Roth IRA vs. Thrift Savings Plan (TSP) 401k – Which Is Better?

Should members of the military, their families, and U.S. Government Federal employees invest in a Roth IRA or the Federal Thrift Savings Plan (TSP)? Both investing options are great choices to invest for retirement, but there are certain strategies for members of the military and their family to consider when investing. There are several fundamental differences between the two plans which point to where you might want to invest first. A Roth IRA allows investors to contribute “after tax” dollars to the investment and then withdraw the principle and earnings tax free during retirement. The Federal Government’s Thrift Savings Plan (TSP) functions like a civilian corporate 401(k) plan or public 403(b) plan. Money contributed to TSP is “before tax” dollars and withdraws in retirement are then taxed at your normal income tax rate.

There are many differences in the two plans, and you need to understand the intricacies to get the most out of your investments. Below is a list of the common features of both:

Most members of the military are in a low income tax bracket while serving in the military and then usually move into a higher tax bracket towards the end of their careers and in retirement. Because TSP money is taxed when you withdraw it, you would then end up paying more in taxes using a 401-k retirement plan or TSP rather than a Roth in most scenarios. There is a distinct tax advantage to maxing out your contributions to a Roth IRA first, and then investing in the TSP with any additional savings after that.

For example, say you had $1,000 to invest and are in the 25% tax bracket right now. Your one time investment of $1,000 will go straight into TSP and grow to a little over $4,600 in twenty years (8% growth a year). Then, you withdraw it and owe taxes. But, now you are in the 38% tax bracket twenty years into the future. So, you get to keep $2,880 of your hard earned money after taxes. If you had invested that $1,000 twenty years ago in a Roth IRA, you would have $750 to invest after 25% was taken out right away for taxes. That $750 would grow into $3,500 in those twenty years and can be withdrawn tax free.

Now think of that $1,000 on a larger scale. If you maxed out a Roth IRA (currently $5,000 per year if you are under the age of 50) from the time you were 22 until 65, you would have $1.9 million tax free. Don’t believe me? Check out this easy to understand MS Excel spreadsheet where you can plug in your specific circumstances and see how much a Roth is actually worth. The spreadsheet gives you a comparison between a Roth IRA, a 401-k plan like TSP, and a standard mutual fund. Take a look at the spreadsheet and see how much each letter of the word Roth could be worth to you.

There is one last thing to think about with respect to the TSP for all the non-military Federal employees. The U.S. Government contributes a match of up to the first 5% you put into TSP. That is equivalent to a 100% return!! You should always put the maximum the government will match in TSP first or else you are just throwing away free money.

As of 2008, a person can put up to $5,000 in a Roth IRA or $10,000 in a joint fund if married. To open a Roth IRA, an investor has to have earned an income and file taxes. High wage earners making over $114,000 a year or $166,000 if filing a joint tax return cannot contribute to a Roth IRA. People over the age of 50 can invest an extra $1,000 as a catch-up payment for a total maximum investment of $6,000.

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