Creating retirement savings as a federal government employee is slightly different from civilians. One of the choices people in these positions have is which retirement plans they want, a TSP – a unique federal government retirement plan.
Still, most people wonder whether they should go for a TSP or a regular Roth IRA. What are the differences between them? Or is TSP an IRA?
In this article, we’ll explain:
- What a TSP is and how it works;
- What is a Roth IRA;
- What are the main similarities between TSP and IRA;
- What are the main differences between TSP and IRA;
- How a rollover from TSP to IRA works;
- How to gain financial independence.
Let’s look at both of these plans and what they entail!
What Is a TSP?
A Thrift Savings Plan, or TSP for short, is one of the three sections of the Federal Employees Retirement System (FERS).
To put it simply, it’s a retirement account automatically set up for all federal employees. There are two types of a Thrift Savings Plan – a Traditional TSP and a Roth TSP. We’ll go into more details about both of them later, but they’re partly similar to a Traditional IRA and Roth IRA.
The funding of this account is done through payroll deductions, personal contributions, and agency contributions, which we’ll explain in more detail next. The funds in these accounts can freely grow until the employee is ready to retire.
According to data, as of September 2021, the number of federal workers with $1 million or more in their TSP rose to 98,523 people.
Here’s everything you need to know about Traditional IRAs and Roth IRAs.
Like the Traditional IRA, a Traditional TSP contributions are funded with dollars that you haven’t paid income tax on. To put it simply, you’ll have to pay income taxes for this money after withdrawing funds from the Traditional TSP accounts.
Keep in mind that you’ll have to pay additional taxes for any growth of the Traditional TSP account caused by interest, as it’s not tax free, unlike a Roth TSP account.
As mentioned before, a Roth TSP, first created in 2012, is very similar to a Roth IRA. To put it simply, Roth TSP contributions are made by employees with post-tax dollars, which means that the money will be entirely their in full once you retire.
A Roth TSP account also offers tax free withdrawals, so you want have to worry about income taxes .
All of the funds in a Roth TSP account grow tax-free, because Roth TSP funds are built with post-tax money.
How It Works
As you can see, both Traditional and Roth TSP are distinctive retirement savings plans, and they have a lot in common with IRAs. However, they’re not the same, and one of their many differences, which we’ll get into later, is the funding.
We already mentioned the funding basics and how the federal employee makes TSP contributions. However, one of the more significant advantages Thrift Savings Plan has is its employer contributions. There are three types – automatic agency contributions, federal employee contributions and matching contributions.
The agency contributes 1% of the basics pay to the employee’s Thrift Savings Plan, and the FERS employee doesn’t have to make contributions to get this free money.
They only need to be vested, which simply means that a certain period needs to pass, during which employees have to work before they can gain access to the money. This usually lasts two to three years, depending on the job.
As of October 1, 2020, every employee is automatically enrolled in a Thrift Savings Plan, and 5% of their basic pay is deducted and deposited into the account. The percentage before this date was only 3%. FERS employees can freely leave this retirement plan, whether Traditional or Roth TSP, if it doesn’t suit them.
However, if they choose to stay, they can benefit from employer contributions. Employer contributions are made by the agency, and you’ll have to pay income tax on them, although they don’t match the complete 5% of the employee contributions.
They match the first 3% of the total basic pay, and the next 2% is matched for 50 cents per dollar. The agency won’t match anything more than 5% of the income.
The Thrift Savings Plan retirement income also has contribution limits that change every year. For 2022, the annual contribution limit to a TSP account is $20,500. You can invest this money in several investment funds to let it grow.
An employee can only gain access to the funds in their Traditional or Roth TSP if they’re eligible for it, or they’ll have to pay a penalty fee.
They either have to be over 59½ years old or even 55 if they retire or separate. In some instances, it’s even possible to gain access if you’re older than 50.
Federal Employees Retirement System
The Federal Employees Retirement System, or FERS for short, provides benefits to their employees, and they’re automatically enrolled into it. It’s segmented into three parts – the Thrift Savings Plan (TSP), a Basic Benefit Plan and Social Security.
Unlike the TSP, the Basic Benefit Plan and Social Security aren’t optional. An automatic payroll deduction of 0.8% basic pay is taken to fund these two, and the agency also contributes. As mentioned before, the TSP section of the FERS plan is optional.
