Traditional TSP vs. Roth TSP

tax form Roth TSPThe decision whether to invest in a traditional TSP or a Roth TSP boils down to whether you believe you will be in a higher or lower tax bracket when you take your distributions.

With the traditional TSP, contributions are made with pre-tax money (income which has not been taxed), grows tax free over the years, and then you are taxed on everything you withdraw. (Unless you are a member of the military making tax-exempt contributions such as combat zone tax exclusion pay, in which case you are not taxed when you withdraw your original contributions.)

In a Roth TSP, your contributions are made with income on which you have already been taxed (unless you are military making a tax free contribution), then they grow tax free over the years, and finally you withdraw both contributions and gains tax free.

Despite all the arguments on either side of the issue, there is no real advantage in terms of how much growth you can expect from your money over the course of your career by choosing one option over the other. The effects of compounding the higher contributions made to a traditional TSP exactly match the benefit you obtain by not paying taxes on the gains under a Roth TSP.

Here’s the math showing how much money will you have available to spend in 10 years, after paying income taxes, under the traditional TSP vs. the Roth TSP:

Let’s start with some simple assumptions:

  • You put $10,000 from your salary into your Thrift Savings Plan this year.
  • Your combined marginal federal and state income tax bracket is currently 35 percent.
  • Your Thrift Savings Plan account earns 5 percent per year.
  • You will retire in 10 years and withdraw both the contribution which you made this year and the returns earned. At that time, your combined marginal income tax rate is still 35 percent.

Contributing to the traditional TSP: Since you aren’t paying income taxes on the $10,000, you can invest the full amount. At 5 percent annual investment returns, the $10,000 in your traditional TSP will grow to $16,289 ($10,000 times 1.05**10). You’ll pay $5,701 of that amount in taxes, leaving an after-tax amount of $10,588 to spend.

Contributing to the Roth TSP: You’ll pay $3500 (35%) income taxes today on your $10,000 contribution. You’ll have $6,500 left to invest in your Roth TSP. Your $6,500 will grow to $10,588 ($6,500 times 1.05**10). Since Roth TSP accounts aren’t taxed upon withdrawal, you will have $10,588 to spend.

Traditional TSP versus Roth TSPSo the only question you need to answer to make this decision is whether you expect to be paying a higher tax rate now or when you retire. If you believe you will be in a lower tax bracket after you retire, you should stick with the traditional TSP. If you believe average tax rates will go up in the future or you will be in a higher tax bracket at the point you start withdrawing, you should seriously consider a Roth TSP. If you are likely to be in the same tax bracket, it probably doesn’t matter which you chose.

I personally don’t believe tax rates are likely to be higher overall when I start withdrawing from my Thrift Savings Plan in another 15 years or so. And I don’t believe that my various sources of income at that stage will be enough to push me into a higher tax bracket (and I might well fall to a lower bracket), so I have elected to stay with the traditional TSP.

More information on the Roth TSP:

Contributions:

  • You can contribute to a traditional TSP, a Roth TSP, or both. You do so with a contribution election to instruct your agency what to do (TSP contribution elections vary by agency, so contact your human resources department to obtain the form or get pointed to the online page).
  • The combined total of your Roth TSP and tax-deferred traditional TSP contributions are capped at the elective deferral limit.
  • Agency contributions will always be made to your traditional TSP balance.

Allocations and Transfers:

  • All contribution allocations or interfund transfers will apply to the investment of both your Roth TSP and traditional TSP contributions or balances.

Existing TSP funds:

  • Funds which are already in your account when you begin making Roth TSP contributions will remain part of your traditional TSP balance. You may not convert those funds to a Roth TSP.

Withdrawals:

  • You can take loans, in-service withdrawals, and partial withdrawals from your Roth TSP account just as you could with a traditional TSP. They will come out of your account on a pro rata basis with a proportional amount from your traditional TSP and Roth TSP balances.
  • When you withdraw from your Thrift Savings Plan account, you will be able to separately transfer any portion of your Roth TSP and traditional TSP balances to IRAs or to other eligible employer plans.

