Four Reasons to Sign Up for a Roth TSP

You may not realize it yet, but the long-delayed Roth alternative to the Thrift Savings Plan could be an exciting new addition to your retirement toolkit.

I'm actually grinning ear to ear as I consider the possibilities the new Roth TSP offers. I periodically bemoan the fact that participation in the TSP among military service members hovers somewhere south of a paltry 40%, so I regularly encourage readers to sign up and jump-start their retirement savings. Now with the addition of a Roth TSP, there's another compelling reason for service members to start or increase what they're saving for retirement.

The TSP is the federal government's version of a 401(k). It allows participants to invest money for retirement through payroll deductions. Contributions to the original, traditional version of the plan are made on a pretax basis (your contributions reduce the amount of income upon which you are taxed), grow tax-deferred and withdrawals are taxed as ordinary income in retirement.

What's so exciting about a Roth TSP?

It allows you the potential to create a tax-free stream of income in retirement. In my mind, tax and free are two very cool words — when said in one breath. Unlike the original TSP, contributions to the Roth version do not reduce your tax bill now; however, those contributions and all of their earnings over the years will potentially be available to you tax-free once you're 59½ and have had the account for at least five years.

Not excited yet? Here are four good reasons to get you so fired up about "tax-free" you'll sign up for the TSP or bump-up what you're saving:

1. Tax-free could get better with time. I don't have a crystal ball, but if your personal tax rate increases over the years, tax-free could be even more exciting in the future than it is today. If you crunch the numbers, going the Roth route makes sense for those who anticipate paying higher taxes in the future than they do today. For those just starting out who will see their income skyrocket in the future, or those who just expect across-the board-tax rates to do the same, the Roth TSP may be just what the doctor ordered.
2. Never pay taxes. Combat zone contributions to the new Roth TSP and all their earnings offer the potential to accumulate a big chunk of money on which you'll never pay taxes ... without breaking the law. In 2012, if you're outside a tax-free combat zone you'll be limited to investing $17,000 into the Roth TSP ($22,500 if 50 or over). However, in a combat zone, that number jumps to $50,000. Whether you invest $5,000 or $50,000, never paying taxes is a sweet deal.
3. Own ALL of your retirement. Hey, I'm a big proponent of the original TSP, traditional IRAs and 401(k)s, but the reality with all of them is that once you get to retirement Uncle Sam has his hand out. Your withdrawals from these plans will all be taxed as ordinary income ¿ in essence, part of your retirement savings won't belong to you. That's not the case with the Roth.
4. That's a big pile of tax-free. So just how much tax benefit are we talking about here? Let's look at an example of the career of an E-6 with eight years of service. If he starts saving today in the Roth TSP by contributing 3% of base pay, the monthly investment would be less than $100. With each pay raise, he bumps the contribution up by 1%. When promotions to E-7 and E-8 happen, he directs a third of the pay increase into the Roth TSP (leaving 2/3 to improve quality of life). After 22 years of service, he retires and launches his second career leaving the TSP alone to grow for his next retirement. At age 60, assuming a hypothetical 8% growth rate and not including anything he accumulated in his second career, he'll have more than $800,000 available — potentially tax-free. All this because he got the ball rolling with a relatively small monthly investment and kept it going by bumping up his contribution with each pay raise or promotion.

Now that the Roth TSP is here, consider signing up and taking control of your financial future.