Traditional vs Roth Thrift Savings Plan: a closer look at the two options available for TSP contributions.

AuthorThomas, Shad

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The Thrift Savings Plan (TSP), the Federal Government and military's version of the 401(k), is a fantastic, low-fee way to save for retirement. The plan has recently added a new option for making contributions, yet the benefits of this feature are not widely understood.

The "Roth" option was introduced to the TSP in 2012 and represented a significant alternative to making contributions to your TSP account. While "Traditional" (pre-tax) contributions are beneficial for some employees, Roth (after-tax) contributions offer a substantial advantage for those who are generally in a low tax bracket. Though the Roth option has been available for three years, many employees remain unaware of the advantages of it, and continue to make Traditional contributions to their TSP accounts, when potentially the Roth option may be more favorable. Choosing between the Traditional and the Roth options can have a substantial impact on the value of your retirement savings. The objective of this article is to provide you with the information needed to make the best decision for your circumstances.

Traditional vs. Roth - The Basics

Traditional contributions are "pre-tax" contributions where the contribution is taken out of your paycheck before income is taxed. The money that is contributed to your TSP will grow, tax deferred, and you will pay taxes on your contribution and its earnings upon withdrawal in retirement. (1) For example, if you make Traditional contributions of $5,000 into your TSP account in 2015 and that money grows to say $25,000 upon retirement, you will pay taxes on the $5,000 contribution plus the $20,000 in earnings when you withdraw them. If you are in the 28% marginal tax bracket in retirement and you withdraw that $25,000, you will pay 28% ($7,000) in taxes.

The Traditional option appeals to members who desire to lower their current taxable income. Using the previous example, an employee making a $5,000 Traditional contribution to their TSP account will lower their taxable income by $5,000 for 2015. As a general rule, if you think your tax rate will be less during retirement years than it is today, you may want to consider making Traditional contributions.

Roth contributions are after-tax contributions, where the contribution is taxed during the current tax year. The money that is contributed to your TSP will grow tax-free and you will not pay taxes on contributions or earnings upon retirement. (2) For example, if you make a Roth contribution of $5,000 that grows to $25,000 upon retirement, you will not have to pay taxes on either the $5,000 contribution or the $20,000 in earnings when you withdraw them during retirement, since taxes were paid on the initial contribution of $5,000.

Traditional vs. Roth - How to Decide

Now that we've covered the difference between Roth and Traditional contributions, let's talk about how to decide between the two. It is important to remember, "Uncle Sam will always get paid," meaning you are going to pay taxes one way or another on your TSP contributions. The difference involves when you are going to pay the taxes. As alluded to before, the crux of the debate is your current tax bracket and how it will compare to your tax bracket when you are in retirement. We examine three different scenarios to illustrate this point:

  1. Your tax bracket now is the same as it is in retirement. If this were true...

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