From the TSP.gov website:

traditional vs roth TSP matrix* If you are a member of the uniformed services receiving tax-exempt pay, contributions from that pay will be tax-exempt.

1 Roth TSP contributions are subject to income taxes, while traditional TSP contributions are not taxed until withdrawn.
2 You would have to pay taxes on any pre-tax amount transferred to a Roth IRA.
3 Transfers to a Roth IRA from a Roth TSP are not subject to the income restrictions which apply to Roth IRA contributions.

28 thoughts on “Traditional TSP vs. Roth TSP”

  1. Good information! I have a child starting college in the fall and I want my AGI to be as low as possible. I’m contributing the max to my TSP as well as $200/pp catch-up. I’m afraid if I change some of that to ROTH TSP that I’d get dinged on FAFSA next year. Thoughts?

  2. Interesting question. While I agree that swapping a portion of your contributions to a Roth TSP would impact your AGI, I don’t know anything at all about what effect that might have on FAFSA applications.

  3. I thought another advantage to the ROTH is that it grows tax free meaning all of the interest earned is tax free whereas the traditional gets taxed on the total amount as you withdraw. To me it makes sense to pay some of my taxes upfront especially later in my career as the interest earned will get larger. Or am I wrong?

    1. Studies show the effects of compounding the higher contributions made to a traditional TSP (your contribution is higher because you don’t pay tax on those funds) almost exactly match the benefit you obtain by not paying taxes on the gains under a Roth TSP. So any advantage will be determined by the tax rate you are paying when you do pay those taxes.

  4. I still have a lot to learn about this. When you talk about what tax bracket you are in now compared to when you retire, are you referring to the tax bracket that you are in based on the income from the job you retired from, or based off your pension amount?

    1. Your tax bracket at retirement will be based in your pension, disbursements from your TSP, and any other income you may be generating (rental income, dividends, interest, etc.)

  5. I’ve wondered about the actual advantage of the TSP Roth vs Traditional TSP in the long run. Can you please post links to the studies, or copies of the studies, you refer to above? I’ve been contributing the max to both for a couple years now, but only this year able to add the catch-up to the Roth. I don’t know how many younger employee’s can afford retirement contributions and a mortgage at the same time.

  6. Great question, and you have inspired me to do a little rewrite up above to provide the math showing that you will wind up with exactly the same amount of money in your Thrift Savings Plan account to spend if your combined marginal tax rate is the same at retirement as it is now.

  7. This example is incorrect since the whole 10000 will be invested in the Roth. The 3500 tax will be immediately paid out of other money, not the invested money. You can then earn the 16,289, and subtract he 3500 tax previously paid, to be left with 12789, which is more that 10588!

    1. I see what you are saying, but that is changing our hypothetical rather dramatically. If we suppose the Roth investor has an extra $3500, we should let the traditional TSP investor put in $3500 more too. And then they both again wind up with the same amount come retirement.

      1. Thank you for showing the math; that has helped me in my decision-making. Until I saw this page, I didn’t quite understand why people were saying “the only thing that matters is your future tax rate”. Now that I understand why they said that, I’ll be switching from traditional TSP to Roth TSP immediately.

        I will be on the end case – that is, always contributing the maximum the law allows. Doesn’t matter what my current or future tax rate is – I’ll contribute the maximum.

        So in that case, I agree with Jennifer’s math. The Roth option is a no-brainer. I’ll have a little less disposable income now because I’ll stop doing the traditional TSP and start doing the Roth TSP, and therefore pay more in taxes this year. But I’ll have hugely more money when I retire.

      2. TS Paul, I have been researching TSP heavily since I hired on about 4 1/2 years ago. I ran the numbers several times and think this is a good way to explain it: You will pay more taxes on the back end of a Traditional due to there being more money from compounded growth than you had put in. The realized net growth (in your pocket) will more than compensate for those taxes due to the factors you mention above (the $3500 difference on the front end). In a nutshell, you pay more taxes, but it effectively grew more due to the cost-difference on the front end. You still get more in-pocket.