The Blended Retirement System for Military Personnel
The Blended Retirement System (BRS) for military personnel is a new program founded in 2018. It’s used to combine, or “blend,” the annuity for career service and the Thrift Savings Plan.
This makes it a separate retirement system with its own rules and options, and participants have to choose to “opt-in” on it. In comparison to that, all employees will automatically have a Traditional or Roth TSP account after 60 days of service, but they can opt-out from it at any time.
Combat Zone Tax Exclusion
Combat Zone Tax Exclusion is a concept created for those employed in the military, and it gives them a tax break.
To put it simply, all of the income someone earns while they’re in a combat zone is counted as a tax deduction, which means that if they contribute to a Roth TSP or a Roth IRA they don’t suffer tax consequences at all.
A deployed military member can also utilize a Roth TSP or Roth IRA to save all of their tax exempt combat pay during deployment, which they will never have to pay taxes for.
This is because withdrawals from these accounts come with tax benefits. After all, they’re contributed to from after-tax money.
What Is an IRA?
Now that you know everything you should know about the Thrift Savings Plan, we should briefly look at IRAs and what they entail.
An IRA, which is short for an Individual Retirement Account, is a plan that allows individuals to save money for retirement. A financial institution sets it up, and it’s entirely dependent on the person it’s for, hence the Independent in the name.
To put it simply, it’s like a retirement savings bank account, but with a few added rules.
When it comes to the types of retirement savings plans most often used in the US, an IRA is one of the most oten used ones along with the Roth 401 k. That being said, there are plenty of differences between an IRA acount and a Roth 401 k.
Employees make their contributions to this account without the matching contribution from the employer.
There are three distinct types of an IRA — Traditional IRAs, Roth IRAs and Rollover IRAs. Here’s everything you should know about them:
- Traditional IRA – this type of IRA, similar to the Traditional TSP, is funded with pre-tax dollars. This means that this is taxable income and you’ll have to take care of that once you withdraw them because it’s tax-deferred.
- Roth IRA – Contrary to the Traditional IRA, and similar to the Roth TSP, this type of IRA is funded with taxxed dollars, so you don’t have to worry about paying taxes when you start withdrawing money.
- Rollover IRA – rollovers happen when you transfer money from one retirement plan to the other. The plan has to be qualified, and it will roll over into a Traditional IRA.
You can invest money in funds and stocks from all three and let the funds compound with the help of interest rates. This has the potential to make your retirement money grow exponentially.
Another benefit is no required minimum distributions.
The biggest downside for IRAs, both Traditional IRAs and Roth IRAs, is that they have an income limit and a contribution limit.
An income limit for single people who wont to contribute to a Roth and Traditional IRA for 2021 is $140,000, while married couples that file their taxes jointly have to make under $208,000.
The contribution limits are $6,000 annually and $7,000 for those older than 50.
Lastly, taking out a loan against your Traditional or Roth IRA is illegal and will get you in trouble with the IRS.
Similarities – Roth TSP vs. Roth IRA
In this part of the article we’ll discuss the similarities between the Roth IRA and a Roth Thrift Savings Plan, mainly because they’re used more often because of they’re funded with after-tax money and allow for more growth, unlike the Traditional TSP and Traditional IRA, which are funded with pre tax money.
The 5-Year Rule
Both Roth TSP accounts and Roth IRAs are retirement income plans subject to the five-year rule. You can generally take out funds from the Roth IRA and Roth TSP accounts when you reach retirement age, are older than 59 ½ or if you have a disability.
However, the 5-year law states that at least five years need to pass from January 1st of the year you first contributed to your Roth TSP before making any distributions from the accounts.
Additionally, if you have a Traditional TSP account, you might be able o access your funds if you’re even older than 55, or just 50, in case of special provision FERS.
After-Tax Retirement Accounts
Another feature that both Roth TSP and Roth IRA have in common is that they’re retirement accounts with tax benefits, which means Roth contributions are funded with after-tax money. This is the money that you already paid income tax for in the year you earned it.
This is the case with all Roth account, whether it’s a Roth Thrift Savings Plan, a Roth IRA or a Roth 401 k.
Although, you have to pay taxes on contributions made during the year, they’re tax-free. This essentially means that you don’t need to pay taxes on the money you take out from the retirement savings unless they’re matching donations.
