(Tax Treatments of Your Contributions)
Key Points:
Understanding the difference of pre-tax and after-tax contributions Cd otherwise be entitled because you must contribute to receive the agency match.
So you’ve decided to get serious about TSP investing – great move! And you’re wondering what all the fuss is about between traditional and Roth TSP accounts? Well, the main difference is when you pay taxes on your contributions. It’s an important consideration, as well as a personal one…and one that confuses many people so don’t feel silly if you don’t understand the difference.
Traditional vs Roth Contributions
Two tax treatments are available for your employee TSP contributions - pre-tax and after-tax contributions. You indicate your choice(s) when you make a contribution election. Did you know that you can use both? Yes, you can! And you can also change your election at any time. However, you cannot convert any portion of your existing traditional pre-tax TSP balance to an after-tax Roth balance.
Traditional TSP – when you make traditional contributions, you defer paying taxes on your contributions and their earnings until you withdraw them. These pre-tax contributions are taken out of your paycheck before your income is taxed, lowering your taxable income. Earnings on your traditional contributions grow in your account tax-deferred. When you withdraw the funds, you pay taxes on both the contributions and their earnings. All employee contributions made before May, 2012 are considered traditional contributions.
Roth TSP – when you make Roth contributions, you pay taxes on your contributions as you are making them, i.e. contributions are taken out of your paycheck after your income is taxed. This means that when you withdraw funds from your Roth balance, you will not have to pay tax on the distribution because you already paid taxes on the contributions. Contrary to “urban legend,” there are no income limits for Roth TSP contributions. Restrictions you may have heard about apply to Roth IRAs.
But what about paying taxes on the earnings of your Roth TSP? This is a bit confusing but we’ll try to simplify it for you. You will not have to pay tax on the earnings of your Roth TSP account if your withdrawal is qualified. Roth earnings become qualified (i.e. paid tax-free) when two conditions are met:
Five (5) years have passed since January 1 of the calendar year in which you made your first Roth contribution (you’ve had the account for five years), AND
You are age 59 ½ or older, permanently disabled, or deceased.
If either requirement has not been met at the time of your withdrawal, the distribution is not qualified so the earnings portion of your distribution will be taxed as income.
If you’re thoroughly confused…or would like to see this information presented another way…we suggest you check out this Traditional/Roth Comparison Matrix at the TSP site.
One other important thing to know is that if you have both traditional and Roth TSP balances, they are kept in separate “buckets” in your TSP account for tax purposes.
Action Step:
Watch the TSP video about traditional and Roth contributions here
The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular individual or circumstance. This article is not intended to be a client-specific analysis or recommendation. Do not use this article as the sole basis for any financial decisions. Consider all relevant information. Information should not be considered as tax or legal advice. You should consult with your tax advisor and/or attorney regarding your individual circumstances.
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