Author Topic: Roth TSP vs. Taxable Brokerage  (Read 816 times)

TenMoreYears

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Roth TSP vs. Taxable Brokerage
« on: November 03, 2019, 04:50:48 AM »
Hello.  I am currently in the US Navy and planning to retire in about 10 years - I even have permission from the wife!  This will put us both at just about 50 years old.  Current finances look something like; Roth TSP $90k, combined Roth IRAs $60k, wife 401k $10k, taxable brokerage $130k, "oh crap" savings $10k.  We also have no debt and due to the nature of military pay vs. allowances our taxable income is only $50k.

For the last 2 years we have been fortunate enough to be in a position where we could max my TSP ($19k), both IRAs ($12k), and throw enough in the wife's 401k to get full employer match. 

I have been working on our 2020 budget and started wondering if I am making a mistake putting so much into retirement accounts at the expense of nearer term savings.

Some more details; once retired we will have about $6500/month in government backed pension/VA that receives an annual COLA adjustment.  We are looking to spend about $8500/month (I know this is a lot).

My thoughts; Originally I was going to continue maxing out my Roth TSP and our Roth IRAs, however doing so would leave about $1500/month to put in the taxable account.  This leaves us about $700/month short of the $8500 goal (I use a conservative 5% rate of return).  If we flip-flop retirement and taxable contributions (about $3k/month in taxable) we will be just about spot on.  The other consideration is that the taxable could be withdrawn from at >4% since within 10 years we will be able to tap the retirement accounts, that we I go with the original plan will be somewhere in the 800-900k range. 

I have read a bit about conversion ladders but don't fully understand them and am unsure if this is something could apply to us.

I think we are in pretty good shape regardless of the execution, but am curious what the brains around these parts have to say. 

Thank you for any inputs

terran

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Re: Roth TSP vs. Taxable Brokerage
« Reply #1 on: November 03, 2019, 06:19:11 AM »
Since you're contributing to Roth you don't need to worry about conversion ladders since that's for getting money out of tax deferred accounts without penalty. You can withdraw contributions (but not gains until you're 59.5) from Roth at any time without penalty. I would absolutely max all available Roth accounts before contributing to taxable.

Assuming your pension will be taxable income, I think you're one of the rare cases where Roth is definitely better than traditional.

Nords

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Re: Roth TSP vs. Taxable Brokerage
« Reply #2 on: November 03, 2019, 10:58:14 AM »

I have been working on our 2020 budget and started wondering if I am making a mistake putting so much into retirement accounts at the expense of nearer term savings.

Some more details; once retired we will have about $6500/month in government backed pension/VA that receives an annual COLA adjustment.  We are looking to spend about $8500/month (I know this is a lot).

My thoughts; Originally I was going to continue maxing out my Roth TSP and our Roth IRAs, however doing so would leave about $1500/month to put in the taxable account.  This leaves us about $700/month short of the $8500 goal (I use a conservative 5% rate of return).  If we flip-flop retirement and taxable contributions (about $3k/month in taxable) we will be just about spot on.  The other consideration is that the taxable could be withdrawn from at >4% since within 10 years we will be able to tap the retirement accounts, that we I go with the original plan will be somewhere in the 800-900k range. 
This is tinkering at the margins, and I donít think itís going to make much difference. 

If your annual taxable income is $50K and youíre filing your income taxes as married filing jointly then youíre already in a low income-tax bracket.  If you have kids then youíre also receiving the benefit of the Earned Income Tax Credit and paying very low taxes:
https://www.eitcoutreach.org/blog/how-much-are-the-eitc-and-ctc-worth-in-2020/

If you forecast your spending between ages 50-59.5, you might already have enough in your taxable brokerage account and from your Roth IRA contributions to support your expenses (in excess of your income).   After age 59.5 you can tap your retirement accounts free of penalty and (for the Roth TSP & Roth IRAs) free of income tax.

If you invest your next decade of savings into your taxable accounts then youíll pay more annual income taxes (on the dividends and capital gains distributions).  You might also lose some tax credits, although thatíll happen anyway as you promote.

Since your assumed portfolio return is already conservative, Iíd recommend continuing to maximize your contributions to your Roth TSP, your Roth IRAs, and your spouseís 401(k) match.  Then invest the rest of your savings into a taxable account, and continue to add the majority of every annual pay raise, every biennial longevity pay raise, and every promotion to your taxable accounts.   

Current finances look something like; Roth TSP $90k, combined Roth IRAs $60k, wife 401k $10k...

For the last 2 years we have been fortunate enough to be in a position where we could max my TSP ($19k), both IRAs ($12k), and throw enough in the wife's 401k to get full employer match. 

I have read a bit about conversion ladders but don't fully understand them and am unsure if this is something could apply to us.
Let me be more specific on the vocabulary. 

Your Roth TSP account will not be subject to taxation (because you already paid taxes on your contributions) but itís still a ďdesignated Roth accountĒ and subject to Required Minimum Distributions at age 70.5.
https://www.irs.gov/retirement-plans/ten-differences-between-a-roth-ira-and-a-designated-roth-account

If youíre in the militaryís Blended Retirement System (and contributing at least 5% of your base pay to your TSP) then you have DoD BRS agency/matching contributions in your traditional TSP.  Those are tax-deferred (youíll pay taxes someday) and also subject to RMDs. 

