Q: I’m curious as to why you are unconvinced that paying tax on Roth TSP contributions now and then withdrawing your balance tax-free is not necessarily a better option than deferring tax payments on traditional TSP contributions and then withdrawing the balance at a lower tax rate.
I used the following assumptions:
Annual contributions – $17,000
Tax rate – working 18 percent
Tax rate – retirement 14 percent
Interest rate (all years) 6 percent
Compounding periods 26
Years of service 25
I show identical balances after 25 years. I then assume 35 years of equal monthly withdrawals (6 percent annual earnings). I show a tax burden of $330,003.12 for the traditional TSP and $76,500 for the Roth, a difference of $253,503.12. Is there something I’m missing? I’m not a financial professional, just a guy with Excel and a curious mind, but the advantage in this case seems to be clearly to the Roth.
A: You’ve pumped up the Roth savings contributions by neglecting to reduce them by the 18 percent tax rate. Try $17,000 to the traditional TSP and $13,940 to the Roth. These amounts equalize the reduction to your paycheck.
To simplify the analysis, consider this example:
Contribute $17,000 to the traditional TSP and assume that it quadruples in value to $68,000 over 20 years. Withdraw it under an 14 percent tax rate and you’ll be left with $58,480 to spend in retirement. Alternately, contribute $13,940 to the Roth option and assume that it quadruples in value to $55,760 over 20 years. Withdraw it with no tax loss and you’ll be left with $55,760 to spend retirement. Notice that, in this scenario, using the Roth will reduce your standard of living in retirement by about 4.65 percent.