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Roth TSP Option
- Thread starter Tomodachi
- Start date
Explain your reasoning here... your Vanguard is an IRA right? If it is, then your TSP Roth has nothing to do with that.
When to use a traditional or Roth is based on the answer to the question: Do I expect to be in a higher or lower income tax bracket when I retire compared to where I am now. As others have posted most officers are at a low enough effective tax rate when you factor in things like BAH and BAS not being taxed. Roth is the way to go for both IRAs and TSP. No one should avoid the Roth TSP. You can contribute to both a personal Roth IRA (preferably with Vanguard as other have mentioned) and the Roth TSP.
The Roth TSP should be funded first because it has even lower fees than Vanguard does. Most mutual fund companies have expense ratios around 1.0-1.5%. Vanguard's expense ratios are typically around 0.2%. The TSP expense ratios are around 0.02%. In investing, the money you DON'T spend is a big factor for compound returns. If you are capable of investing more than the allowed $17,000 this year (or $17,500 next year) that is when you should contribute to a person Roth IRA.
A good rule of thumb is that once your marginal tax rate is in the 30% or higher brackets, then you should switch to the traditional type accounts to save on taxes now. I don't know any officers with a taxable income over $178,650, which is when the first marginal rate over 30% kicks in. The 28% tax bracket doesn't even kick in until $85,650.
The Roth TSP should be funded first because it has even lower fees than Vanguard does. Most mutual fund companies have expense ratios around 1.0-1.5%. Vanguard's expense ratios are typically around 0.2%. The TSP expense ratios are around 0.02%. In investing, the money you DON'T spend is a big factor for compound returns. If you are capable of investing more than the allowed $17,000 this year (or $17,500 next year) that is when you should contribute to a person Roth IRA.
A good rule of thumb is that once your marginal tax rate is in the 30% or higher brackets, then you should switch to the traditional type accounts to save on taxes now. I don't know any officers with a taxable income over $178,650, which is when the first marginal rate over 30% kicks in. The 28% tax bracket doesn't even kick in until $85,650.
Caveat: if Congress doesn't come to an agreement vis-a-vis the fiscal cliff and the extension of the Bush tax cuts, the rates will likely go up for everyone:
http://www.forbes.com/sites/moneybu...deral-income-tax-brackets-and-marginal-rates/
Meaning that this 30% rule would kick in at a much lower income level of $87,850 for single filers and $146,400 for married filing jointly. Much easier threshold for the more senior officers to meet. That said, those expecting to retire with a long time in service (25 years or so) should still take advantage of Roth retirement vehicles, since their pensions are determined by their salaries for the last three years of service, which will invariably be much higher than their starting salaries.
For people who joined the military after September 8, 1980, your pension (which you are eligible for if you retire after at least 20 years of service) is the average of your 36 months of highest basic pay, which is usually your last 36 months in service. If you retire at 20 years of service, you get 50% of that figure each month. At 30 years, you'd get 75%, and at 40 you'd get the full 100%. In the extreme, consider someone with 40 years of service, meaning in the up-or-out system they'll have gotten 40 years of promotions and COLA adjustments, and their pension will be the same as their salary when they retire. They'll be in a MUCH higher tax bracket when they retire than when they started, which means a Roth would've offered them significant tax savings.
TL;DR: considering the military is an up-or-out system, raises/promotions and COLA's combined with a generous pension in retirement for people who serve at least 20 years generally make the Roth TSP and Roth IRA the better choices for servicemembers.
EDIT: Disregard what I said about COLA's, it's my understanding that next year, whatever the numbers are, the tax thresholds will be linked to the CPI and adjusted each year in the same way the COLA adjusts paychecks, so it's irrelevant, but the rest still applies.
Question: If I have been contributing to TSP for 7 years, should I switch over to the Roth option? Should I try to transfer money from TSP to the Roth TSP?
Bert may know more about that, he mentioned that he was considering it earlier in the thread:
Your regular and Roth TSP will be two separate accounts. You can roll the regular TSP to a Roth IRA but will have to pay all of the previously deferred taxes at once for this tax year, and 7 years on you would likely be at a higher rate. I rolled my TSP to a regular IRA, and at my new job opted for regular 401k, but I'm pretty much in tax hell compared to when I was in the service.
MasterBates
Well-Known Member
Yep.. Making better money than in the Navy, but I'm probably paying 10-15% more in effective tax rate due to all income being taxable, as opposed to a solid 25% of my USN income being tax free.