In addition, your spouse has employer matching contributions in her traditional 401(k).  You donít specifically mention whether her 401(k) is a traditional 401(k) or a Roth 401(k), so perhaps her contributions & growth are also tax-deferred and subject to RMDs.

Roth IRA conversions make sense when you know that your future income-tax bracket will be higher.  For many taxpayers (including military retirees) that happens when youíre receiving Social Security and forced to take RMDs in your 70s.  To avoid RMDs (and higher taxes), each year you convert a little of your traditional TSP and traditional 401(k) into a Roth IRA.  After you leave your employer (military or civilian) you roll over the traditional TSP and traditional 401(k) to a traditional IRA and do the conversion a little every year.  Youíll probably start this after you reach FI (and stop working for paychecks), and the goal is to complete the conversions by the time you reach age 70.5. 

In the case of me and my spouse, we spent 16 years on the conversion project.  (We definitely paid lower income taxes by converting now rather than taking RMDs.)  Ironically, in less than six months Iíll be age 59.5.  Itís become blatantly clear that our taxable investment accounts are far more than enough.  We might never touch our Roth IRAs.

If you need a higher amount of early withdrawals from your retirement accounts (beyond your taxable accounts and your Roth IRA contributions) then youíd roll over and convert that higher amount every year for five years before the first year of your need.  After five tax years youíd be able to withdraw the amount of the conversion (but not its growth) free of penalties and further taxes.

Hereís the list of military options along with Roth IRA conversions:
https://the-military-guide.com/early-withdrawals-from-your-tsp-and-ira-after-the-military/

You can read the technical details (with links to the tax code) at Michael Kitcesí most excellent post. 
https://www.kitces.com/blog/understanding-the-two-5-year-rules-for-roth-ira-contributions-and-conversions/

If you want to walk through the annual details with a fee-only CFP and build your own plan, then I can recommend a firm founded by two military veterans.  They offer free information, and there are no commissions or upsells.  Youíre only paying them for their time & expert labor. 

Hello.  I am currently in the US Navy and planning to retire in about 10 years - I even have permission from the wife!  This will put us both at just about 50 years old. 
Hereís my response whenever I see this ď10 yearĒ comment.

Youíre going to reach financial independence on your high savings rate.  Although itís mathematically easier to reach FI with a military pension and cheap healthcare, itís not necessary.  You have tremendous human capital and you donít need to deplete it on active duty.  The lifestyle costs of gutting it out to 20 may be more expensive than youíd care to pay. 

Stay on active duty as long as youíre feeling challenged & fulfilled.  When the fun stops, then consider leaving active duty for the Reserves or National Guard.  Youíll still accrue retirement points for a pension that starts at age 60 (with cheap healthcare).  Youíll also enjoy most of the good things about the military with much less of the sucky parts.  Youíll have a better work-life balance and a higher quality of life. 
https://the-military-guide.com/dont-gut-20-leave-active-duty-reserves-national-guard/
« Last Edit: November 03, 2019, 11:01:03 AM by Nords »

Buffalo Chip

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Re: Roth TSP vs. Taxable Brokerage
« Reply #3 on: November 03, 2019, 11:12:01 AM »
Iím not an investment advisor. Speaking for myself if I woke up in your shoes I would contribute up to the match in the traditional TSP. Then contribute to the max in any Roth IRAs.*Then if there was money remaining max out the traditional or Roth TSP. Anything left goes to 529 plans (if your state subsidizes as mine does) and then plain old non tax advantages accounts.

Youíre in a bit of a different and very fortunate situation as you will have a traditional pension. If I were you I would be striving to live off of that alone. So all your investments will just be gravy. Nice position to be in.

*why: a Roth TSP is subject to RMDs where a Roth IRA isnít.

Buffalo Chip

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Re: Roth TSP vs. Taxable Brokerage
« Reply #4 on: November 03, 2019, 12:25:20 PM »
Wow. NORDS is here. Listen to him. Heís THE expert.

simonsez

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Re: Roth TSP vs. Taxable Brokerage
« Reply #5 on: November 04, 2019, 08:09:13 AM »
a Roth TSP is subject to RMDs where a Roth IRA isnít.
Okay, what if at retirement/separation the person just moves the Roth portion of TSP to Roth IRA?  With the new rules it doesn't have to be proportional based on the traditional TSP: Roth TSP ratio anymore (in case they had some traditional dollars in there).  If the person is maxing out both the TSP (via Roth TSP contributions) and Roth IRA first before dipping toes into taxable, the order doesn't really matter.  But until that point, it's hard to argue against maxing the TSP limit first, especially with the newer more flexible withdrawal rules. 

Either way, you're winning the game OP.  Congrats! 