Differences – Roth TSP vs. Roth IRA
One of the most significant differences is that a TSP, unlike an IRA, doesn’t have an income limit. You can make any amount of money if you want to make TSP contributions, which are deducted from your payroll, but the limit for the Roth IRA owners is defined by law.
For the year 2021, your modified adjusted gross income needs to be under $140,000, and if you’re filing jointly with your married partner, you have to have less than $208,000.
On the other hand, the TSP has no income limits.
Even though you might want to contribute more money, IRAs stop you from having too much money saved if you’re in a higher tax bracket.
If you want to use a TSP, you’re going to have to deal with required minimum distributions (RMDs).
The Roth IRA doesn’t have these, and they essentially mean that you’re going to have to take out a certain amount of money from your account once you’re over 72 years old, or you’ll have to pay a 50% penalty.
This means that you can’t leave your money in your TSP account so it can grow and thus take advantage of the account.
However, you don’t have to worry about RMDs since they’re not mandatory if you have a Roth IRA.
One significant difference in the TSP vs. IRA debate is in contributions. Individual retirement accounts (IRAs) mean that you’re contributing money by yourself, and there are no matching contributions from your employer.
Also, Roth IRA contributions are limited to $6,000 annually if you’re under the age of 50 and $7,000 annually if you’re older than that.
On the other hand, the Roth TSP contributions are limited to $19,500 annually, which is significantly higher than the one for an IRA, and you even get matching contributions from your agency. Also, your contributions are deducted from your payroll.
Withdrawing Money Early
Although both accounts have early withdrawal penalties, there are slight differences.
Firstly, the Roth IRA doesn’t let you withdraw money before you approach retirement age, which is before the age of 59 ½ without having to pay the 10% tax penalty.
The TSP also doesn’t let you do this, but there are different rules regarding retirement. For example, if you retire after 55 or even 50 for special provisions FERS, you can gain access to the Traditional TSP without the 10% penalty, but not the Roth TSP.
Last but not least, only one of these two retirement pans lets you take out loans from them, and that is the TSP. You can take out two types of loans, either a TSP “general purpose” loan or a TSP “residential” loan.
In comparison to that, taking out a loan from a Roth IRA is strictly prohibited, unlike with a 401 k, and your account can get terminated or taxed if you do this.
taking out a loan against a retirement plan, in general, is a step the you should think about a lot before committing. You might even need to contact financial planner or a different financial professional.
TSP to Roth IRA Rollover
Did this article help you determine which one of these retirement accounts is the right one for you? Are you wondering whether you should roll over funds from a TSP to a Roth IRA? Well, that’s certainly possible, but should you do it?
Before we begin, it’s good to know that transferring accounts to a Traditional IRA is considered a rollover, while transferring to a Roth account is regarded as a conversion. That being said, we’ll just cover the basics.
Making a rollover is a possibility worth considering, but only if you know your financial goals. We already mentioned a lot of advantages that come with owning a TSP retirement account. Some include higher contribution limits, no income limits, matching contributions, loans, etc.
But should you roll over to an IRA?
Firstly, an IRA gives you more investment options, while a TSP has minimal options. If you want to invest in stocks, ETFs, and other similar options, you should go for an IRA. In addition to that, it’s simple to use, and you can make contributions even after retiring.
If you choose to go for the rollover, in the end, you can quickly finish all the steps online. You just need to access your TSP account and choose to withdraw money. After that, you need to fill out a form with your personal information and the information about your new IRA (or old) account.
There are a couple more steps after that, but these are the basics. If you’re unsure whether this is the right step for you, it’s best to contacts a financial planner to get legal or financial advice.
Make Your Future
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Even though a TSP isn’t the same as an IRA, similar accounts are utilized for retirement planning. When it comes to federal employees, they’re both solid choices but with plenty of advantages and disadvantages.
Choosing one of them might be challenging, so make sure you know your circumstances and preferences first. A TSP is a better choice for those that qualify for matching funds because they essentially get free money from matching contributions.
On the other hand, a Roth IRA doesn’t require minim distributions, so you can leave your money to grow.
We hope that this article helped you determine which retirement plan is the better choice for you. We also hope that it interested you in banking with Whole Life insurance. If you want to learn more about Whole Life insurance and get a step-by-step guide for reaching financial goals, watch our free masterclass.
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