Agency contributions max out at 5% and will always be part of non-Roth balance. I will receive a 19.86% salary increase in 3 months, with more growth potential in the coming years. I am single, no dependents.
Hi Dena, it is so great that you are starting to save for retirement at an early age--way to buck the trend! If you're receiving 5% pre-tax contributions from your employer, then the Roth TSP may be a good option to diversify your investments from a tax perspective. As Dave said, money from your employer going into your non-Roth TSP will be taxed at retirement. Money you contribute to a Roth TSP means no tax break now, but it won't be taxed at retirement. So by using both, you'll have two types of income available to you in retirement: taxable and tax-free (from the Roth). That kind of flexibility can be really nice in your retirement years, because you can draw from one type of account or the other, depending on your tax situation at that time. And who knows what taxes will look like in 35-45 years?? By contributing to both types of accounts now, you'll have options down the road.
The marginal federal tax rate means the tax rate you pay on your highest dollar of income. In 2012, for example, a single person can have up to $35,350 of taxable income and pay 15% in taxes. (Taxable income, by the way, means what you have after things like the standard deduction and any exemptions--it's not the same as your gross income or your salary.) But if you earn $1 more than $35,350, that dollar is taxed at the 25% rate. The 25% bracket runs all the way up to $85,650--so any taxable income in that range pays 25%. The next bracket is 28%, and so on. See the IRS website for more info (www.irs.gov).
You may want to visit with a good tax advisor or Certified Financial Planner for more specific advice for your situation. Keep on saving!!
Mike
There have been two great answers for you already, Dena. Michael Wilson's idea of "tax diversification" is a good one. I'm a huge fan of that, generally speaking. However, I also have a bias towards taking the benefit you have today (the tax deferral of your TSP contribution) rather than the benefit tomorrow (the Roth TSP). This is a variation on "one in the hand versus two in the bush."
While your question "To Roth or not to Roth?" is mostly a mathematical one, there is a sense in which it is a personal preference. Although, a decision against the math may cost you more in taxes to execute, there are those who will argue strongly in favor of doing the Roth anyway.
Again, I prefer the tax benefit today of the TSP over the Roth TSP. Assuming you are not already maximizing your annual TSP contribution, I would recommend doing that. That is, unless you have a strong, concrete reason to believe your tax rate after age 59.5 will be higher than it is now. This is what the math tells us. But not everyone agrees with this approach.
Good luck!
Great question Dena and congratulations on being financially responsible.
Uncle Sam, your employer, says you can pay your income tax now or you can pay me later on the money you want to save for your retirement.
The money going into your TSP is the money you will pay taxes on later. The money going into your Roth 401(k) is the money you pay taxes on now because you do not deduct it from your income.
The correct answer as to which works best depends on what you believe your income tax rate will be from when you are older than 59 ½ until you are no longer living in this world. If you believe your income tax rate will be higher than it is today, the Roth 401(k) is the place to invest your retirement savings after you maximize the contributions in the TSP required to get the 5% match. You pay the taxes today at a lower tax rate on the contributions to your Roth 401(k).
If you believe your income tax rate will be lower from the time you are 59 ½ until the day of your demise, you should maximize your contributions to your TSP because you will pay less income taxes on your funds as you withdraw them during your retirement years.
Currently another benefit of the Roth 401(k) is your heirs will not have to pay any taxes on the funds in your Roth 401(K) when they inherit the funds. However if their tax rate is lower than your current tax rate they will receive more money net of taxes if they inherit your TSP.
This assumes the rate of growth of your TSP and the Roth 401(k) is equal.
You may also want to consider placing your surplus income in a taxable investment account because it will be available to you before you retire for major purchases like real estate, college tuition, vacation homes…etc…
A professional financial advisor will help you navigate through these variables and the changes that occur during your lifetime.
Thank you for your service to our nation and good luck, Dave
Dena - Given your current tax bracket and time horizon, it is likely that a the ROTH option will offer you a greater overall benefit. You may wish to review this financial guide, which discusses the benefits of ROTHs compared to traditional, tax-deferred accounts: https://www.brightscope.com/financial-planning/advice/guide/1958/Quantifying-The-Benefits-Of-A-Roth-Account/
Best of luck!
I believe in taking a staggered approach with ROTH vs regular TSP. Doing equal parts in both can reduce current liability and put away money that can later be taken out tax free, barring any political snafus. With your upcoming salary increase, we typical tell clients to take half of their raise and save it in some form or another. This can mean increases in contributions to retirement plans or putting money into a liquid savings account. By doing this you begin to save a large portion of your income vs spending it and over the years you can accumalate a lot of money. Without saving money you can have no investment returns.
