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TSP vs IRA
By JD Bluefield | April 22, 2008
Should I put my money into a TSP, 401k, Traditional or Roth IRA? I was recently asked the question, “Right now I contribute the max $15,500 to TSP, should I contribute less money to my TSP and put it into a Roth IRA?” The answer to that question differs for ever person’s particular situation, but I’ll try to shed some light on what each one does and how I approach it.
What is a TSP? A TSP (or Thrift Savings Plan) is the Federal Government equivalent of the 401k. It has matching contributions similar to a 401k and similar contribution guidelines. Unfortunately for Federal workers there are no Roth 401k versions in the TSP system.
What are the benefits of a TSP/Pre-tax 401k? Most companies will match around 5-6% of your income that you contribute. For example, my employer matches the first 3% dollar for dollar, and the next 2% at $.50 per dollar. That is an instant 100% return the first 3% and an instant 50% return on the second 2%. Where are you going to find an instant return like that anywhere else? So first, before we get into IRA’s, at the very minimum you NEED to contribute whatever your employer will match. Missing out on the contribution match is missing out on free money. You’d be a fool not to.
If your income is above the phase out levels for a Traditional IRA, another benefit of the TSP/Pre-tax 401k is the lowering of your current taxable income. Some of the disadvantages of the TSP/401k are the limited vehicles to invest in.
So I contributed up to what my employer matches, where do I put the rest? To answer this question, it boils down to whether you want to pay your taxes now or later and if you think you will be in a higher tax bracket now or later.
- If you want to bring down your taxable income now and/or think you will be taxed less in the future, then allocate more to the TSP, Pre-tax 401k and Traditional IRA.
- If you want to pay less taxes during retirement and/or think you’ll be taxed more in retirement, than you may want to go with the Roth 401k or Roth IRA.
- Below is a quick table of some of the features of the different retirement accounts.
- I’ve found a calculator at Morningstar.com that will project your retirement savings, click here. StateFarm has a simpler version of a retirement projection calculator, click here.
| Account | TSP/ Pre-tax 401k | Roth 401k | Traditional IRA | Roth IRA |
|---|---|---|---|---|
| Max Contribution | $15,500; $20,500 catch-up | $15,500; $20,500 catch-up | $5,000; $6000 catch-up | $5,000; $6000 catch-up |
| Eligibility | From Employer, contribution limits vary with plans. | From Employer, contribution limits vary with plans. | Benefits phase out after $53k income for singles, $85k for couples, $159k non-working spouse. | Benefits phase out after $101k singles, $159k couples. |
| Tax Features | Pre-tax dollars in | After-tax dollars in | Pre-tax dollars in | After-tax dollars in |
| Taxed on withdrawl. | $0 taxes on withdrawl. | Taxed on withdrawl. | $0 taxes on withdrawl. |
With all that said, what am I doing? First I contribute what my employer matches in my TSP/Pre-tax 401k to catch the instant return and bring down my taxable income. I don’t have access to a Roth 401k, so that is out of the question. Since my income is above the cut off limits for a single earner, I don’t contribute to a Traditional IRA either. I am relatively young and expect to be in a higher income tax bracket down the road, so I will be maxing out my contribution on the Roth IRA.
I think that the Roth IRA is very hard to beat. You pay now, but ALL future earnings that you pull out of the Roth are tax-free! In my opinion, even if you think you’ll be earning less in retirement, you should still invest in a Roth IRA. Check out this quote from Money Magazine and it quickly puts things in perspective:
You might not remember it - perhaps you blocked it out - but the top federal income tax bracket in 1980 was a mind-numbing 70%, or double today’s rate. Even if you were in the middle class, earning $100,000 in today’s dollars, you fell in the 49% bracket.
If income taxes rise anywhere near those levels, it pretty much makes the tax savings of a Traditional IRA almost moot. And put it this way, 2 out of the 3 top candidtaes have promised to increase income tax rates and almost double and triple the taxes on capital gains and dividends, respectively. I don’t mind paying my fair share, but I hope it never gets to 1980’s levels.
| Candidate | Maximum Capital Gains Rate | Maximum Dividends Rate | Top Income Bracket Rate |
|---|---|---|---|
| Current Rates | 15% | 15% | 35% |
| Clinton | 24% | 39.6% | 39.6% |
| Obama | 28% | 39.6% | 39.6% |
| McCain | 15% | 15% | 35% |
The article also goes on to predict that by the year 2050, Social Security and Medicare will absorb 76% of all Federal Taxes collected, they currently only make up 8.6%! The difference will have to be made up somewhere. Again, I don’t see taxes going anywhere, but up. So if you have tax free income available that is a great position to be in.
Another option I am looking at to help fund my retirement/passive income is actually contributing less to my TSP/Pre-tax 401k. How does that work? Well, with the market lower and housing coming down, there may be opportunities to purchase an investment that would require cash on hand. As I alluded to in Ten Biggest Stock Crashes, the worst may be further down the horizon.
BluefieldMoney Quick Tip: You can now roll your TSP into a Roth IRA! Find out more information here at TSP.gov.
Topics: Personal Finance, Retirement, Taxes |
5 Responses to “TSP vs IRA”
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April 22nd, 2008 at 10:16 pm
I say, put the minimum amount into TSP (just enough to take advantage of the matching) and invest the rest. There is always a balance in this world and every newspaper is implying “The Sky is Falling, buy canned goods, water and camp out in a bunker!” If everyone is losing money, there must be a few people who are making a lot of money. Which one do you want to be?
April 24th, 2008 at 4:35 pm
Hey JD, you didnt mention, but one thing that IRA differs from TSP is that with IRA you are able to invest in all sorts of stuff and not just G F C S I …. funds. heres a excerpt from a real estate website.
“Most banks and brokerage companies—the most common IRA account options—limit your choices to certificates of deposit, stocks, mutual funds, annuities, and similar financial instruments. But Section 408 of the Internal Revenue Code permits individuals to purchase land, commercial property, condominiums, residential property, trust deeds, or real estate contracts with funds held in many common forms of IRAs.”
So with enough money in a roth IRA you are able to buy real estate with it and any money you make from the real estate is tax free? I dont know exactly how that works but that sounds like an awesome tax shelter/retirrement plan.
April 24th, 2008 at 4:40 pm
JD, just to make sure. I dont think you can put TSP money into Roth IRA, only traditional.
check this doc : The Thrift Savings Plan and IRAs
http://www.tsp.gov/forms/oc91-16.pdf
“Can I move money from my IRA into my
TSP account — or money from my TSP
account into my IRA?
Generally, yes. However, you can move your
money only from the TSP into a “traditional IRA”
or from a traditional IRA into the TSP. A traditional
IRA is an individual retirement account described
in § 408(a) of the I.R.C. or an individual retirement
annuity described in I.R.C. § 408(b). It does not
include a Roth IRA, a SIMPLE IRA, or a Coverdell
Education Savings Account (formerly known as an
education IRA).”
April 24th, 2008 at 6:34 pm
I thought I’d leave that for another day, but you do bring up a very good point Diverdan, Roth’s have many options unavailable in the TSP program and many 401k plans!
I think that is the rule that just got changed. Check out http://www.tsp.gov/faq/faq15.html
It gives detail on how to roll your TSP to a Roth, and of the restrictions.
April 25th, 2008 at 7:42 pm
I don’t want to burst any bubbles, but can the govt use your tsp money, or borrow from it. If so, the govt can use your money like the general fund. If not then make sure the govt does not touch it.