As we start a New Year and people I’ve been getting more questions about Roth retirement contributions. So I’m using the next few episodes to introduce you to Roth. Think of Roth as a retirement plan’s first name. Although Roths share the same first name, they belong to different families. And lthese families have their own family rules and norms. Common Roth last names are Thrift Savings Plan (TSP), 401(k), and Individual Retirement Account (IRA). So what’s so special about Roth? You pay income tax on your contribution’s BEFORE you put them into a Roth retirement account. All the money you earn on those contributions over the years is all yours, tax-free when you pull it out, as long as you meet a couple of requirements. If you have to pay taxes now, why would get hitched to a Roth? Look at what tax bracket you are in now. What tax bracket you will you be in when you retire? Generally, if you are earning less money now than in retirement, it pays to choose Roth and pay less tax overall in your lifetime. If you're earning more now, it often pays to choose one of Roth’s traditional siblings. To some extent you need a crystal ball to predict the future. I’ll cover more details and examples in another episode.
There is a special rule for our military servicemembers contributing tax-exempt combat pay to TSP. Put it in a ROTH TSP. You won’t pay tax if you use it to make contributions to a Traditional TSP account. BUT when you take that money out in retirement, you will be taxed on your contributions. If you will be earning tax exempt combat pay make only ROTH TSP contributions with that pay, not Traditional TSP contributions.
How long until you tap your retirement savings? Roth can be fun, but it could be a costly mistake if it’s a one-night stand. You have to wait for 5 years from your first contribution to a Roth and be at least 59 ½ years old when you begin withdrawals to stay tax and penalty free. There are just a few exceptions. Pull out early, and you’ll pay income tax on the earning and an additional 10% penalty for an early withdrawal. An early breakup is gonna cost you.
Also, Roth can be a faithful partner in old age. The IRS will require you to begin taking withdrawals from traditional retirement accounts at age 72. Your Roth retirement savings can stay invested and grow with you until you decide.
What about those last names? 401k plans are sponsored by your employer. They can offer a traditional 401k and a Roth 401k if they want. TSP follows the same rules as the 401k family. TSP does offer both Traditional TSP and Roth TSP. Your combined yearly contributions don’t exceed the limit, which in 2021 is $19,500 a year, plus an additional $6,500 a year if you are age 50 or older.
Roth IRAs? Your employer has nothing to do with it. You would open an IRA on your own. The IRA family is not tied to the TSP or 401k families in any way. For 2021, your combined yearly IRA contributions (whether Roth and Traditional) ca be $6,000 per year, plus an additional $1,000 if you are 50 or older. There is no rule baring you from contributing your full $19,500 total to the Roth and Traditional TSP family as well as $6,000 total to the Roth and Traditional IRA family. So to wrap things up, remember if your retirement plan has a first name of Roth, you pay income tax up front when you contribute, and as long as you follow the family rules, all your withdrawals are tax-free in retirement. If your retirement plan has a last name of TSP or 401k, you cam make contributions up to $19,500 a year, plus $6,500 a year 50 or over. through your employer. If your retirement plan has a last name IRA, you set the account yourself and can contribute up to $6,000 a year, $7,000 50 or over. And yes you can contribute the max amount to the TSP/401k family and the maximum amount to the IRA family at the same time.
