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Wednesday, December 2, 2009

When it opens, should I fund the Roth or the traditional TSP? Maybe neither!

Let's start with the basics. Dollar for dollar, the money in the Roth Retirement savings account is more valuable than the money in the traditional TSP or 401K. Here's a link to help explain why.

So, all other things being equal, if you can scrape together with $16,500 post tax, the Roth TSP/401K is worth between 25-33% more than the same amount of money in the traditional TSP/401K account because of the taxes.

It's a two edged sword, of course, because you'll have to come up with more money up front because you'll have to pay the taxes now.

When funding retirement savings, conventional wisdom goes like this: Fund your TSP (or 401K) up to the limit of the company match (which of course is $0 for military members), then fund your Roth IRA to the max ($10,000 per married couple) then go back and max out the traditional 401K to the limit ($16,500 in 2010). The Roth IRA allows you to simplify this dramatically. Max out the Roth IRA, then max out the Roth TSP. To do both you'll need to save $2208/mo! That's a lot of clams.

So here's the wildcard: what if you can't save that much? Is it better to have a larger balance growing in a traditional (taxable) 401K or a smaller (post-tax) balance in a ROTH 401K? All other things being equal, it would appear to be a wash--but--current tax laws treat traditional 401K benefits as earned income when computing your taxable portion of your Social Security benefits. It's like getting taxed twice on your money.

So, the bottom line is that as long as you believe that you'll be in a similar or higher tax bracket in retirement, the best plan is max out your ROTH TSP if you can.

Others waffle more than me. but I think this is a solid plan.

The last item to consider is investment choices. Since there's no matching for military members (yet), when the ROTH TSP option becomes available I recommend this plan:

1. Max out your ROTH IRA to maximize your investment options.
2. After you've done that, begin funding your Roth TSP.
3. Once 1 and 2 are complete you can begin to contribute to taxable account using tax advantaged accounts like exchange traded funds.

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