable retirement by contributing to your account. However, you have a choice: deposit to a traditional or Roth TSP. Your selection will determine when you pay income tax on contributions and earnings. Here’s a breakdown of the key differences but you can also work with a financial advisor to help you choose the right investments for your situation.

What Is a Thrift Savings Plan (TSP)?

A Thrift Savings Plan (TSP) is an investment account that government employees, including military members, receive as a benefit. TSPs have minimal administrative costs and allow participants to contribute pre- or post-tax dollars.

In addition, most government entities offer matching TSP contributions for employees. For instance, you might receive matching funds for contributing up to 5% of your paycheck to your account.

However, if you don’t contribute any of your paychecks to your plan, your employer will still deposit an amount equivalent to 1% of your salary to your account annually. This automatic deposit happens once you become vested by working for the number of years your government agency requires.

TSPs also offer flexibility in two ways. First, you can select from a range of investment types and funds for your TSP portfolio. Second, you can roll over your account to another investment account if you leave your government job and go into the private sector.

Traditional vs. Roth TSP: Key Differences

traditional vs roth tsp

The government divides TSPs into Roth (post-tax dollar contributions) and traditional (pre-tax contribution) accounts. Both offer advantages that will fit you depending on your financial situation. Here are the differences:

Contribution Limits

You can contribute up to $20,500 to your TSP in 2022 and $22,500 in 2023. Whether you have a Roth, traditional or both, your contributions to all of your TSP accounts combined cannot exceed the elective deferral limit. The exception to this rule is if you’re age 50 or older, in which case you can deposit extra catch-up contributions of up to $6,500 in 2022 and $7,500 in 2023.

Matching Contributions

After working for the vesting period, all government employees receive matching contributions equal to 1% of their pay without having to deposit any money themselves. However, you’ll receive additional matching contributions for depositing up to 5% of your paycheck to either TSP type.

All matching contributions go to your traditional TSP, not your Roth – even if you contribute solely to your Roth account. In other words, a Roth TSP cannot receive matching funds, but any matching dollars you receive will go into your traditional account.

Taxation

Remember, your TSP type determines whether your contributions are from pre- or post-tax dollars. With a traditional TSP, you can fine-tune your contributions to ensure you land in the lowest tax bracket possible. Plus, your withdrawals from a traditional account during retirement are exempt from capital gains taxes and only incur regular income taxes.

On the other hand, you’ve already paid income taxes on the money you deposit to your Roth TSP. As a result, you won’t pay taxes on your withdrawals during retirement. This advantage allows you to withdraw any amount you like in retirement without worrying about raising your tax burden.

Withdrawals

Because TSPs are retirement accounts, you’ll incur a 10% penalty tax on withdrawals from your account before age 59.5. This penalty applies to both TSP types.

Roth TSP withdrawals are tax-exempt if you make them after age 59.5. Plus, you must wait five years since your first contribution to withdraw money from your account.

Conversely, you don’t have to wait five years from your first deposit to access your traditional TSP money. Remember, you will pay income taxes on these withdrawals, even if you’re 59.5 or older.

Traditional vs. Roth TSP: Which One Is Right for You?

The primary difference between Roth and traditional TSPs is how they’re taxed. Specifically, a traditional TSP is better if you want to leverage your account to decrease your current income taxes and pay for withdrawals during retirement. This choice is particularly advantageous if you think you’ll have lower taxes in retirement or think tax regulations will be in your favor later in life.

On the other hand, a Roth TSP allows you to get taxes out of the way immediately. Then, in retirement, you can withdraw money without worrying about your taxes ballooning. This choice can make sense if you want to pay minimal taxes during retirement. Furthermore, since retirees usually receive fewer tax breaks than employees in the middle of their careers, a Roth can give you a tax advantage at the cost of paying income taxes upfront.

One key point to remember is if you choose a Roth TSP, matching contributions will go into your traditional TSP. So, unless you devote your deposits solely to a traditional TSP, you’ll end up with money in both account types. This situation will give you more flexibility in retirement, as you can choose which account to withdraw from, depending on your tax circumstances.

The Bottom Line

traditional vs roth tsp

If you’re a government employee with a TSP, you have a powerful, tax-advantaged account to use. You’ll receive free investment money in your retirement account and can decide whether you want to pay income taxes now (through a Roth TSP) or during retirement (through a traditional TSP). However, by choosing a Roth TSP, you’ll divide your investment money between your contributions in the Roth and the matching contributions from your employer in the traditional.

Tips for Retirement Planning 

  • Choosing between investment accounts and types can be challenging. You’ll need to consider your risk tolerance, time until retirement and your living expenses during retirement. Fortunately, a financial advisor can help. Not only can an advisor optimize your retirement savings, but they can also help you get the rest of your finances into shape as well. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • A TSP is a significant benefit for retirement savings. However, if your employer doesn’t provide one, you can save for retirement in other ways and still receive matching funds. Whether you have a 401(k) or another employer-sponsored account, it’s recommended to contribute enough to take advantage of employer matching programs.

Photo credit: ©iStock.com/AndreyPopov, ©iStock.com/jacoblund, ©iStock.com/LaylaBird

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