  8. Where I see an issue…the government matching your traditional TSP and not matching your contributions in the ROTH. So, if you are splitting your traditional and ROTH investment, and this puts you under the matching percentage…you will not get the maximum matching percentage aligned in the traditional investment. (basically, why do the government not match the Roth contributions?)
    As well, the AGI will be affected as you move forward with splitting or leveraging more of the Roth investment….thoughts?

    1. JC: agency matching is based on total contributions to both your Traditional TSP and ROTH TSP accounts. All of the agency contributions, however, are deposited into your Traditional TSP account.

  9. [email protected] says:

    You must list your contributions to your TSP on your FAFSA and they take that into account when they determine your EFC so it doesn’t matter. You also must list your TSP account balance on the CSS Profile that all colleges also require and use to determine aid.

  10. What if I contribute the maximum allowed each year, whether it is in Traditional or Roth TSP. Then, don’t I get a bigger benefit from investing in Roth?

  11. That depends entirely upon whether you will be in a higher tax bracket when you are withdrawing from your Thrift Savings Plan. See the post above…

  12. Background: Retired Military with traditional. non-matched TSP. New Federal employee (FERS) seeking to participate in agency matching.

    Question 1: When its said that when you contribute X% of income, will the amount be the same whether you elect for that to be traditional or Roth?

    Question 2: [If I read this right] If you elect Roth, the agency contribution will go into traditional, so you’re really making a half-n-half contribution: X% from you and X% [up to 5%] from the agency.

    Quesiton 3: Will the contributions you make as a new FERS federal employee be “merged” with the similar type account as military active duty?

  13. As a uniformed member that contributes 10% is there any benefit to split the contribution in half Roth/Traditional?

    Based on the math above it would seem like it wouldn’t matter.

    Is it safe to play the middle of the road?

    1. Anything is possible with our elected leaders – they could change the rules somewhere down the road and make one suddenly more advantageous than the other, but I wouldn’t split it just for that reason.

      If I was military and relatively junior (so I was in a low tax bracket), I might be inclined towards the Roth TSP under the theory that I would likely be in a higher bracket at the point when I started withdrawing.

  14. Your math works for your hypothetical example but it seems that at the maximum contribution limit the Roth version would have an advantage. For a traditional version the “extra” you have from tax savings verses the Roth is taxed and grows taxed. Can you show the math here?

  15. Yeah, I agree Dave, the way I have been doing it is putting in as much money to the limit through traditional as I can, then once I figure I have reached the limit (18,000 as of 2015) to go back and calculate out the percentage of your income you want to add in as Roth since it is more advantageous after hitting cap. Weird but I found this remarkably similar to calculating stats for World of Warcraft endgame raids, lol.

  16. Thank you for the clarification. I do have one more nuance. What about the exemptions your are claiming (dependents)? My brain is telling me that my dependents give me a much lower tax rate; therefore, I should be contributing all my money to the Roth TSP to take advantage.

  17. I know you are trying to make your math easy, and for a general explanation of this posts purposes it does its job. However, I would use the actual compounding formula, A = P (1 + r/n) ^ nt, I would hate for someone to try and use the above formula in your post and be confused. Otherwise great post! I’ve been doing Roth and max contributions, but you have me thinking. I live in a state where I pay state taxes but i definitely will retire in a no state tax (Texas), so why do roth? when I can defer those state taxes doing traditional and then retire in a no state tax and only pay the federal taxes. I also suspect not to be in a higher tax bracket (50/50 chance) or at least be in the same one.

  18. Another variable just as important as your retirement tax rate is the 5% assumed growth rate in your TSP accounts. Any growth rate above that 5% tilts the advantage to the Roth. I noticed on my 2015 Annual Benefits statement that just came out today they assume a 7% growth rate on my TSP balance from today to the various retirement ages.

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