Roth TSP vs. Roth IRA: This is a decision that federal government employees and members of the United States military must make when deciding on a retirement savings plan. The underlying debate is whether we should use the government-sponsored account or self-fund a Roth IRA.
This is a simple choice, given recent changes to the federal retirement program. In summary, employers are now matching a portion of retirement funds at a higher rate than private corporations already give.
What is Roth TSP?
The Roth Thrift Savings Plan (TSP) is the Federal Employees Retirement System's third component (FERS). The TSP is an account that is created automatically for the employee. The agency deposits an amount equivalent to a fixed proportion of the basic salary earned each pay period. The employee may also make contributions, and the agency may make matching contributions.
A Roth TSP is similar to a Roth IRA in that it offers many of the same tax advantages as a Roth IRA.
8 Employee contributions to the TSP account are made after-tax, which means that income taxes are still withheld from the paycheck before the payment is placed into the TSP account. After retirement, people should owe no more taxes, as their contributions and investment gains are tax-deductible.
Agency/Service Automatic (1%) Contributions
For FERS employees, the agency or service that employs them contributes 1% of basic pay to the TSP account each paid month. These contributions are called agency/service automatic (1%) contributions, and the employee is not required to make them.
On the other hand, employees must be vested before they may possess the money. Vesting is a period, often a specified number of years, during which employees must work before receiving their money—typically three years for the majority of FERS employees. After two years of service, FERS personnel in congressional and certain noncareer positions become vested.
FERS Employee TSP Contributions
FERS employees employed on or after October 1, 2020, are automatically registered in the TSP by their employer, and 5% of basic pay is withheld and put into the employee's TSP account on a pay period-by-pay period basis. Those who began working for the federal government between August 1, 2010, and September 30, 2020, are automatically enrolled in the 3% payroll deduction.
Agency Matching Contributions
Once eligible, members may receive a match from the organization or program depending on their donation. The match is equal to the first 5% of pay contributed by an employee each pay period. The first 3% of pay contributed is matched dollar for dollar, resulting in the employee receiving an additional 3% of pay. However, the employee's second 2% contribution is matched at 50 cents on the dollar, meaning the employee receives 1% of pay for the 2% contribution.
A Roth IRA is known as an individual retirement account financed with after-tax dollars that allows you to withdraw cash tax-free at 59 12.
Individuals establish retirement plans with a financial advisor of their choice. They withdraw their after-tax income from their bank account and put it directly into the plan. Employers do not deduct earnings from their paychecks.
When individuals reach retirement age (and have held the account for five years), they can withdraw the money tax-free, including years of tax-free profits. Individuals may also withdraw their contributions without incurring any tax or penalty prior to reaching retirement age.
Individuals were permitted to deposit $5,500 to their Roth IRA in 2015. However, Roth IRAs have income limits - if they earn less than $116,000 as an individual or $183,000 as a married couple, they cannot contribute as much to a Roth.
Numerous similarities exist between the Thrift Savings Plan (TSP) and individual retirement arrangements (IRAs). However, the two forms of retirement funds have some subtle distinctions.
Failure to recognize these distinctions may result in penalties, tax costs, and the possible loss of retirement funds. The expanded TSP withdrawal options began in late 2019, including increased opportunities for traditional TSP transfers to traditional IRAs and Roth IRAs and direct Roth TSP transfer to Roth IRAs. The TSP participants must understand the distinctions between the TSP and IRAs to avoid incurring unnecessary penalties and paying additional taxes.
1. Rules for Contributing and Annual Contribution Limits
An individual must be employed by the federal government or a member of the military services to join the TSP. Individuals (or their spouses) must have earned income (salary/wages or self-employment) in order to contribute to an IRA. The TSP adjusts contribution limits each year following the IRS's yearly "elective deferral limit" for all defined contribution plans.
The IRS has a distinct contribution ceiling for IRAs. For example, in 2021, federal employees and uniformed service members can contribute up to $19,500 to the TSP ($26,000 if they are over 49 before December 31, 2021), while anyone with earned income can contribute up to $6,000 to an IRA ($7,000 if they are over the age of 49 as of December 31, 2021). These contribution ceilings are distinct. The IRS charges a 6% "excess contribution" penalty on IRA owners and TSP participants who exceed these retirement account contribution restrictions in any given year.
