When it comes to retirement planning, most of us know that making regular contributions to a retirement account is one of the best (really, mandatory) ways to prepare for the future. As a federal employee, you can enjoy more than just one stream of income in retirement, since you will also receive payments from your annuity. But contributing to your Thrift Savings Plan (TSP) is still highly recommended.
So, do you just set up automatic contributions, and then forget about it? Well, not exactly. You will face many choices with regard to establishing and managing your TSP, so there is no “set it and forget it” option. One of the first, and most important, choices involves traditional versus Roth contributions.
If you choose to make traditional contributions, you will be stashing pre-tax dollars in your TSP account. This means the money comes straight from your paychecks, before income taxes are deducted. The result is that your overall taxable income is reduced each year, and you will save a bit on income taxes.
Traditional contributions accumulate in your TSP with income tax deferred until retirement. In other words, no matter how much your funds grow, that growth happens free of taxation. However, your withdrawals will be taxed as regular income once you begin taking them in retirement.
One exception to this rule applies to members of the armed forces. If you contribute your tax-free combat pay to your TSP, you will only owe taxes on the interest earned.
Roth contributions work in essentially the opposite way. You will contribute after-tax dollars now, during your working years, but then you won’t owe income taxes on withdrawals in retirement. If you meet certain IRS guidelines regarding qualified earnings, you won’t owe income taxes on accumulated interest, either.
So, which type of contributions should you make? The answer often comes down to your expected tax bracket in retirement, and that can be a bit difficult to predict. Since one choice or the other might save you thousands in income taxes, we urge you not to make this decision lightly. Schedule an appointment with us, and we’ll review your TSP contribution options.
