The Thrift Savings Plan (TSP) began offering a Roth TSP option in 2012. The Roth Thrift Savings Plan option is similar to a Roth 401(k). It is basically a merger of two of the popular retirement plans currently available; the Roth 401(k) and the Thrift Savings Plan. This article details how the Roth TSP works, benefits of investing in the Roth TSP, and additional information to help you decide if the Roth TSP is the best option for you or if you should invest in a Traditional TSP account.
What is the Roth Thrift Savings Plan? Offering the Best of Both Worlds
The Thrift Savings Plan is a good deal for investors. There are a few downsides, but it’s almost all good for the average investor. The average investor won’t be able to find such a simple and easy to use investment plan that offers wide investment diversity, or one that offers lower management fees.
Roth IRAs are valuable for investors because of their long term tax benefits. You are able to contribute funds which have already been taxed at your current income level, invest those funds and allow them to grow until you reach retirement age, then you can withdraw them tax-free.
Since most military members are in a relatively low tax rate, this is an incredible opportunity to pay a relatively low amount of taxes on your income, let it compound for decades and never pay taxes on it again.
The Roth TSP account offers the best of both worlds as it combines the benefits of a Roth IRA with the Thrift Savings Plan. You can contribute to any of the Thrift Savings Plan funds (which are best in class in terms of management fees), and enjoy the long term tax benefits of the Roth classification.
Traditional vs. Roth TSP Contributions:
A Roth version of the Thrift Savings Plan combines the benefits of a Roth savings plan with the TSP retirement savings plan. Instead of making contributions before paying taxes like you currently do with the Traditional TSP (and paying taxes when you withdraw the money), Roth participants will pay taxes now and make tax free withdrawals in retirement.
This means your Roth savings will grow without the drag of taxes because your contributions have already been taxed. You will not pay any federal income taxes on your withdrawals so long as you meet Roth withdrawal eligibility guidelines – typically age 59½ and have been making Roth contributions for a minimum of five years.
Roth TSP Eligibility & Contribution Limits
Another benefit adopted from the Roth 401(k) plan is an absence of income limitations for plan participation. All Thrift Savings Plan participants can contribute to the Roth TSP regardless of how much money they make. This differs from Roth IRA contribution limits, which are tied to income.
The Roth TSP contribution limits will be the same as all TSP contribution limits, regardless of whether you invest in the Roth option or the traditional option.
It is important to note that the Thrift Savings Plan contribution limits apply to your entire TSP account. So if the annual contribution limit is $20,500, you can contribute up to that much across your entire TSP account for that calendar year. You can make the contributions in your Traditional TSP, Roth TSP, or a combination of the two, so long as you don’t exceed the annual contribution limit.
Matching contributions don’t count toward the $20,500 limit.
Roth TSP Contributions Must Be Made as a Percentage of Pay
Prior to January 1, 2015, Roth TSP participants were able to make contributions in a fixed dollar amount. However, the TSP set new rules limiting contributions to be set as a percentage of their pay instead of a dollar amount. Traditional contributions were already processed based on a percentage of pay. The change was made to standardize the system across Traditional TSP accounts, Roth TSP accounts and the civilian and military pay systems.
Who is affected? All active duty members of the Air Force, Army and Navy who contribute to the Roth TSP. This will also affect members of the Guard or Reserve who are activated for over 30 days.
How to Max Out Your Roth TSP Contributions
If your goal is to max out your annual Roth TSP contributions, then it’s not too much trouble to calculate the percentage you need to contribute.
The annual Roth TSP contribution limit in 2022 is $20,500, which comes out to $1,708 per month. Just divide this by your salary to determine how much you need to contribute. If your salary is $6,000 per month, you would divide $1,708 by $6,000 and you would get 25.69%. So you would need to contribute a little over 28% of your income.
Catch-up contributions, for those age 50 and over, are limited to $6,500 per year. So if you are eligible to make catch-up contributions, be sure to include that in your calculations. The max for you would be $27,000 per year, or $2,250 per month. If you have an $8,000 salary, you would divide your $2,166.66 contribution by your $8,000 salary, which would come out to about a 28% contribution.