I guess I still don't understand the difference. I can max out ($5000 a year) my standard Roth IRA with Vanguard/USAA/whomever (Vanguard in my case with funds of my choosing) AND the Roth TSP (which is $5,500?)? I get economics and investing; but I don't know tax law beyond the very very very basics - including this, obviously. If that's the case, can I be pointed to a publication that says so? My undserstanding was that the Roth TSP counted just as much towards the overall total of your yearly Roth contributions for a tax shelter. If that's the case, I choose Vanguard because of their variety of funds, ability to contribute when I want (not just per paycheck), ease of use of their website and near-instant updating of my returns/losses and great customer service - all of which I find TSP to be lacking (annoying website, contributions at the end of the month only, inaccurate return on investment - perhaps not 'up-to-date' is better - hard to reach customer service comparatively, etc.)
You can max out the Roth IRA (the limit is $5,500 next year) AND the Roth TSP (the limit is $17,500 next year). Both TSP types have the same limit, and both IRA types have the same limit.
It is advisable to max out the Roth IRA first, since you will have more discretion in where you want to invest your money (like the Vanguard funds), as opposed to the limited TSP offerings. Once you've reached that $5,500 limit, any excess should be contributed to the Roth TSP, because it's my understanding that their fees are comparable to, or maybe even lower than, the equivalent Vanguard funds.
There's a matrix on Wikipedia that compares all four types, I thought it might help you out: http://en.wikipedia.org/wiki/401(k)_IRA_matrix
Thanks. Yeah, that's what I've been doing so far. I max out my personal Roth IRA then I put it into the traditional TSP. The Roth TSP option is something I'll consider - but the tax advantage now of the Traditional TSP gives me more "excess" to put in if that makes sense. I see it as this way - and I don't know what the numbers are now as a LTJG, but as an ENS, a 1% additional contribution of my base pay to Traditional TSP gave me ~ $63 dumped into the funds I selected. My net change in take home pay was ~$12 for each 1% because that $63 was no longer taxed, so I see that as 51 more dollars that I now have to invest since I'm only losing out on 12. I'll look into the Roth TSP though...
While Vanguard and other mutual fund companies may have more options, the TSP offers all the options you really need. They have pretty much all of your index fund investing available with the lowest costs available. Take a look over at the Boglehead's forum and those guys would slit someone's throat to be able to invest in the TSP.
DanMa, prior to the advent of the Roth TSP your plan of maxing out your Roth IRA and then adding to the TSP was spot on. Now with your relative low income and low tax liability and the Roth TSP option I recommend people max out their Roth TSP before investing in their Roth IRA. This is due to the lower cost associated with investing in the TSP. When contributing to the Roth TSP you no longer select a percentage of your income, you just put a total dollar amount you want to go in there each month.
DanMa, prior to the advent of the Roth TSP your plan of maxing out your Roth IRA and then adding to the TSP was spot on. Now with your relative low income and low tax liability and the Roth TSP option I recommend people max out their Roth TSP before investing in their Roth IRA. This is due to the lower cost associated with investing in the TSP. When contributing to the Roth TSP you no longer select a percentage of your income, you just put a total dollar amount you want to go in there each month.
While fees are certainly a consideration, especially in long-term investing, there's an argument to be made in favor of maxing out the Roth IRA before the Roth TSP. First and foremost, obviously, is the vast selection of funds and ETFs you're able to pick from, as opposed to only five that TSP offers. Even if you pay a significantly higher fee (an actively managed fund at the extreme), it could still outperform the comparable TSP fund. Or, at the very least, it could have a better risk-return profile, which is to say that in theory it should perform better over the long term.
On top of that, Roth TSP requires you to take distributions at 70 1/2 years old, whereas the investments in your Roth IRA could grow tax-free indefinitely, and if you can manage to retire without drawing from it at all (e.g., live off your pension, Social Security, and any TSP money), you could leave it in your will to your kids, significant other, etc. Kind of a morbid benefit, but I digress. My point is that there's something to be said for maxing out either one first. Part of it depends on whether you're a hands-on or hands-off (buy-and-hold) investor.
By the way, a tip for those who don't already know: Morningstar.com has a lot of information, most of it free, on just about any fund you could ever think to own, and more information on those funds than you'll know how to use. If you're handy with Google, you can even find ETF's that track the same indexes as the TSP funds (except for G), and see what Morningstar has to say about them.