Roth TSP Rollout Officially Underway
After much hosanna, hurrah and hullaballoo, the Department of Defense rollout of the Roth option to the Thrift Savings Plan is finally underway. While most of the federal government was eligible to contribute to the TSP via a Roth option in May, technical issues with Defense Finance and Accounting Service computer systems required the Department of Defense to phase in the execution of the rollout among the various services. The Marine Corps – the smallest of the services – is first in line: Marines are eligible to contribute to a Roth option in their TSPs this month. DoD civilian employees are slated to become eligible in July. And Army, Navy and Air Force personnel can elect to make Roth contributions in October, under current projections.
Yes, we also noticed that the DoD civilians in charge of the rollout took care of their own before implementing the Army, Navy and Air Force rollouts (while keeping the Marines as guinea pigs, in case something goes wrong!).
TSP contributions under Roth accounts are taxed differently than traditional TSP accounts. Until now, when you made a contribution to your Thrift Savings Plan, the government made that contribution before taking taxes out of your military pay. You only paid income taxes on the amount left over after your contribution. DFAS would withhold the income tax, together with FICA, or Social Security and Medicare taxes, and pay you the rest. The catch: You have to pay income tax on any amount you withdraw for income.
You can’t postpone paying taxes indefinitely, either. TSP rules require you to begin making required minimum distributions, or RMDs, beginning April 1 of the year after the year in which you turn 70½, or you separate from government service – whichever is later. This means you have to start taking money out of the account – and paying taxes. The IRS imposes stiff tax penalties, if you fail to do so.
With a Roth TSP, you pay your income taxes now, up front. In return, the entire amount grows tax-free. You never have to pay income taxes again, under current tax law. There are no RMDs to worry about, either.
Are They Right for Me?
All things being equal, the Roth option may be better than the traditional TSP under the following circumstances:
- You believe income tax rates will be higher in the future than they are now.
- You believe you will be in a higher tax bracket than you are now.
- You are unlikely to need to withdraw the money in retirement, and can therefore hold on to assets in your TSP well beyond the age at which you would otherwise have to begin taking RMDs.
- You believe you will have a possible estate tax liability. Any income tax you get out of the way now reduces your estate, and potentially reduces the amount exposed to the estate tax.
- You just don’t want to have to worry about RMDs.
- You want to hedge your exposure to legislative risk by splitting assets into different “buckets.”
- You have an artificially-reduced taxable income this year or next year due to a deployment to a combat zone (resulting in much of your military pay for the year being tax-free.
- You can ‘max out’ your elective deferral limit of $17,000, plus, if you are over 50, an additional “catch-up” contribution of $5,500. If you can pay your income taxes now, you can stuff that much more into the account. This is because a Roth TSP is “larger” than a traditional TSP with the same nominal balance. Roth TSPs can be tapped tax-free in retirement; you still have to pay taxes on any balances in a traditional TSP.
- You are confident you can leave the money in the account for at least five years. Only money that remains in the Roth account for at least five years qualifies for the Roth tax treatment.
Remember: If you retire from the military, your pension income is subject to whatever income tax rates are in effect when you retire and begin receiving your retirement pay. Because you incur substantial risk to your income if Congress raises income tax rates between now and the time you retire, you could wind up with a substantial hit to your income. Diversifying part of your retirement nest egg into an income tax-free account, such as a Roth, can help diversify against that risk.