Author Topic: Federal Employee: Switch TSP Contributions to Roth?  (Read 591 times)

elysianfields

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Federal Employee: Switch TSP Contributions to Roth?
« on: May 06, 2018, 02:04:42 PM »
Hi Everyone,

I stand to qualify for a Federal pension in a few more years, which comes with Federal Employee Health Benefits (FEHB) as long as I continue to pay the employee contribution.

I've been contributing to the deductible TSP for the tax benefits, but I've begun to think that further deductible contributions are counter-productive:
  • Since my pension will fill up the lower brackets in retirement, building a Roth pipeline would result in paying taxes at a higher tax bracket;
  • I've built a large deductible TSP balance, which will result in large required minimum distributions (RMD), and thus a higher tax bill in retirement;
  • Agency matching contributions go into the deductible TSP, no matter whether my own contribution go to the deductible or Roth TSP;
  • With one child in college and another entering soon, TSP contributions don't reduce my income for FAFSA / financial aid purposes, as they are added back as untaxed income.
Consequently, I plan on switching my contributions from deductible to Roth TSP.  Have I failed to consider anything?

MDM

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Re: Federal Employee: Switch TSP Contributions to Roth?
« Reply #1 on: May 06, 2018, 02:16:14 PM »
  • Since my pension will fill up the lower brackets in retirement, building a Roth pipeline would result in paying taxes at a higher tax bracket;
  • I've built a large deductible TSP balance, which will result in large required minimum distributions (RMD), and thus a higher tax bill in retirement;
Those are perhaps the most important.

See Most TSP Participants Should Switch To the Roth TSP to support your idea.

Will the pension put you at exactly the same marginal rate for withdrawals in retirement as the marginal rate at which you would save on traditional contributions this year?

elysianfields

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Re: Federal Employee: Switch TSP Contributions to Roth?
« Reply #2 on: May 06, 2018, 03:30:48 PM »
Will the pension put you at exactly the same marginal rate for withdrawals in retirement as the marginal rate at which you would save on traditional contributions this year?

Hi MDM, thanks for the quick response!

If you could tell me the marginal rates and tax brackets in effect when we retire and when we must take RMDs, as well as the stock market returns during the intervening years, that would really help us calculate what we should do!  ;-)

With my spouse working, we're currently solidly in the 22% marginal bracket.

I'd qualify for a pension in 2026, and my pension in current dollars would fall into the current 12% (but after the TCJA sunsets, in 2026, reverting to 15%) bracket, more than halfway to the lower boundary of the current 22% (post-TCJA-sunset reverting to 25%) bracket.  That would leave only a little room to build a Roth pipeline for 10>x>20 years before RMDs from our deductible TSPs and TIRAs commence.  However, our balances are way too large to exhaust via the Roth pipeline, and (as I mentioned before) the agency matching contributions would continue to build the deductible TSP balance before retirement.

Once the RMDs begin, and since we'd have also by then started taking Social Security Benefits, we'll almost certainly exceed the current lower boundary of the current 22% (in 2026 reverting to 25%) bracket, meaning our capital gains would also result in non-zero CG taxes.

By switching our TSP contributions to Roth now, we'd pay 22% now to avoid paying 25% (under current law) in retirement; if the Congress raises marginal tax rates in the future, which I expect, we'd avoid paying an even higher rate.

Consequently, I believe it makes the most sense to switch to Roth TSP contributions now. 

MDM

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Re: Federal Employee: Switch TSP Contributions to Roth?
« Reply #3 on: May 06, 2018, 03:46:45 PM »
Consequently, I believe it makes the most sense to switch to Roth TSP contributions now.
Seems you have analyzed well - good luck!

elysianfields

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Re: Federal Employee: Switch TSP Contributions to Roth?
« Reply #4 on: May 06, 2018, 04:18:51 PM »
Two more data points:

Since we have one child in college, we need to watch the limits for claiming the American Opportunity Tax Credit.  The credit begins to phase out at $160k for MFJ ($80k for single filers) and reduces to zero at $180k ($90k for single filers).

Our children no longer qualify for the Child Tax Credit, but will qualify for the new $500 "Credit for other dependents", for which the phase-out commences at $400k for MFJ ($200k for single filers).

simonsez

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Re: Federal Employee: Switch TSP Contributions to Roth?
« Reply #5 on: May 07, 2018, 07:28:43 AM »
Two more data points:

Since we have one child in college, we need to watch the limits for claiming the American Opportunity Tax Credit.  The credit begins to phase out at $160k for MFJ ($80k for single filers) and reduces to zero at $180k ($90k for single filers).

Our children no longer qualify for the Child Tax Credit, but will qualify for the new $500 "Credit for other dependents", for which the phase-out commences at $400k for MFJ ($200k for single filers).
Roth TSP is not an all or nothing exercise.  Put what you can into Roth TSP while maximizing these credits and then put the rest in traditional. 

If in hindsight while you're sipping Mai Tais if you realize you should've switched more to Roth TSP earlier during your working years, that's okay as that means you still won the game.  i.e. paying "too much in taxes" in retirement due to the traditional TSP funds means you have plenty of money.  Don't let perfect be the enemy of good.

