Roth TSP vs. Roth IRA: How Do They Compare?

Roth TSP vs. Roth IRA: This is a choice that federal government employees and U.S. military professionals need to make when they consider choosing a retirement savings plan. The real question is, do you go with the account offered under the government plan or, like any civilian, fund a Roth IRA on your own?

Recent changes to the federal retirement program make this an easy choice. In short, your employer is now matching part of your retirement savings, and at a level that is more generous than private companies are offering these days.

About the Roth TSP

The Roth Thrift Savings Plan (TSP) is part of the Federal Employees Retirement System (FERS). If you are a federal employee or member of the military, you are automatically enrolled in FERS, and 0.8% of your base salary is deducted to pay for it.

The first thing to keep in mind is their similarities between a Roth TSP and a Roth IRA. They are two versions of Roth accounts, with the same benefits that all Roth accounts offer.

You pay in a portion of your earnings in post-tax dollars. That is, the income tax you owe on that money is paid in the year you pay it in. Once you retire, you should owe no additional taxes. The entire account, both your contributions and the profit it earns, is tax-free when you withdraw it.

And here’s the no-brainer part of the answer: Once you are in FERS, when you sign up for a retirement account, whether it is a Roth account or a traditional account, your government employer will automatically match at least 1% of your base pay contribution. After some period of service, it will add more, up to an additional 4% more, if you contribute that much or more on your own. The rules and the matching amounts are a bit different depending on whether you are military or civilian.

That’s a pay increase of up to 5%, tucked away in a retirement account along with your own contribution.

What Is the Blended Retirement System (BRS) for Military Personnel?

Launched in 2018, the Blended Retirement System (BRS) allows military personnel the option of joining a new program that “blends” two major sources of retirement income, the annuity for career service and the thrift savings plan.

The annuity portion is a much-reduced legacy of the old Civil Service Retirement System (CSRS), which was, until 1984, the only government retirement program. The few remaining employees on that old legacy plan will get a much more generous annuity, but they aren’t eligible for the TSP employer match.

Those who are interested have to “opt in” to join the BRS. It’s a fairly comprehensive retirement plan, with its own rules and options. 

By contrast, you don’t have to opt into the TSP program. After you serve 60 days, the military will automatically start contributing 1% of your salary to it. It also will automatically start deducting 3% of your base pay to the TSP, although you can opt out of that anytime. The government contribution will continue if you’re in the BRS.

Thrift Savings Plan Contribution Limits

TSPs parallel the contribution and catch-up limits of the 401(k) plans that are available to many private-sector workers. For 2021, the Thrift Savings Plan contribution limits are as follows:

• $19,500 if you’re under age 50
• $26,000 if you’re age 50 or older (including a catch-up contribution of $6,500)

What Is a Thrift Savings Plan (TSP)?

Many private employers offer their employees a 401(k) retirement savings plan. The government created its own retirement savings plan for its employees and military personnel and called it the Thrift Savings Plan (TSP).

The purpose of a TSP is to allow employees to build a retirement savings account over time by setting aside a percentage of their paychecks, to be invested and grow until they retire and are ready to spend the money.

Like 401(k) plans, TSP plans come in two basic flavors, and the employee can choose which to take:

• If you have a traditional TSP, the money you pay into the account comes out of your pre-tax dollars. That is, it’s taken off the top of your gross pay, and you don’t pay income taxes on it until you retire and start withdrawing money. At that time, you will owe income taxes on both the principal and the interest your money earned. Government employers have offered the traditional TSP since 1986.
• If you have a Roth TSP, you’ll pay in post-tax dollars. The taxes owed on the income will be withheld that year. When you retire, the entire proceeds are yours tax-free. The Roth TSP has been offered only since 2012.

Summary of Roth TSP and Traditional TSP Rules

Whichever you choose, the rules are similar to those for private-sector employees, with some consideration for the needs of federal employees and military personnel:

• You can contribute up to a maximum annual limit, which may be adjusted annually. For the 2020 and 2021 tax years, the maximum is $6,000, plus $1,000 if you’re age 50 or older. That’s for a Roth TSP or a traditional TSP, or even a combination of accounts if you have more than one.
• Your federal employer makes a contribution of a minimum of 1% and as much as 5% to your account. 
• Your money will be invested in your choice of several investment funds and “lifestyle cycle” funds. The latter are funds that gradually reduce risk to your principal as you approach retirement age.

