GovExec Daily: Why Aren't More Feds Taking Advantage of the Roth TSP?

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Ross Gianfortune
This is GovExec Daily, where we bring you the federal stories that really matter.  It's May 9, 2022. I’m Ross Gianfortune.

Federal employees have a lot of choices for their retirement finances. Thinking long-term is obviously important in retirement planning and the Thrift Savings Plan can offer many options, including the Roth TSP option.

Originally called an "IRA Plus," the Roth IRA goes back to the late 1990s after it was approved by Congress as part of the Taxpayer Relief Act of 1997. The Roth TSP option for feds, however, is much newer, having been introduced in 2012. 

The Roth TSP is still underused by federal employees. According to one estimate, nearly 85% of feds do not make use of the Roth TSP options at all. But, with the Roth TSP, contributions go into the TSP after tax withholding. Feds will  pay taxes on your contributions at their current income tax rate and won't pay taxes later on withdrawal and any qualified earnings.

Dallen Haws is a financial planner and host of the “Plan Your Federal Benefits” YouTube channel as well as a podcast at PlanYourFederalBenefits.com. He is also the author of the book Building Wealth in The TSP: Your Road Map to Financial Freedom as a FERS Employee . After a short break, he’ll join the show to talk about Roth TSP options and the benefits feds may see from them.

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Ross Gianfortune:
Federal employees have a lot of options for their financial future, including around the Thrift Saving Plan. That is why it is so crucial to have a great tax strategy in retirement to make sure you can minimize your taxes as much as possible.

Dallen Haws is a financial planner and host of the “Plan Your Federal Benefits” YouTube channel as well as a podcast at PlanYourFederalBenefits.com. He is also the author of the book Building Wealth in The TSP: Your Road Map to Financial Freedom as a FERS Employee . He joins me now to talk about how feds should be preparing for this year’s tax season.

Dallen Haws:
Thank you, Ross. Always a pleasure.

Ross Gianfortune
 So why aren't feds using the Roth TSP option?

Dallen Haws:
You know, you know, Ross, I asked myself this question all the time. And when you look at the numbers, I think last time I checked, it was I think it was 15 to 16% of Fed were using that Roth TSP. So that means the vast majority of federal employees are not. Right. And I think there's a couple of reasons. First, it only became available in 2012. Right, so we're hitting about the 10 year anniversary. And so for many folks, especially as they approach retirement, well, this was not around when they started working, right. And even now, it's not the default. So if you just start working in teams, nothing, you're not going to be using the Roth TSP, right. So most people have to really research and find this out by themselves and start using it all on their own accord, which, for the vast majority of people, this doesn't happen. They're busy living their life doing their thing. Right. So I think that's why for the most part, people just don't know much about it. So they don't use it.

Ross Gianfortune:
What are the differences between the Roth TSP and the traditional TSP? We talked about sort of the opt in notion of it, but sort of give us a more detailed breakdown of that sort of thing?

Dallen Haws:
Yeah, no, I think that's important. And I think if people understand the key differences, a much bigger amount or percentage of these people would use it. So basically, this is the core difference is when you pay taxes, right? With a traditional tsp. When you put money into it, you you're for the IRS sake, your income in that year went down, you get a tax deduction, right? With the Roth TSP is exactly the opposite. Where the year you put money in You don't get a tax deduction, but that money you put into that account, it can then grow tax free for basically forever. So let me give you an example. Right, so let's say you put $50, in the traditional TSP, let's say over the course of your career, let's say it grows to $500. Well, guess what, when you take the money out, again, out of the traditional TSP, you got to pay taxes on that entire $500, not just your initial 50, that you got the tax deduction for, but the entire 500 grew to the Roth TSP, exactly the opposite. So you, let's say you put 50 in, you don't get a tax deduction, no tax benefit in the year you do it. But let's say it grows to 500. In retirement, you take the entire $500 out tax free, which is huge. Now, why is that important? Well, most people, when you talk to basically anyone, and you ask them, Hey, do you think taxes are going to go down on the future stay the same or go up? No one's gonna tell you, honestly, they think it's gonna go down, maybe stay the same most likely go up. Right? So if we know, hey, in the future tax rates are gonna be higher? When do you want to pay taxes now or later? Well, now when tax rates are relatively low, right, so if you understand kind of that structure of the main difference, and when you pay taxes, hey, there's a huge advantage of not having to pay taxes later, when tax rates are just gonna be higher. Right?

Ross Gianfortune:
You mentioned earlier, the Roth TSP is comparatively new 10 years in the grand scheme of this stuff is pretty, pretty young, such as it were, how's it performed since it became available 10 years ago?