Nords

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Re: Roth TSP vs. Taxable Brokerage
« Reply #6 on: November 04, 2019, 11:06:22 AM »
a Roth TSP is subject to RMDs where a Roth IRA isnít.
Okay, what if at retirement/separation the person just moves the Roth portion of TSP to Roth IRA?
My understanding of those rules is that (after the military) a Roth TSP can be rolled into a Roth IRA.  Five tax years after the rollover, the amount of the rollover can be withdrawn. 

It's all free of income taxes, of course, but the "five tax years" waiting period avoids the penalty.

Michael Kitces' post goes into more detail with the tax code, but it'd be essential to walk through those details with a CFP or CPA.

terran

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Re: Roth TSP vs. Taxable Brokerage
« Reply #7 on: November 04, 2019, 01:17:35 PM »
a Roth TSP is subject to RMDs where a Roth IRA isnít.
Okay, what if at retirement/separation the person just moves the Roth portion of TSP to Roth IRA?
My understanding of those rules is that (after the military) a Roth TSP can be rolled into a Roth IRA.  Five tax years after the rollover, the amount of the rollover can be withdrawn. 

It's all free of income taxes, of course, but the "five tax years" waiting period avoids the penalty.

Michael Kitces' post goes into more detail with the tax code, but it'd be essential to walk through those details with a CFP or CPA.

I'm not familiar with the TSP, so this could be something specific to that, but wouldn't the 5 year waiting period for a Roth employer plan to Roth IRA rollover only apply if there wasn't an existing Roth IRA? I'm pretty sure that 5 year rule only requires that any Roth IRA be open in that persons name for at least 5 years.

There's also the separate 5 year rule for traditional to Roth conversions, which would apply if you converted a traditional TSP to a Roth IRA.

Nords

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Re: Roth TSP vs. Taxable Brokerage
« Reply #8 on: November 04, 2019, 06:06:16 PM »
a Roth TSP is subject to RMDs where a Roth IRA isnít.
Okay, what if at retirement/separation the person just moves the Roth portion of TSP to Roth IRA?
My understanding of those rules is that (after the military) a Roth TSP can be rolled into a Roth IRA.  Five tax years after the rollover, the amount of the rollover can be withdrawn. 

It's all free of income taxes, of course, but the "five tax years" waiting period avoids the penalty.

Michael Kitces' post goes into more detail with the tax code, but it'd be essential to walk through those details with a CFP or CPA.

I'm not familiar with the TSP, so this could be something specific to that, but wouldn't the 5 year waiting period for a Roth employer plan to Roth IRA rollover only apply if there wasn't an existing Roth IRA? I'm pretty sure that 5 year rule only requires that any Roth IRA be open in that persons name for at least 5 years.
I'm pretty sure that's correct-- when there's already an existing Roth IRA then the five tax years starts when the existing Roth IRA was created. 

That seems too easy.  A typical servicemember usually has a Roth IRA that might already be five tax years old.  When they leave the military, they'd simply roll the Roth TSP over to the Roth IRA and (because the Roth IRA would already be five tax years old) they'd be free to tap the amount of the rollover the day after it's credited to the Roth IRA.

Hence my skepticism and the advice to check the Roth IRA account date with a CFP or a CPA.  I'm not a licensed CFP or CPA and we don't always get enough details in these forums to confirm that's the right approach.

TenMoreYears

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Re: Roth TSP vs. Taxable Brokerage
« Reply #9 on: November 04, 2019, 06:52:26 PM »
Thank for for all the feedback.  I was unaware of the difference between contributions and earnings regarding the Roth IRA... knowing that we can with withdraw contributions at any time without penalty makes continuing to max the Roth IRA a no-brainer.

I am legacy high-3 TSP so no government contributions are on the table.  Right now we have about $50k in traditional TSP and about $40k in Roth TSP, currently set up so all future contributions go into Roth.  TSP documentation makes it seem like the Roth TSP can be transferred to an existing Roth IRA... if this is true does making the transfer remove the minimum distribution requirement at 70.5?

I appreciate the comment about having other opportunities outside the military, however my "10 more years" statement wasn't intended to be negative.  I still enjoy going to work and helping train the next generation of Sailor, and the added carrot of a paycheck forever just to wake up makes the lifestyle worth it at this moment in time.

TenMoreYears

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Re: Roth TSP vs. Taxable Brokerage
« Reply #10 on: November 04, 2019, 06:59:48 PM »
It appears as though my question was addressed while my post was saved trying to figure out "the first word of the first blog ever"....  agree it's best to run all this by a professional to make sure good decisions are being made. 

Thank you again for the insights.

Nords

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Re: Roth TSP vs. Taxable Brokerage
« Reply #11 on: November 04, 2019, 07:38:17 PM »
TSP documentation makes it seem like the Roth TSP can be transferred to an existing Roth IRA... if this is true does making the transfer remove the minimum distribution requirement at 70.5?
Yes, but you can only roll over TSP accounts after youíre out of the military.  When you roll a Roth TSP over to a Roth IRA then you no longer have to make RMDs from the Roth TSP.

There may be reasons to leave your Roth TSP alone after you leave the military.  A TSP account has some protection from litigation and bankruptcies.  You could also use a Roth TSP to buy an annuity, although that would only be for longevity insurance.  You might not need more longevity insurance if you already have Social Security or a military pension.