In case you haven’t been paying attention, or are new to federal employment, the Thrift
Savings Plan offers you two ways to save for retirement. You may elect to defer your federal pay into a Traditional account, before state and federal income taxes are deducted; or you may defer your pay, after taxes, into a Roth account. You may use one, the other, or both of these options, and start or stop either or both types of contributions when you like. The Traditional account allows you to avoid paying taxes today in exchange for agreeing to pay them later, when the money is withdrawn from the account. The Roth account allows you avoid paying taxes later, in exchange for agreeing to pay them today.

Based on the questions I receive from Federal Times readers through the Ask the Experts forum online, the “pay now and not later” approach offered by the Roth account is inherently appealing to many TSP participants. The reason is often the idea that paying tax on a smaller amount – usually assumed to be the contribution – is better than paying tax on a larger amount – usually assumed to be the withdrawal. The problem here is that this is not inherently the case. To illustrate this fact, consider some arithmetic: Start with $10,000 and remove 25 percent, or $2,500 for tax payments. Invest the remaining $7,500 in a Roth account until it doubles to $15,000. Withdraw it from the Roth a few years from now, tax-free, and you’ll have $15,000 to spend on that new iPhone with the built-in hair dryer.

Instead, you could contribute the same $10,000, before-taxes from your paycheck into a
Traditional TSP account, leave it there until it doubles in value to $20,000, withdraw it, pay 25 percent, or $5,000 in taxes and be left with $15,000 to spend on that new iPhone. What? In the Roth example, you only paid tax on $10,000, while in the Traditional example you paid tax on twice that amount. Yet, in each case you were left with the same spendable income, all the way through. How can that be? Well, in part, it’s the way the world works, and in part it’s the analytic method I used. Key to the result were the facts that I held the tax rates the same for both the contributions and the withdrawals, and that I based the analysis on comparable gross, or pre-tax, investment amounts. Both of these assumptions are reasonable possibilities – maybe even likely – but not the only possibilities. If the tax rates differ on either end of the analysis, or if I assume that the TSP’s contribution limits are reached in each case, the results will be different.

The point I’m making here is not that one contribution alternative, or the other, is better. My point is that it’s impossible to say that one is better than the other in a general sense. The analysis always requires that the analyst make predictions about the future, and these predictions, while unreliable, will heavily influence the analytic results, and the conclusions drawn from those results. Who knows what the tax system will look like 20, or even 5, years from now?

In addition to the influence of analyst’s assumptions, your individual circumstances will
determine the type of analysis that best suits the decision and the results that will be produced by that analysis. Every case is unique and must be considered on its own.

In addition to the results of scenario and mathematical analysis, there are other factors to
consider when deciding between Traditional and Roth TSP contributions. Once you make a Roth contribution, both types of money in your account must be invested and managed the same way. Each withdraw you make will come, proportionately, from each type of money. When you reach the point when you must begin withdrawing your money, your Roth balance will be used in determining the size of the required withdrawal each year – something that does not happen in a Roth IRA or a regular, taxable investment account. These are complicating factors that should be carefully understood, considered and weighed against any benefit that is expected to accrue before you decide to make Roth TSP contributions.

Finally, when considering whether, or not, to contribute to the Roth TSP, you should benchmark that option against the alternatives of contributing to a Roth IRA, if you are eligible, or to a regular, taxable investment account. It may be possible, using one or both of these alternatives, to obtain similar results using a less complicated solution.

Written By Mike Miles
For the Federal Times
July 6, 2015