When most of us begin to withdraw money from our TSP or other 401(k) accounts, a lot of it will go to pay the taxes on our contributions and earnings.
But if you could convert your existing pre-tax TSP account into a Roth option, you could pay the taxes up front and then be able to make tax-free withdrawals after you retire. Unless you make too much money, which many feds do.
But according to CPA Bob Leins, that’s going to change next year when income limits for making Roth conversions disappear. Which is why he says 2010 is the year of the convert.
First, he says, understand what you already have.
401(k) Affectionately known by its tax “Code Section” number 401(k), it is an investment an employee can make from their salary. Sometimes referred to as a “traditional” 401(k), it is a salary deferral plan that continues to be your money but is invested before being taxed. The TSP is sometimes (although not properly) referred to as a 401(k) plan. In summary, the earnings as well as the salary deferral are not taxed until you withdraw them.
Roth 401(k) Similar in name, but drastically different than the “traditional” 401K. Investment in a Roth 401(k) is not tax deferred. But, the earnings are not taxable. However, there are rules to be aware of. Unlike a Roth IRA, one’s total income (modified adjusted gross income, or MAGI) can prevent investing in a Roth IRA. Roth 401(k) contributions have no such limitations.
Who should consider a Roth 401(k) The answer initially is everyone but do your analysis first. Initially, focus on those in the early and late career stages. Other considerations include those who cannot invest in a Roth IRA because of income. Also, who will be in a lower tax bracket (Federal and state) in retirement may not find the Roth 401(k) attractive.
Do not let the tax tail wag the dog The “TSP 401(k)” will not be available for full implementation for a while. Much will be written but more important, computer programs and radio programs on FederalNewsRadio will become available to aid in the decision making process. The decision should never be made that if “it’s tax free – it must be good”! BL