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This week’s reader question is one that’s practically as old as the Roth retirement plan. Namely, when it comes to retirement plans, which is better: Roth or regular?
Should I convert my TSP traditional to a Roth TSP? — Carole
If you’re confused about “TSP,” that stands for Thrift Savings Plan, a federal government plan that functions much like a private company 401(k) or the nonprofit version, the 403(b). For the purposes of this discussion, they’re all interchangeable, but if you’re curious about TSPs, you can read about them here.
The difference between regular and Roth
Both Roth and regular retirement plans provide tax deferral on investment earnings. But when it comes to contributions and withdrawals, a Roth is the mirror image of a traditional plan.
With a traditional retirement plan, you deduct the money you put in, but you pay taxes on withdrawals as ordinary income when you take it out in retirement. With a Roth, you don’t get to deduct your deposits, but when you take the money out, it’s tax-free.
So when you’re asking whether a traditional or Roth is better, what you’re really asking is whether it’s better to get a deduction now or get tax-free income after retirement.
Which is better?
While many financial writers sing the praises of the Roth and recommend it almost universally, which is best isn’t really that cut and dried.
That’s because the answer ultimately depends on factors you can’t know. For example, if you’re in a high tax bracket now but expect to be in a zero tax bracket when you retire, you’d obviously be better off avoiding the Roth and deducting your retirement contributions.
If you’re going to be in the same tax bracket when you retire or a higher one, it would be best to use a Roth and pay no taxes when you take the money out.
Unfortunately, there’s no way to know what the tax tables will look like when you retire, especially if it’s far in the future. And as one of my tax professors was fond of saying, “In the long term, we’re all dead.”
In other words, some might argue that today’s bird in hand — a deduction on contributions — is better than tax-free withdrawals at some future date. After all, while it’s unlikely, Congress could theoretically change the rules and start taxing Roth IRA withdrawals. Then, of course, there’s also the possibility you may not live to see your golden years.
There are calculators online that are supposed to help you decide. Here’s one from Money Chimp, here’s one from Bankrate, and here’s one specifically for those in TSP plans. But all require you to know the unknowable: how much you’re going to earn on your investments, and your tax bracket after retirement.
After fooling around with a few calculators, you’ll probably decide that a Roth is the way to go, especially if you believe taxes will be higher in your golden years. But here’s the answer I most often give: Since you’re not required to fund only one type or the other, why not have both? That way you can get some deductions now, and you’ll have a tax-free source of retirement income, too.
Doing a Roth rollover
Thanks to new rules, more and more employers are allowing plan participants to convert existing 401(k) balances from regular to Roth. The basics are simple. You simply designate all or part of your existing 401(k) to Roth and pay the income taxes on the amount you convert.
Not all employers allow for these conversions. According to this recent Forbes article, about half currently do and more are expected to add the feature this year.
As for TSPs, according to the Federal Retirement Thrift Investment Board, you can’t convert existing TSP balances to Roth. You can, however, designate future contributions as Roth, either in whole or in part.
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