By: Joel Cundick, CFP®
Published: March 20, 2019
What is a “Roth”, and where did it come from? In 1974, Congress passed legislation allowing the creation of Individual Retirement Accounts, or IRAs. Twenty-three years later in 1997, a new form of IRA was created by Congress. Labeled a “Roth IRA” (after the late Senator William Roth of Delaware), this new IRA allowed individuals to choose to pay taxes before contributing to the IRA, and then pay no taxes on growth and income in the account at the time of future withdrawals. From this point forward, the initial tax-deferred IRA option began to be referred to as a “Traditional IRA.” Roth options in employer retirement plans began to be offered in 2006 generally, and specifically in the Thrift Savings Plan in 2012.
What is the difference between Roth and Traditional? When you save for retirement using the Traditional option, your taxable income for the year is reduced dollar for dollar for your contributions. In other words, you defer taxes today and pay them on future withdrawals of contributions and growth. When you use the Roth option, you use after-tax dollars: you pay taxes today. However, when you take withdrawals at retirement, you owe no tax – on what you initially contributed or the growth in the account.
Should I use Roth or Traditional for my retirement savings? The TSP allows you to defer up to $19,000 of your income per year into the plan. If you are 50 or over, you can defer an additional $6,000 per year. You can use the Roth or Traditional option for your deferrals – OR a combination of both (still totaling no more than $19,000 or $25,000 if 50 or over). The decision of which to use centers around your current tax rate on income versus what you expect your tax rate to be at retirement. If you expect your income to rise in future years and for your tax rate to be higher at retirement, then using the Roth option may be best. If you are in your peak earning years and you think your tax rate at retirement is likely to be lower than the rate you currently pay, then the Traditional option may be the better choice.
Can my match from my agency go into the Roth option? No. You have the choice of how to defer your contribution, but all the match is automatically tax-deferred (or “Traditional”).
Can I owe penalties on Roth TSP withdrawals? Yes. Similar to Traditional early withdrawals, withdrawals from Roth balances are subject to 10% penalties if withdrawn prior to age 59 ½.
Do I have to select allocations in the TSP for my Roth and Traditional balances separately? No. All allocation choices you make in the TSP will apply to both your Roth and Traditional balances.
Can I roll over my balances separately if I choose to move funds out of the TSP at retirement? Yes. You are permitted to roll over all Traditional balances to a Traditional IRA, and you can separately roll over Roth balances to a Roth IRA.
Joel Cundick, CFP® has worked as a financial advisor for over ten years. He is a seminar presenter for NITP.