Per MDM's post in the Investment Order thread:
"Also, if you pick traditional and that ends up being wrong it will be because you have "too much money" - not the worst problem.
If you pick Roth and that ends up being wrong it will be because you have "too little money" - that can be a real problem."

FindingFI

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Re: Federal Employee: Switch TSP Contributions to Roth?
« Reply #6 on: May 07, 2018, 01:19:34 PM »
One more piece to consider: When withdrawing from the TPS, you do not have the ability to choose how much comes from traditional and how much comes from Roth.  From what I understand, you determine how much you wish to withdraw and the amount from each account is proportional to the balances. This may not have a significant impact on your plan, but its worth knowing that you won't be able to access only your Roth balance unless you roll it out into an IRA, for example.

elysianfields

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Re: Federal Employee: Switch TSP Contributions to Roth?
« Reply #7 on: May 07, 2018, 01:41:45 PM »
One more piece to consider: When withdrawing from the TPS, you do not have the ability to choose how much comes from traditional and how much comes from Roth.  From what I understand, you determine how much you wish to withdraw and the amount from each account is proportional to the balances. This may not have a significant impact on your plan, but its worth knowing that you won't be able to access only your Roth balance unless you roll it out into an IRA, for example.

Thanks for the reminder.  I'm waiting to see what changes occur in the withdrawal options once the Federal Retirement Thrift Investment Board (FRTIB), the trustee for the TSP, implements the TSP Modernization Act of 2017.  Rolling out funds to separate IRAs are always an option, though it would be nice to keep the funds in the TSP given the super-duper low expense ratio, 0.033% in 2017.
« Last Edit: May 07, 2018, 01:47:22 PM by elysianfields »

elysianfields

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Re: Federal Employee: Switch TSP Contributions to Roth?
« Reply #8 on: May 07, 2018, 01:55:16 PM »
Roth TSP is not an all or nothing exercise.  Put what you can into Roth TSP while maximizing these credits and then put the rest in traditional.

Correct.  Given that our income might approach the AOTC limit of $160k in 2019, I can always switch my contributions from one to the other as needed.

If in hindsight while you're sipping Mai Tais if you realize you should've switched more to Roth TSP earlier during your working years, that's okay as that means you still won the game.  i.e. paying "too much in taxes" in retirement due to the traditional TSP funds means you have plenty of money.  Don't let perfect be the enemy of good.

Per MDM's post in the Investment Order thread:
"Also, if you pick traditional and that ends up being wrong it will be because you have "too much money" - not the worst problem.
If you pick Roth and that ends up being wrong it will be because you have "too little money" - that can be a real problem."

Indeed, excellent reminders.  I'm not obsessed by the future income taxes we'll have to pay on our RMDs, and given the unknown variables, optimizing that number at the minimum amount seems impossible anyway.  As you & MDM observe, I'd prefer a margin of safety with the requirement to pay a slightly larger tax to running out of money.

elysianfields

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Re: Federal Employee: Switch TSP Contributions to Roth?
« Reply #9 on: May 11, 2018, 09:31:05 PM »
One more piece to consider: When withdrawing from the TPS, you do not have the ability to choose how much comes from traditional and how much comes from Roth.  From what I understand, you determine how much you wish to withdraw and the amount from each account is proportional to the balances. This may not have a significant impact on your plan, but its worth knowing that you won't be able to access only your Roth balance unless you roll it out into an IRA, for example.

According to the FRTIB, this will soon no longer be the case:

Quote from: The FRTIB
By the way, in addition to the changes made by the new law, we’re also adding the ability to specify how much of your withdrawal should be Roth and how much should be traditional; withdrawals currently come out pro rata from both sources.

Source:  https://www.tsp.gov/PDF/formspubs/tspfs10.pdf

Beach_Stache

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Re: Federal Employee: Switch TSP Contributions to Roth?
« Reply #10 on: May 12, 2018, 04:58:26 AM »
At what age will you retire?  Then at what age will you start collecting a pension (i.e. will it be the same year or a deferred pension)?  I am Fed as well and can retire w/30 years in at age 58 (only 10 years in).  We max out our 401k's (My TSP) and Roth IRA's (DW's just last year) and have post-tax investments as well.  Up until this year I just put everything on pre-tax TSP, but as I did the projections, if we kept it up (or even if I just stopped putting anything in my TSP) we'd have a lot in 401k's.  With the tax rate shift and going from the top of 25% down to 22% (right at that cut off) I decided this year to shift about half to Roth TSP and half to normal TSP.  I probably would have switched all to Roth TSP, however I still contribute to the Roth IRA and don't want to miss out, and we are close to that cut off and I don't want to push over the limit where I can contribute, so this year I'm doing $10k to TSP and $8.5k to Roth TSP.

I figure from ages 58-70 I'll convert a lot over each year from TSP to Roth (after I move it over to Fidelity or Vanguard), so even when I'm collecting a pension, it'll only be the equivalent of like $35k/year, which is still something, but much lower than my working years, and during those 12 years I can hopefully rely on our post-tax investing.

Up until last year I just threw everything into pre-tax but the last year I've really been trying to project what my retirement accounts will be which is why I'm switching.  That with the lower tax rates in 2018.  I think you've just got to figure your tax rate this year, what you think it'll be in retirement and do the math on compounding and what your stash will be come retirement.
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