How the Roth TSP and the Traditional TSP Differ

In either case, this is your retirement account, so you are discouraged from making early withdrawals. But the rules are different for a Roth TSP and a traditional TSP:

• You can’t touch the money in your traditional TSP before you reach age 55 (if you retire or separate) or age 59 1/2 (whether or not you retire), or you will pay a tax penalty. In any case, you’ll also owe the income taxes on that money in the year you withdraw it.
• You can take the principal in your Roth TSP any time you want. It’s your money, and you already paid the taxes. But you can’t touch any of the profits your money earned without paying a penalty.
• When you reach age 72, you are required to take some money out of your traditional IRA account every year. There are no similar restrictions on a Roth account. 

The Roth option will be a source of delight for you in your retirement years. But only you can decide whether you can spare the greater loss to your paycheck that paying the income taxes up front will entail.

Differences Between Roth TSP and Roth IRA

One crucial difference, at least for those who are at the top of the salary pool: There is no limit to the amount of money you can earn and still contribute to a Roth TSP. 

The standard Roth IRA or Roth 401(k) plan available to private-sector employees phases out contributions for those who earn above a certain amount. As of the 2020 tax year, that is $183,000.

There is no salary limit for those who want to contribute to a Roth TSP.

Roth TSP vs. Roth IRA

Anyone who earns an income can open a Roth IRA or, for that matter, a traditional IRA, at a bank, through a broker, or through an online investment account.

As far as the Internal Revenue Service (IRS) is concerned, the rules are much the same as for a TSP. You’ll get the tax break now (with a traditional IRA), or you’ll pay the taxes upfront (with a Roth IRA).

The annual limits to your contribution are the same, too.

If you go this route, your payments into the account won’t be automatically deducted from your paycheck, although you could set up an automatic withdrawal from a bank account.

Combat Zone Tax Exclusion

If you’re a member of the military, TSP taxes may work differently because of the Combat Zone Tax Exclusion. The income you earn while deployed in a combat zone is excluded from your taxable income. As a result, your contributions to a Roth TSP (or a Roth IRA) are exempt from taxes. 

Note that qualified withdrawals in retirement from a Roth TSP (or Roth IRA) are always tax-free.  That means that a military member who is deployed to a combat zone can divert money into a Roth TSP (or Roth IRA) and never pay tax on the contributions or earnings. 

How Do Roth TSPs and Roth IRAs Compare?

While Roth TSPs and Roth IRAs are excellent retirement-savings vehicles, they have different characteristics and benefits. Here’s a comparison.

Similarities

Both are after-tax retirement accounts. You pay taxes on your contribution the year you make them (unless you qualify for tax-exempt contributions). Contributions and earnings grow tax-free, and qualified withdrawals are tax-free, as well (except for matching contributions).  

Both are subject to the 5-year rule. To take tax-free distributions, you must be at least age 59½ or have a permanent disability, and at least five years must have passed since Jan. 1 of the year you first contributed. 

Differences

Only the TSP is a payroll deduction. With a Roth IRA, you would open an account and contribute to it directly. Roth TSP contributions come out of payroll deductions.

Only the TSP has no income limits. Roth IRAs are subject to income limits, but you can contribute to a Roth TSP no matter how much you earn. 

You can’t withdraw money early from a TSP. You can withdraw your Roth IRA contributions at any time, with no tax or penalty. This is not an option with a Roth TSP.

You must make minimum withdrawals from a Roth TSP. Roth IRAs have no required minimum distributions (RMDs) during your lifetime. But you must start taking RMDs from a Roth TSP at age 70½ (unless you’re still working at your federal job).

Roth IRA vs. Roth TSP: Which Is Better for You?

There’s an important question to ask before you decide: Do I qualify for matching funds? If you’re a civilian employee and qualify, you should contribute at least up to the federal match first because you’re automatically earning 100% on matched money (think: free money).

On the other hand, a Roth IRA has the same excellent tax benefits plus freedom from required minimum distributions later in life. No RMDs mean you can leave your savings untouched if you don’t need the money, and your beneficiaries can enjoy years of tax-free growth and income. 

Then, if you have extra money left to contribute, consider either a regular or Roth TSP contribution, depending on whether you want a tax deduction now or later.

The Bottom Line

Roth TSPs and Roth IRAs are excellent ways to save for retirement. And there are no rules that prevent you from contributing to both. Ideally, you could max out both accounts to boost your retirement savings.

Before making any decisions about your retirement savings accounts, it’s helpful to discuss your options with a trusted financial planner or advisor.

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