Federal employees have had the option to make after-tax contributions to the Roth Thrift Savings Plan (TSP) since spring 2012. This account offers the advantage of tax-free withdrawals in retirement, on top of the agency match. However, despite its potential benefits, the Roth TSP may not be the best choice for everyone. Before adding it to your retirement plan, consider the pros and cons.
Contributions Are Made After-Tax
With the Roth TSP, contributions come from after-tax income, meaning you pay taxes now based on your current rate, allowing for tax-free withdrawals in retirement. This structure is advantageous for those expecting higher income later, but if you’re managing a tight budget while raising a family, pre-tax contributions to the traditional TSP might be more beneficial. These reduce taxable income now, and if you expect to retire in a lower tax bracket, your tax on withdrawals from a traditional TSP will likely be less.
Consider: The Trump-era income tax cuts are set to expire on December 31, 2025.
High Earners Might Find Better Options
Dual-income households or high earners may benefit more from traditional TSP contributions. Higher-income earners are often in a bracket where pre-tax savings can have a more immediate impact. With tax cuts possibly expiring in 2025, re-evaluating contributions to the Roth TSP in favor of the traditional TSP could be worthwhile, especially in the final working years.
For Those Nearing Retirement, Roth TSP May Not Be Ideal
Current data shows that only about 20% of TSP participants use the Roth TSP, and those who do often have smaller balances compared to their traditional TSP accounts. If you’re close to retirement and at your peak earning potential, paying taxes on Roth contributions might not make sense. Traditional TSP contributions, including catch-up contributions, could significantly reduce your tax burden in those years.
If you expect to be in a lower tax bracket in retirement, the Roth TSP might not be the best choice. Consider working with an FRC® advisor to project your retirement tax liability and evaluate your best path forward.
