May 2012
Interpreting the new Roth Thrift Savings Plan
The Thrift Savings Plan (TSP) will soon give your spouse a new way to save for your retirement. Heard of a Roth IRA? Well here comes the Roth TSP.
What is the difference between a TSP and a Roth TSP?
When you pay the taxes. TSP contributions reduce taxable income today and taxes are due when you take the money out. Roth TSP contributions do not reduce taxable income today but if you meet the IRS requirements (five years since your initial contribution and waiting until you are 59 1/2) then your withdrawals are tax-free.
Let’s look at an example. Your spouse’s base pay is $50,000 of which you contribute $5,000 into the TSP. Come tax time the IRS only taxes you on $45,000 of income. With a Roth TSP, if you put $5,000 into your Roth TSP, you are still taxed on the full $50,000 you earned.
Now, fast forward to age 59 1/2. Both accounts have been growing tax-free over the years and let’s say you have a balance of $200,000. You want to use $15,000 to go on your dream retirement vacation. If you have a TSP you will withdraw about $20,000, withhold $5,000 in taxes, assuming 25% tax bracket, and then have $15,000 to spend. If you have a Roth TSP, and it has been established for five years, you withdraw what you need and there are no taxes due on the $15,000.
Now, what is the difference between a Roth TSP and a Roth IRA?
How much you make and how much you can save. A Roth IRA allows you to contribute $5,000 per year, $6,000 if you are over 50. A Roth TSP allows you to save $17,000 per year, $22,500 if you are over 50, a very big difference. If your adjusted gross income as a couple is over $183,000 you cannot contribute to a Roth IRA. There are no income limits to being eligible to contribute to a Roth TSP.
So, what should you do?
It is not possible to know for certain if you are in a higher tax bracket now or if you will be in a higher tax bracket when you are retired. If we knew that we could calculate if a TSP or a Roth TSP makes the most financial sense. What we do know is that there are tax advantages to military pay which may put you in a lower tax bracket today and therefore make it more desirable to do the Roth TSP. When you are retired, if your spouse has earned a military pension you know that will be taxed. Consider being diversified from a tax perspective and funding the Roth TSP so that you have some tax-free income as well.
But, don’t get too excited. TSP announced the Roth will be available May 7, 2012, but Defense Finance and Accounting System (DFAS) announced the Roth TSP will be available in June or October, depending on your branch of service. Marine Corps will have access in June 2012 and Army, Navy and Air Force will have access in October 2012. Do your homework, pull out your paystub and make a plan for when it becomes available.
What is the difference between a TSP and a Roth TSP?
When you pay the taxes. TSP contributions reduce taxable income today and taxes are due when you take the money out. Roth TSP contributions do not reduce taxable income today but if you meet the IRS requirements (five years since your initial contribution and waiting until you are 59 1/2) then your withdrawals are tax-free.
Let’s look at an example. Your spouse’s base pay is $50,000 of which you contribute $5,000 into the TSP. Come tax time the IRS only taxes you on $45,000 of income. With a Roth TSP, if you put $5,000 into your Roth TSP, you are still taxed on the full $50,000 you earned.
Now, fast forward to age 59 1/2. Both accounts have been growing tax-free over the years and let’s say you have a balance of $200,000. You want to use $15,000 to go on your dream retirement vacation. If you have a TSP you will withdraw about $20,000, withhold $5,000 in taxes, assuming 25% tax bracket, and then have $15,000 to spend. If you have a Roth TSP, and it has been established for five years, you withdraw what you need and there are no taxes due on the $15,000.
Now, what is the difference between a Roth TSP and a Roth IRA?
How much you make and how much you can save. A Roth IRA allows you to contribute $5,000 per year, $6,000 if you are over 50. A Roth TSP allows you to save $17,000 per year, $22,500 if you are over 50, a very big difference. If your adjusted gross income as a couple is over $183,000 you cannot contribute to a Roth IRA. There are no income limits to being eligible to contribute to a Roth TSP.
So, what should you do?
It is not possible to know for certain if you are in a higher tax bracket now or if you will be in a higher tax bracket when you are retired. If we knew that we could calculate if a TSP or a Roth TSP makes the most financial sense. What we do know is that there are tax advantages to military pay which may put you in a lower tax bracket today and therefore make it more desirable to do the Roth TSP. When you are retired, if your spouse has earned a military pension you know that will be taxed. Consider being diversified from a tax perspective and funding the Roth TSP so that you have some tax-free income as well.
But, don’t get too excited. TSP announced the Roth will be available May 7, 2012, but Defense Finance and Accounting System (DFAS) announced the Roth TSP will be available in June or October, depending on your branch of service. Marine Corps will have access in June 2012 and Army, Navy and Air Force will have access in October 2012. Do your homework, pull out your paystub and make a plan for when it becomes available.