Dallen Haws:
Yeah, no, great question. So the good news is, when it comes to performance, the Roth TSP is can perform exactly the same as the traditional tsp. And let me tell you why. Because when you invest money in the TSP, well, you invest them exactly the same, the traditional tsp and the Roth TSP, whatever you choose is your max and the TSP between all the funds that G fund that fund CSSI, they're going to invest your traditional tsp and the Roth TSP exactly the same. So when it comes to performance, it's identical. So that's good news.

Ross Gianfortune:
The misunderstanding sort of come up a lot when it comes to the different options, and particularly, what are the misunderstandings that come up about the Roth TSP option?

Dallen Haws:
Yeah, so I think one of the biggest objections I get when I talk about the Roth TSP is most people say, in retirement, I'm going to be in a lower tax bracket, I my tax cuts can be lower later. So I'm just going to get the tax deduction now, because in retirement, incomes will be lower. Now, there's some truth to that sometimes. But what I've seen, I mean, I'm a financial planner, so I run numbers for people all the time. And what I'm going to see their income is going to be in retirement. For many federal employees, you have this interesting issue where you have a pension, you're gonna have Social Security, you have your TSP, you have lots of sources of income. So often, your taxable your tax bracket is not going to be lower in retirement, which is a good thing, that's more money for you. But again, you're probably not going to be in a lower tax bracket. So that doesn't really hold water. And so for most people, it's like, well, make sure you look at your numbers, you're probably not going to be in a lower tax bracket in retirement. So you should probably at least consider it to summary doesn't mean you have to put everything in the Roth TSP tomorrow, just look at the option it could it could do a lot of good for you over the long term.

Ross Gianfortune:
You mentioned a few times with the tax issues that come up what taxes should Feds be cognizant of when approaching the Roth TSP, especially when you talk about retirement?

Dallen Haws:
Yeah, no, it's a good question. So certainly, as people are near the end of their career, their salary is probably as big as it's ever going to get. Right. And so when you do make a switch, let's say, let's say someone's near the end of their career, they're pretty high on the GSA schedule, so they're making a good salary. If they are currently putting, let's say, all their tsp contribution into the traditional TSP, and if they switched 100%, over then to the Roth TSP, then in those years, you could pay significantly more taxes. 1000s of dollars in taxes depend on your salary, how much you're putting in, which in the grand scheme of things probably is gonna save you money, you just have to understand that if you're going to make a dramatic switch like that, every every paycheck, a piece of the paycheck goes to to be withholding withheld for taxes, you just want to make sure you're withholding enough is the biggest thing. So I see people really get excited about the Roth TSP, they see the benefits, they make a big switch, they forget to withhold more so come April 15, the next tax you know the next year like oh, man, I didn't withhold enough on I owe I owe tax owe taxes when they're not used to doing that. So that's one thing to keep in mind. Again, there's great benefits of doing it. Run the numbers for you. That's something to definitely keep in mind. Right.

Ross Gianfortune:
We got a lot of users on our website and listeners to our show who are near retirement, you know, the so-called retirement way that's I've been hearing about for as long as I've been working so I will end on this: How should someone who is near retirement approach the Roth TSP option?

Dallen Haws:
Yeah, you know, it's a great question. As a general rule, having some Roth TSP can be super helpful now, to what extent that really depends on people's situation. But I think for the whoever's listening, I think if you've never heard about the Roth TSP, or you're kind of fairly familiar with it, start start doing some research, right? You can only cover so much in a short podcast like this is to start doing some research, start looking at your situation and start saying, okay, my income is X right now, what is it going to be in retirement? Do I want to have money I could pull out on retirement and not pay a dime in taxes. That's something I into okay, how do I do that? Right. There's no blanket statements other than, hey, it's really nice to have at least some money in the Roth TSP, you should be looking at this at least to some degree.

Ross Gianfortune:
It sounds like pretty solid advice. If I were in that situation, obviously, I'm not a fit, so I get it, but we really appreciate you coming on talking to us. So thanks so much. 

Dallen Haws:
Yeah, my pleasure.

Ross Gianfortune:
Thanks for listening to GovExec Daily. Our show was produced by Adam Butler and hosted by me, Ross Gianfortune. We want to thank Dallen Haws for joining the program. Our music is the song “Signals” by Catfish Dancing. Be sure to rate, review and subscribe on Apple Podcasts or Google Podcasts or wherever you get your podcasts. Check us out on the Clubhouse app by searching GovExec Daily. You can email us any feedback at podcast @ govexec.com or hit us on Twitter @ Govexec. 

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