Obviously, not all numbers work out that easily. But the concept is the same.
Can you contribute too much to the TSP?
The TSP has processes in place that should automatically stop contributions once you reach your annual contribution limit. If you accidentally contribute too much, the Thrift Savings Plan should refund the extra contributions. That said, you might find that it is a manual process, or there may be a delay in the refund. So try to get as close to the contribution limit as possible without going over.
You should also be very careful if you change jobs during the calendar year. The TSP will not have any information regarding previous TSP or 401(k) plan contributions. These will share the same annual contribution limit and there will be no process in place to automatically stop or refund contributions if you contribute too much.
Benefits Associated with the Roth 401(k)
Here are some benefits you should expect to see with the Roth TSP account:
- Contributions are made after taxes have been withdrawn from your payroll.
- There are no taxes on withdrawals from a Roth TSP so long as you meet withdrawal eligibility requirements.
- There are no income restrictions regarding who can contribute to a Roth 401(k), so you can contribute regardless of income level.
Deployed contributions to a Roth TSP are tax-free
I’m a big fan of investing in the TSP while deployed because of the tax benefits:
you don’t pay income tax on the money you contribute and the portion you contribute while deployed can be withdrawn tax free, giving traditional TSP contributions similar rules to Roth 401(k) contributions.
However, there are some downsides to the Traditional TSP contributions while deployed. Only the contributions are tax-exempt upon withdrawal. The earnings are still taxed. And the tax-free portion of your withdrawals will be prorated across all regular TSP withdrawals. So you lose flexibility when deciding how you will make your withdrawals. It is possible to roll the tax-exempt contributions into a Roth IRA, but you will need to wait until after leaving the service before being able to make any IRA conversions.
The Roth TSP, on the other hand, offers tax-free withdrawals. Since you can make contributions with tax-exempt combat pay, you will have the unique opportunity to contribute to a retirement account with money that hasn’t been taxed, watch it grow without the drag of taxes slowing it down, and be able to make tax-free withdrawals in retirement. This is a unique opportunity to invest and withdraw your money without it ever being taxed.
The Roth feature will eliminate the necessity to track which portions of contributions and withdrawals are tax-free. However, there are still Required Minimum Distributions once you reach age 70½. Even so, these benefits make the Roth TSP feature much more flexible.
Bottom line: You won’t get taxed on income and you can make tax-free withdrawals in retirement.
Should you invest in the Roth Thrift Savings Plan?
This could be a great opportunity to save some money with great tax benefits, though it may not be the ideal situation for everyone.
You should look at your investment goals, tax obligations and other factors before making the decision to switch from the traditional TSP plan to the Roth 401(k), or consider contributing to a hybrid approach and making a portion of your contributions to each plan so you can diversify your tax liability in retirement.
When the Roth TSP is a Good Option
Many military members start off their career in lower tax brackets because they often receive a large portion of their income as non-taxable military benefits. This allows military members to put away a lot of money that was taxed at a comparatively low rate – potentially lower than they would be subject to in retirement years. This can be a great way to save for retirement and practice tax planning at the same time.
Generally, if you are in a low tax bracket, or you have tax-free deployment income, then you might want to consider the Roth TSP feature. If you are in a higher tax bracket and don’t have tax-free income, then the tax situation should be similar to deciding whether or not you should invest in a 401(k) or IRA.
The following articles can give you more insight into when it makes sense to choose a Traditional account or a Roth account, and how each affects your tax and retirement planning.
- 5 Reasons to Consider a Traditional IRA over a Roth IRA
- 6 Reasons to Choose a Roth IRA over a Traditional IRA
A quick read of the above articles will help you understand how each of these accounts will impact your current and future tax and retirement planning.
Does the Thrift Savings Plan Allow In-Plan Roth Rollover Conversions?
Unfortunately, the Thrift Savings Plan does not currently allow members to do a Roth in-plan Rollover. Some commercial 401(k) plans allow participants to transfer some or all of their current 401(k) plan assets from a Traditional account to a Roth account. There are generally tax consequences for the conversion, since you are taking money that was contributed before taxes and converting it to an after-tax investment account. But there can be long-term benefits, depending on your situation.