2. Withdrawals to Buy First Home
A traditional IRA owner may withdraw up to $10,000 from the IRA to assist in purchasing their first house. The IRA owner will pay federal and state income taxes on the withdrawal amount but will not be subject to the 10% early withdrawal penalty, even if the IRA owner is 59.5.
A TSP owner under the age of 59.5 cannot make a partial withdrawal to assist in purchasing his or her first house. Rather than that, federal employees with TSP accounts may obtain a residential loan to assist with purchasing their first house, as discussed below.
3. Higher Education Expense Withdrawals
While distributions from traditional IRAs made before age 59.5 for post-high school tuition and fees, books, and other higher education-related expenses are fully taxed, they are not subject to the 10% early withdrawal penalty. No withdrawals from the TSP prior to 59.5 in service for higher education are permitted.
4. Age 55 to 59.5 Withdrawals
Suppose a TSP participant retires during the year in which he or she turns 55. In that case, the person may begin withdrawing from his or her standard TSP account without incurring a 10% early withdrawal penalty. However, a 10% early withdrawal penalty applies to conventional IRA owners who withdraw funds before reaching the age of 59.5, with limited exceptions.
This distinction in how the traditional TSP and traditional IRA treat pre-age 59.5 withdrawals may present some complications for a TSP participant who retires from federal service between the ages of 55 and 59.5 and wishes to transfer a portion of his or her traditional TSP account to a traditional IRA.
This transfer of conventional TSP assets to a "rollover" traditional IRA could be for various reasons, including the IRA's increased investment alternatives and more flexible withdrawal options. The issue is that if the TSP participant withdraws any of the transferred TSP money from the conventional IRA before reaching the age of 59.5, the transaction will be subject to a 10% early withdrawal penalty.
If the identical money were retained in the original TSP and removed, any withdrawal would be exempt from the 10% early withdrawal penalty if the TSP participant was over 55.
5. Required Minimum Distribution (RMDs)
RMDs begin at age 70.5 for retired federal employees born before July 1, 1949, in the regular IRA and the TSP (traditional and Roth TSP accounts). The secure act became law in December 2019, requires retired federal employees born after June 30, 1949, to begin RMDS.
A traditional IRA owner and retired TSP participant follow their attainment of age 70.5 (or 72 born after June 30, 1949) to begin taking their first required minimum distribution from their traditional IRA and TSP account respectively. With the TSP, a participant who continues to work in the federal government after reaching the age of 70.5 or 72 (if born after June 30, 1949) does not need to take the first RMD until April 1 of the year following retirement from federal service.
As a result, certain federal employees who work for the federal government after reaching the age of 70.5 (age 72) and who own conventional IRAs may choose to consider converting their traditional IRAs to traditional TSP accounts. By doing so, they can postpone the start of their conventional IRA required minimum distributions until April 1 of the year following their retirement from federal service.
6. TSP Loans
TSP participants may get one of two types of loans through the TSP: a TSP "general use" loan or a TSP "residential" loan. Borrowing against an IRA, on the other hand, is forbidden and will result in the IRA being terminated and subject to taxation.
Which One Should We Choose?
1. The Roth TSP's expense rules. When it comes to running expenses, an IRA has a difficult time competing. In 2019, the Thrift Savings Plan's average expense ratio was.042 percent. This corresponds to a return of 42 cents on a $1,000 investment. On the other hand, the amount people pay with an IRA will vary depending on where they invest, but it will almost certainly be more — possibly significantly more.
2. Access is more favorable to Roth IRAs. Donations to a Roth IRA may be repaid tax-free and penalty-free. That is not a TSP option.
3. The TSP offers loans. In terms of access, the TSP does permit loans. While taking one is not always a good idea, it is not possible with a Roth IRA.
4. The Roth IRA offers a broader range of investment options. At the moment, the TSP offers a limited number of investment options. Contrary to popular belief, they are diverse and unique in the case of the G Fund. However, if people are interested in investing in real estate, commodities, emerging markets, or other "niche" areas, the TSP does not offer the same investment opportunities as a Roth IRA. In 2022, the TSP intends to open a mutual fund which will provide participants with a wider variety of assets.
