Why is the Roth TSP Less Popular?, by Todd Carmack

In June 2020, 3.5 million participants of the Federal Employees Retirement System contributed to the Thrift Savings Plan. However, only 666,175 federal employees actually contributed to the Roth TSP. This participation represents 18% of TSP participants. For the Federal Employees Retirement System population, the average Roth balance is much lower than the traditional Thrift Savings Plan average balance.What causes the difference between the two types of TSP? What is the reason why people do not participate in Roth?The simple answer is because the traditional TSP has been available for a long time. The Roth TSP was introduced in 2012, while the traditional TSP came into use in 1986. Although this may be why the Roth TSP is less popular, this is not the only reason.The primary reason why the Roth TSP is less used is because of the general “rule of law†that applies to retirement planning. The rule’s strongest belief is that you will be in a lower tax bracket when you retire. With this mindset, it is reasonable to defer your tax now and repay it at retirement because you will be in a lower tax bracket at that time. The traditional TSP allows pre-tax contributions, which grows your deferred tax until you can withdraw contributions at retirement. Having this mindset is not your fault, but the fault of financial experts, who have only recommended the pre-tax strategy for many decades.This belief is not valid because there are many reasons why your tax bracket may not be low during your retirement, and your best option is to pay the tax now. Thus, if you’re a federal employee, you need to consider the Roth TSP for your retirement savings. You will use after-tax dollars to make contributions into the Roth TSP, and your savings will be free from tax during its growth and retirement. When you save in the Roth TSP, you will enjoy tax flexibility and benefits that will give you even more benefits in the future.

Here are the reasons why you should use the Roth TSP instead of the traditional pre-tax TSP

Your income may be less taxable at retirement, but your tax bracket may not be lower. Your annual income taxes are based on your eligible deductions, income, and credits. Your earnings may not be much at retirement, but you will also not retire with many credits or tax deductions. During your early working years, tax deductions have a more massive impact on your earnings than when you retire. Besides, the tax laws are continually changing. In 2017, the Tax Cut and Jobs Act (TCJA) reduced taxes for many workers, but this tax reduction will expire in 2026. When this tax law expires, the current standard deduction will end, and a higher tax bracket will reappear if Congress doesn’t interfere. Will you be in your retirement period then?

You can pay taxes yearly during your retirement period, but you might pay more in certain years

Most retirees want to spend their retirement years in a friendly environment. If you want to buy a condo in Florida, you will need a huge amount of money to make a down payment. Where will you get the money?If the only savings account you rely on is your traditional TSP, you may not have any other option than to use this TSP for your down payment. Here is the point. Every withdrawal you make from the traditional TSP will be taxed just like your ordinary income. Due to the progressive tax rate system, you will pay taxes by your income and TSP withdrawal. The IRS will tax your TSP as your ordinary income, irrespective of whether you are using your TSP as a boat or for your retirement income. Your tax bracket may increase due to retirement system pension or if you exceed your TSP withdrawal limit. You can make many withdrawals under the Roth TSP because you will not pay tax on your withdrawal.

With the Roth TSP, you can pay off big bills at lower costs when you retire

This may sound strange, but it’s true. Some retirees have a mortgage balance they need to pay off when they retire. Paying off your mortgage balance is a major retirement strategy. You can imagine the satisfaction you get when you pay off that mortgage because you are now free from excess cash flow. Paying off your mortgage seems like an excellent plan, but you might pay more taxes when you want to withdraw your remaining balance from the traditional TSP account. You will be in a higher tax bracket if you pay off your loan with a traditional TSP. Everyone hates fees; therefore, your Roth TSP is the best plan for paying off your mortgage.

Distributions outside the Roth TSP do not influence your Social Security taxes

When determining the taxable portion of your Social Security, your 401(k), TSP, and traditional IRA will be counted among the factors that will influence your Social Security tax. The higher your TSP withdrawal, the more income tax you will pay on your Social Security check. However, distributions outside the Roth TSP don’t affect your Social Security taxes.Finally, there is no 100% assurance that one strategy is the best for everyone. Using Roth depends on your income needs during retirement, unique tax situation, projected future tax bracket, and current tax law. Although tax laws frequently change, including a Roth TSP in your retirement portfolio will give your retirement plan flexibility. Retirement time is uncertain and full of changes. It would be best if you prepare for it. You will enjoy your money with the Roth flexibility because you will better manage your taxes with the Roth TSP.
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Bio:
I grew up in Dubuque, Iowa, where I learned the concepts of hard work and the value of a dollar. I spent years in Boy Scouts and achieved the honor of Eagle Scout. I graduated from Iowa State University and moved to Chicago and spent a few years managing restaurants. I then started working in financial services and insurance helping families prepare for the high cost of college for their children. After spending years in the insurance industry, I moved to Arizona and started working with Federal Employees offing education and options on their benefits. I became a Financial Advisor / Fiduciary to further help people properly plan for the future. I enjoy cooking and traveling in my free time.

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