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TSP 101: Traditional TSP vs. Roth TSP

Traditional TSP vs. Roth TSP


As a federal employee or member of the uniformed services, you could have a great retirement savings option in the Thrift Savings Plan (TSP). Beyond knowing that it could be great overall, you may be wondering how to use it in ways that could make it great for you. The first step to navigating that process is making sure you understand the differences between the Traditional TSP and the Roth TSP, and why you might choose one over the other.

What is a Traditional TSP?

The Traditional TSP has been in existence since 1986, and gives federal employees an option for saving a percentage of their paychecks through automatic payroll deductions that go into their TSP under parameters set by the employee (like amount and type of account). Any contributions you make are yours to keep, whether you leave your federal position or stay through retirement. The way those contributions are taxed is the biggest difference between types of accounts.

Source: https://www.fedweek.com/tsp/tsps-evolution-performance-past-30-years/

With the Traditional TSP, your contributions are pre-tax. This means you do not pay any taxes on them or on any earnings made from them until you withdraw them. And if you choose to make a withdrawal prior to reaching age 59 ½, you will incur a penalty. Traditional TSPs give you a tax break in the here-and now by lowering your taxable income.

What is a Roth TSP?

The Roth TSP was established more recently, in 2012. It works in an alternate way to the Traditional TSP in that contributions to your account are made only after you’ve already paid taxes on those paycheck earnings. That means another large difference when you decide to start withdrawing funds from the account is you won’t pay additional taxes on your initial contributions. Earnings grow tax-free until withdrawn as well.

Source: https://www.sec.gov/oiea/investor-alerts-bulletins/ib_rothtsp.html

In order for those earned distributions to be considered “qualified” by the IRS, however, you and your account must meet two requirements: In general, you must be 59 ½ years of age or older, and five years must have passed since January 1 of the first year you made Roth contributions to your TSP.

How Traditional and Roth TSPs are Similar

You don’t have to choose between either a Traditional TSP or a Roth TSP. You can contribute to both or just the Traditional TSP or just the Roth TSP as long as the total amount of your contributions doesn’t exceed the maximum annual limit.

In 2022, the total limit on contributions employees under age 50 are allowed to make to their combined TSP is increasing to $20,500. If you are above age 50, you are also allowed additional “catch-up” contributions of up to $6,500. This allows for those who might not have saved enough early in their careers to make up for it. However, it doesn’t matter how much you’ve contributed throughout your career, once your turn 50 and you’re fully contributing the base amount, you’re eligible to make catch up contributions.

Source: https://www.tsp.gov/making-contributions/contribution-limits/

While you can decide to enroll in one or both TSP accounts, keep in mind that if you only enroll in a Roth TSP, you will not receive one of the great perks of enrolling in a Traditional TSP, which is that the government will match your contributions to that account up to the first 5%. The government will only contribute those matching funds directly into a Traditional TSP, where they will be taxed after you withdraw. They will not match your contributions in a Roth TSP.

Which TSP is Right for You?

Deciding whether a Traditional TSP or a Roth TSP is right for you is dependent on your own circumstances and knowledge. Because you have to pay taxes on both accounts one way or another, think instead about whether you’ll be better off paying those taxes now or later.

If your current income level and tax bracket are lower than you think they will be in the future, it might be wise to contribute primarily to a Roth IRA, because the taxes you would pay on withdrawals from a Traditional TSP will likely be higher. If you’re early in your federal government or armed services career and expect your future income to increase considerably, consider paying taxes now on your TSP contributions, rather than waiting until the future.

But if you’re someone who would benefit from having a lower taxable income in your current circumstances, a Traditional TSP might be a better option. You may pay higher taxes on any withdrawals on the back end, but your circumstances for paying those taxes might be much more feasible then as well.

Choosing the right TSP comes down to understanding the pros and cons of each, realizing your own financial situation and career path, and thinking about your comfortable ratio of risk to reward.

Ann Vanderslice Federal Benefits Made Simple, an E.A. Buck Company is an independent financial services firm helping individuals create retirement strategies using a variety of insurance and investment products to custom suit their needs and objectives. This firm is not affiliated with or endorsed by the US government or any governmental agency. E.A. Buck is an independent financial services firm, offering investment and insurance products to consumers. Neither the firm nor its agents or representatives may give tax or legal advice. Individuals should consult with a qualified professional for guidance before making any purchasing decisions. Securities offered only by duly registered individuals through Madison Avenue Securities, LLC (MAS), member FINRA/SIPC. Investment advisory services offered only by duly registered individuals through AE Wealth Management, LLC (AEWM), a Registered Investment Adviser. Insurance services offered through Ann Vanderslice Federal Benefits Made Simple an E.A. Buck Company. MAS, AEWM, and Ann Vanderslice Federal Benefits Made Simple, an E.A. Buck company are all separate entities. 01163196 12/21.