5. Each of these steps is automatable. Priority should be given to oneself, and this is a viable concept. Because TSP contributions are paid by payroll deduction, this is, by definition, "first." Of course, people can fund their Roth IRA with an allotment or an automated investment and achieve comparable results. Pwople enjoy the TSP because they can choose to contribute a percentage of their earnings rather than a fixed monetary amount. People will save more money over time due to wage raises and promotions, even if they do not boost that percentage (which I hope you do!).
6. Both need to be top of mind during a deployment. Whether TSP or IRA, Roth accounts can be an excellent option to save for retirement while in a tax-free zone. Roth contributions combined with tax-exempt combat pay allow people to accumulate a pool of retirement funds – their contributions and any growth – on which they will never pay taxes.
7. All members of the armed forces are eligible for the Roth TSP. Anyone serving in the military at the time of enrollment may contribute to the Roth TSP. There are no income eligibility requirements. Individuals earning more than $140,000 ($208,000 for joint filers) will be unable to contribute to a Roth IRA beginning in 2021.
8. The TSP enables people to accumulate. The maximum contribution to the Roth TSP in 2021 is $19,500. If they are 50 or older, an additional $6,500 "catch-up" payment is available. The maximum contribution to a Roth IRA is a meager $6,000, plus an additional $1,000 for people aged 50 or older.
9. The TSP may offer money for nothing. Employer contributions to TSP accounts are capped at 5% for eligible service members covered by the Blended Retirement System who contribute 5% of their own money. That is an incredible price people do not want to pass up.
10. The Roth IRA can simmer for an extended period, and Required Minimum Distributions do not apply to a Roth IRA. On the other hand, people must begin withdrawing funds from their Roth TSP at 72.
11. A Roth TSP may provide further protection. The TSP is backed by substantial federal ERISA safeguards in the case of liabilities, lawsuits, or insolvency. IRA protections vary by state and are governed by state statutes.
FAQs
Is a Roth IRA or a Roth TSP a Better Investment?
It depends, but the majority of people should contribute at least up to the matching funds limit to their TSP (3 percent of your salary). Additionally, the TSP is preferable if the current taxes are high and people anticipate them to be significantly lower in retirement. Applying the deduction to the higher tax rate is preferable, and the Roth IRA is preferable as people near retirement.
Can You Contribute to a Roth TSP and a Roth IRA at the Same Time?
The contribution limits for TSPs and IRAs are distinct. As a result, each dollar contributed to a TSP does not count towards your IRA contribution maximum. However, the limits apply cumulatively to Roth and traditional TSPs and Roth and traditional IRAs.
What are the Similarities?
Both of them are tax-deferred retirement accounts. You are taxed on your contribution in the year it is made (unless you qualify for tax-exempt contributions). Contributions and gains accumulate tax-deferred, and qualifying withdrawals are also tax-deferred (except for matching contributions).
Both are subject to the five-year statute of limitations. To qualify for tax-free distributions, you must be at least 5912 years old or have a permanent disability, and at least five years have passed since the year you initially contributed.
Conclusion
Once you have taken full advantages of the TSP match, the investment decision becomes more difficult. The TSP is preferable if your current taxes are high and you anticipate them to be significantly lower in retirement. It is better to apply the deduction to the higher tax rate. The Roth IRA is preferable as you near retirement. A longer investment horizon means your money will have more time to grow, allowing you to maximize the tax-free growth potential of your Roth IRA. There is no unambiguously superior alternative. It depends on whether you want to take advantage of your tax savings or save them for retirement.
Roth TSPs and Roth IRAs are both excellent vehicles for retirement savings. If you are eligible for federal match funds, you should contribute at least up to this level to your TSP (3 percent of your salary). Additionally, it may make sense to have a Roth IRA in addition to a Roth TSP: There are no laws to stop you from contributing to both. You would fund both accounts to maximize your retirement savings in an ideal world.
Roth IRAs are particularly advantageous if you are saving more than you believe you will need for retirement, as they do not impose required minimum distributions (RMDs). This means that you can leave a Roth IRA to your heirs, and they will have tax-free access to it.
Before making any retirement savings account decisions, it is a good idea to consult with a trustworthy financial planner or advisor.
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