Government employees enjoy a multitude of benefits, such as special discounts and generous sick leave. These benefits also extend to retirement. Specifically, the Roth Thrift Savings Plan (TSP) offers a tax-advantaged retirement account with matching contributions. Employees of all income levels can participate in Roth TSPs. Below are the details of how they work and whether you should contribute to one. If you’re interested in investing, you can work with a financial advisor to give you the right insight and help you manage your wealth-building roadmap.
What Is a Roth Thrift Savings Plan (TSP)?
A Roth Thrift Savings Plan (TSP) is a retirement account for federal employees the government provides. It gives workers the after-tax benefits of a Roth IRA and the minimal management fees of a typical Thrift Savings Plan. The governmental employee’s department, such as the United States Postal Service or military branch, usually funds the plan with one percent of the employee’s paycheck. The employee can also contribute part of their paycheck to the plan and receive matching funds.
Traditional Thrift Savings Plan VS. Roth Thrift Savings Plan
Traditional TSPs and Roth TSPs differ in one primary way: taxation. Traditional TSPs use pre-tax dollars, meaning they lower the taxable income of the employee while they work. In other words, contributions come from your paycheck before the government applies taxes.
Then, during retirement, the employee pays income taxes on the earnings portion of their withdrawals. In other words, you won’t pay taxes on what you contributed but on your investment income when you make withdrawals. Because your retirement income is usually lower than your income in your career, you’ll save money on taxes.
On the other hand, Roth TSPs use post-tax dollars. So, contributions to your Roth TSP come from your paycheck after the government taxes your income. The payoff is you don’t owe a penny of taxes on withdrawals during retirement. As a result, you can withdraw whatever amount of money you like in retirement without worrying about the income raising your taxes whatsoever.
Roth Thrift Saving Plan (TSP) Eligibility
All government employees can contribute to a Roth TSP, regardless of income level. That said, employees have to work long enough to become vested in the plan. Generally, employees must work for three years to become vested or gain ownership of their TSP, but the requirement varies among institutions.
While the employee can withdraw their funds anytime, they’ll pay a 10% financial penalty for accessing TSP funds before age 59.5. This regulation encourages participants to use the account solely for retirement purposes.
In addition, if the employee passes away with unused money in their TSP, the following parties have the right to withdraw the funds:
- A surviving spouse
- In the absence of a surviving spouse, their children or children’s offspring
- In the absence of a spouse or descendants, the employee’s parent(s)
- In the absence of these, the executor of the employee’s estate
- In the absence of these, the employee’s state’s laws will designate the next of kin to inherit the funds
Roth Thrift Saving Plan (TSP) Contribution Limits
Federal law limits employee contributions to a Roth TSP to $20,500 for 2022 and $22,500 for 2023. Plus, employees age 50 or older can contribute an additional catch-up amount of up to $6,500 for 2022 and $7,500 for 2023.
Remember, the TSP contribution limit applies to your combined deposits to Traditional and Roth TSPs. Therefore, your deposits across both accounts can’t surpass the limit if you contribute to both.
Although TSP contribution limits are in dollars, you’ll set your contributions as a percentage of your paycheck. For instance, say your monthly income is $4,000. You want to contribute $200 monthly to your TSP. Therefore, you’ll set your contribution to 5% of your paycheck.
Pros of a Roth Thrift Saving Plan (TSP)
Your Roth TSP will give you the following benefits:
- Tax-Free Withdrawals: As long as you withdraw money after age 59.5, you’ll pay $0 in taxes on all Roth TSP income.
- Generous Contribution Limit: While the contribution limit for a Roth IRA is $6,500 in 2023, you can contribute $22,500 to a Roth TSP. As a result, this account triples your retirement savings capabilities compared to other plans.
- Eligibility for All Income Levels: While Roth IRAs exclude high-income individuals, you can deposit money into your Roth TSP no matter how much money you make. This characteristic makes Roth TSPs excellent investment vehicles for employees at any stage of their career.
- Affordable, Professional Investing Services: Say you wanted to open up a retirement account on your own. You’d have to shop around for a financial institution to manage your account, select a plan and pick your asset allocations. Or, you would create an account with a brokerage firm and research the stocks, bonds and other assets to fill your portfolio. Doing so requires time and extensive knowledge about investing. On the other hand, your choices with a Roth TSP are minimal. You can choose the funds and assets for your portfolio according to your risk tolerance and time horizon. Then, your plan manages your investments at a significantly lower cost than other retirement plans.
- Take Care of Taxes Up Front: Roth TSPs use post-tax dollars, meaning the government has already taxed the money you contribute to the plan. As a result, you don’t have to worry if tax brackets or rules change during retirement. Plus, you can withdraw any amount you like during retirement without increasing your tax burden.
- Rollover Capability: If you leave your government job, you can take your TSP with you by rolling it into a Roth IRA. As a result, you’ll retain your retirement fund and avoid the required minimum distributions (RMDs) of Roth TSPs, one of the disadvantages of such plans.
Cons of Roth Thrift Saving Plan (TSP)
As with all financial tools, Roth TSPs have their share of drawbacks:
- You Can’t Defer Income Taxes: Choosing a Roth TSP means paying taxes on all your income before depositing it into your account. So, if you think your income level will decrease in retirement, you might miss out on a lower tax rate with a Roth TSP.
- Less Investment Flexibility: Your government agency hires a specific company to administer your TSP. As a result, you must choose among the funds and assets the company offers. Unfortunately, this scenario might mean you can only access mediocre investment funds with exorbitant management fees – it depends entirely on the company managing your TSP.
- Age Requirement for Withdrawals: If you withdraw money from your Roth TSP before age 59.5, you’ll pay a 10% penalty on the money you receive. Plus, you’ll pay income taxes on the earnings you withdraw. For example, you might contribute $10,000 to your TSP and have $15,000 total in the account due to earnings. If you withdraw $12,000 from your TSP before the age limit, you would pay income taxes on $2,000 of that money.
- Required Minimum Distributions: Required Minimum Distributions (RMDs) are from IRS law stating that you must start receiving money from your TSP by age 72 unless you’re still working your government job. This rule can be problematic if you don’t need your retirement savings and would like to leave them to an heir.
Traditional vs. Roth TSP: Which One Is Right for You?
The decision between a Traditional and Roth TSP depends on taxation and income. In other words, if you want to address taxes on all your income now and withdraw money during retirement without tax implications, a Roth TSP is ideal. Because retirement generally involves fewer tax breaks, paying income taxes during your career can help make your golden years easier.
On the other hand, if you want to decrease your income taxes during your career, a Traditional TSP can help. Plus, you might pay less in income taxes if your income is significantly lower in retirement.
The Bottom Line
Taxes are inevitable, but your choice of TSP allows you to choose when you pay them. A Roth TSP allows you to pay taxes while you work and then enjoy tax-free income from the account during retirement. In addition, these plans offer a host of other advantages, such as low fees and rollover capability if you decide to go into the private sector. However, because everyone’s financial circumstances are unique, it’s crucial to consider the ramifications of contributing to a plan before doing so.
Tips on Roth TSPs
- A financial advisor can help you decide what the best investment options are for your long-term financial goals. Finding the right financial advisor for your specific needs doesn’t have to be hard. 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 Roth TSP can be an excellent retirement savings vehicle, but your financial situation might direct you to look for something that fits better. To understand what accounts are available, use this guide for which type of retirement account you should open.
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