Roth or Traditional Thrift Savings Plan Accounts

Once you’ve decided to open a Thrift Savings Plan (TSP) account, you have to choose between a traditional TSP account, and a new Roth TSP account. The main difference between these two accounts is when you pay taxes. If you are familiar with traditional and Roth Individual Retirement Arrangements (IRAS), you already have a head start on understanding the differences between the traditional and Roth TSP accounts.

Traditional TSP Accounts

With a traditional account, money is contributed to your TSP account before you pay income taxes. This reduces your taxable income in the year that the money is contributed. Money grows in your account, and you will pay taxes on the contributions and your earnings when you take money out of the account. This is a better choice for you if you have some reason to anticipate that you will be in a lower tax bracket during retirement. This might also be a good choice if you think that our country is going to decrease its income tax rates.

Roth TSP Accounts

With a Roth account, money is contributed to your TSP account after you pay income taxes. The money grows tax free if five years have passed since 1 January of the year in which you made your first Roth TSP contributions, AND you are 59 1/2 years or older, disabled, or deceased. If you meet the five year rule, and the age/disability rule, there are no taxes due on distribution, either on the contributions or the growth. Tax free income is almost always a good thing.

How To Choose?

Which account is right for you? It depends on a number of factors, including your tax bracket now, your anticipated tax bracket in retirement, and what you think is going to happen to our country’s tax structure in the future. Don’t forget that that you can also choose to put a portion into each account, although the math gets a little trickier.

Most military folks feel that a Roth TSP is a better long term choice. Yes, you will pay more income tax now, but all distributions are tax free. I’ve not yet heard anyone say, “Gee, I wish I hadn’t paid those taxes before.” If you are currently paying little to no federal income tax due to low income, choosing a Roth TSP account is more obvious. No taxes now, no taxes later. It is truly the only way to have completely tax free income.

What If I’m In A Tax-Exempt Combat Zone?

Oh, it is complicated. You can not contribute tax-exempt combat zone pay to a Roth TSP account. I’m not sure why, and I’m hoping that rule will change, but it is true right now. Therefore, contributions to TSP made from tax-exempt pay must be made into a traditional TSP account. It will be noted as “exempt,” so you won’t have to pay taxes on the contributions when you take money out, but you will have to pay taxes on the earnings.

The other issue with tax-exempt contributions is that there are different contribution limits for money that is tax-exempt. Each year, there are three different contribution limits: the regular limit, the additional contribution limit (which includes tax-exempt monies), and the catch-up limit for those over age 50. For 2016, the regular contribution limit is $18,000, the additional contribution limit is $53,000, and the catch-up limit is $6,000.

Understanding the differences between a traditional TSP account and a Roth TSP account allows you to make the best decision for your particular situation. If you absolutely can’t decide, I recommend choosing a Roth account and moving forward. You can always  change the allocations of any future contributions if you change your mind. Don’t let this decision keep you from contributing to a TSP account.

This post is part of a series.  See the other parts for more information:

Day One:  Everything You Ever Wanted To Know About TSP

Day Two:  Roth or Traditional Thrift Savings Plan Accounts

Day Three:  How Much Should I Contribute?

Day Four:  TSP Funds:  One Is Right For You

Day Five:  Taking Money Out Of Your Thrift Savings Plan Account