Federal Employees News Digest
Which is Better for Federal Employees – Traditional TSP or Roth TSP? - Part I
- By Edward A. Zurndorfer
- Jun 10, 2019
The 2018 tax filing season concluded for most federal employees nearly two months ago, and many employees owed thousands of dollars to the IRS when they filed their 2018 federal income tax returns. The obvious question for these employees is what they can do in 2019 to prevent the same tax disaster that occurred in 2018. One action they can take is to contribute more to the traditional Thrift Savings Plan (TSP) in which contributions come from before-taxed salary. Employees can also contribute to the Roth TSP account in which there are no current tax savings but there are potential future tax savings during retirement. This is the first of two columns discussing which type of TSP account - traditional or Roth - is better for an employee.
Both the traditional TSP and the Roth TSP are tax-favored retirement savings plans that encourage employees to set aside a portion of their salaries and withdraw their contributions and accrued earnings in retirement. Employees covered by the Federal Employees Retirement System (FERS) receive an automatic one percent of gross pay (SF-50 salary) contribution and a maximum annual match of four percent, assuming the employee contributes at least five percent of salary each pay date.
During 2019, all employees can contribute - via payroll deduction - a maximum $19,000 to the TSP and an additional $6,000 if the employee is over age 49 as of Dec. 31, 2019. For FERS employees, the agency automatic one percent contribution and four percent matching contributions are not part of the $19,000.
The main difference between the traditional and the Roth TSP is with respect to how employee contributions are made. Contributions to the traditional TSP are deducted from the employee’s gross salary, leading to current year federal and in most states, income tax savings in the year of contribution. The following example illustrates:
Example 1. Robert is a federal employee earning $100,000 per year. During 2019, Robert expects to be in a 22 percent federal tax bracket and in an eight percent state tax bracket. If Robert contributes $10,000 to the traditional TSP during 2019, he will save the following in federal and state income taxes:
Federal: .22 times $10,000, or $2,200
State: .08 times $10,000, or $800
Robert can save a total of $3,000 in total taxes during 2019 by contributing $10,000 to the traditional TSP.
Roth TSP contributions are deducted from an employee’s already-taxed salary (federal and state), meaning that there are no current year tax savings. The tax savings come at the time of withdrawal. If a Roth TSP participant makes a qualified withdrawal, both the contribution and accrued earnings are not taxed. The following example illustrates:
Example 2. Margaret is a federal employee earning $100,000 per year. She contributes $10,000 during 2019 to the Roth TSP. The $10,000 is made from Margaret’s after-taxed salary. She reaps no tax benefits during 2019. When she withdraws the $10,000 and accrued earnings sometime after 2024 and assuming Margaret is at least 59.5, she will owe no federal and state income taxes on the $10,000 plus accrued earnings.
In short, contributing to the Roth TSP is more expensive in the short term because taxes are paid upfront. But this drawback has a future advantage when the money is withdrawn tax-free.
Tax professionals have the following rule with respect to when it is best to contribute to the Roth TSP: The Roth TSP is better for the employee if the employee expects to be in a higher federal and state tax bracket at the time of withdrawal, compared to his or her tax bracket at the time of contribution.
Federal tax brackets were reduced as a result of the Tax Cuts and Jobs Act of 2017 (TCJA). Tax rates were reduced but only for the period 2018 -2025. Starting in 2026, Federal tax rates will revert to the higher rates they were in 2017 before TCJA’s passage, inflation adjusted. State tax rates are more difficult to predict as some employees live in high-income tax states, but they may retire to low income or no income tax states.
In trying to decide which TSP account they will contribute to for the rest of 2019, employees should first look at their 2018 federal income tax returns and see what they owed or what they received in a refund. If they owed much – more than $1,000 – they should definitely consider contributing more to the traditional TSP during the remainder of 2019. On the other hand, if they did not owe much or if they received a refund, then they should consider contributing to the Roth TSP for the rest of 2019. Employees should be aware that they can contribute to both the traditional and the Roth TSP provided their total contributions do not exceed the elective deferral limit of $19,000 during 2019 and, for employees over age 49 as of Dec. 31, 2019, the “catch-up” contribution limit of $6,000.
Edward A. Zurndorfer is a Certified Financial Planner, Chartered Life Underwriter, Chartered Financial Consultant and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, located at 833 Bromley Street Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652.