Is Roth in Retirement Right for You?

Roth in RetirementHave you ever heard someone say, “I just can’t wait to pay taxes this year!” Have you ever said it? The answer to both of those questions is most likely a resounding no. Unfortunately, taxes don’t just go away in federal retirement. Although you cannot escape taxes in retirement you may be able to minimize your tax burden. For federal employees, a Roth Thrift Savings Plan (TSP) can be a powerful tool that provides tax-free growth. Contributing to a Roth TSP while working allows you to make tax-free withdrawals in retirement.

Advantages to Roth TSP continue to stack up over time. Due to federal employees having multiple income streams in retirement (such as your FERS annuity and Social Security), a federal employee may not fall into a lower tax bracket in retirement. The tax-free withdrawals or Roth in retirement may be an important option for a federal retiree to minimize their future tax liabilities.

As a federal employee weighs the pros and cons of a traditional TSP and Roth TSP it may be helpful to ask the question, “What is the best type of money?” The list below provides the answer.

Smart Money List

1. Free Money (OPM)

OPM doesn’t just stand for the Office of Personnel Management. It also represents “other people’s money.” For federal employees that fall under the Federal Employee Retirement System (FERS), this means receiving a 5% match towards your Thrift Savings Plan (TSP). As a FERS employee, you must contribute at least 5% to receive 5% from the government towards your Traditional TSP.

2. Tax Free

Roth accounts, Cash Value of Life Insurance policies, and municipal bonds can all be tax-free upon distribution. Make sure you understand the rules and requirements to get this opportunity. Who doesn’t love tax-free money?

3. Tax-Deferred

When it comes to your TSP, tax-deferred means that you avoid paying tax on your contributions to TSP, but you do pay tax on distributions out of your TSP. Tax-deferred accounts may consist of your Traditional TSP, Individual Retirement Account (IRA), etc. Some federal employees who believe they will be in a lower tax bracket in federal retirement elect to put their funds into tax-deferred accounts.

4. Taxable

Taxable accounts are not tax-free nor are they tax-deferred. Taxable money can be the least efficient form of money over the long haul. Some great examples of taxable money are W-2 income, taxable interest, and dividends.

When you look at this list, ask yourself — Where do I fall? Where are my assets and where do I want to be when I retire? Typically, you are saving money to spend it later. As you plan for the distribution phase in federal retirement, where will your money be?

The Wrapper Concept

Tax Deferred Savings

Traditional TSP

Your money in the traditional TSP or IRA is in a wrapper like a piece of candy. Inside of the TSP your options consist of the G, F, C, S, I, L funds, or any combination of funds. With an IRA your options are broader. You may choose to put your money in mutual funds, gold, annuities, real estate, etc.

When you put funds into the Traditional TSP you pay no tax; however, you will pay the tax once you begin taking distributions from your TSP. The traditional TSP is tax-deferred because you pay the tax on the money only when you withdraw the money.

Tax Free Savings

Roth TSP

Inside a Roth TSP you can have those same funds: G, F, C, I, S, and L funds. If you have a Roth IRA you still have mutual funds, gold, annuities, stocks, bonds, and real estate. So, what’s the difference?

Fundamental Difference in the Wrapper Concept

In a Roth TSP or Roth IRA your money goes into the wrapper with after-tax contributions. Then on the distribution side you can take the money out, tax-free, in retirement. Roth accounts allow for tax-free growth as you generally don’t pay tax on the interest gained from these investments.

The Benefit of Understanding Roth in Retirement

Have you considered what the tax effect on your investments will be in retirement? If not, now is the time to begin asking questions. Understanding your federal benefits, including Roth TSP and tax implications, will allow you to exchange confusion for clarity and be ready to retire!