A new TSP option brings opportunity and tax risk. Smart conversions require careful planning

Terry Gerton We’ve got exciting news, I think. There’s a new TSP option that begins in January of 2026 — these don’t come around all that often — where participants will be able to convert money in their traditional TSP account to a Roth TSP Account. Let’s start at the top. What’s the difference between a Roth and a regular TSP?

Art Stein So, with a regular TSP account, employees who are making contributions are able to deduct those contributions from their taxable income that year, so it reduces the amount of taxes they have to pay, and then the money grows without any taxes on the earnings. When they take the funds from the TSP, taxes are due. And the taxes are whatever their earned income taxes would have been. So, it could be high. With the Roth TSP, and current employees can contribute some or all of their Roth contributions to the Roth TSP now, the contributions are not tax deductible. So it doesn’t reduce your taxable income that year. But when you take the money out, there’s no tax on the withdrawal. So it’s a trade-off between no tax deduction now, no taxes on withdrawal. And, as I say, this is a choice that current employees can make. Now, there is no ability now to transfer money from your regular TSP account to your Roth TSP account. But starting in January, employees and retirees can transfer money from their regular TSP account to a Roth TSP account, and if they don’t have one, then one is created, you don’t already have to have money in there. And that is called a Roth in-plan conversion. Now they also, of course, have the option of rolling their money to an IRA and doing the same thing into a Roth IRA. So here’s the question that everyone is going to need to ask themselves starting in January is, will doing a Roth TSP conversion be a profitable strategy for me? I.E., will it leave me with the ability to have more funds withdrawn from my TSP in retirement? Will it increase my retirement balance and after-tax balance? And that depends on a lot of different things.

Terry Gerton Give us an idea of who a likely candidate for this new program might be. What do they look like?

Art Stein Okay, let me first start off with people don’t need to worry about this. Younger employees, I don’t think need to worry about these. Just if you want a Roth balance in your TSP, just direct your bi-weekly contributions to the Roth TSP and it’ll build up and you don’t have to worry about anything. To benefit from this, you would one, need to have funds available in a taxable account, not only outside the TSP, but outside an IRA, to pay the taxes that are going to be due. Because here’s the big disadvantage of the conversion, is that the money you transfer from the regular TSP to the Roth TSP, that dollar amount is fully taxable that year. So if you transfer $30,000, you’ve increased your taxable income $30,000. And if you needed to withdraw, well, one, the TSP will not withhold the money for taxes, and if you need to take more money out of the TSP to pay the taxes, then I would say forget it. It does not make sense. You need to have the money either in a bank account or something else. Mathematically, if you expect that your tax rate will be lower in retirement than it is when you’re working, mathematically, it’s not beneficial, but that ignores a lot of other benefits and things that are going on. If you expect your tax rate to be higher, then it would be beneficial. So again, for lower-income employees, even retired, they might have a higher tax rate than younger employees who are lower income. For aggressive investors, it makes more sense. If you just have your money in the G fund, you’re not going to get much growth anyway. And if you expect to have money left over when you die and you want to maximum benefit to your heirs, this makes sense. And those are good candidates. Bad candidates, as I said, if you were expecting money from your investments to spend in the near future, in the next five to 10 years, I don’t see the point, because you want to have a long time for the money to grow once you do the conversion, because where it will benefit you is if you transfer $100,000 and when you get around to withdrawing it, it’s worth $300,000 or $400,000, you pay tax on $100,000 in order to avoid tax on $300,000 or $400,000. But, if you’re 75 and you’re already taking money out to live on, then I don’t see the point. And that’s why I mentioned, are you an aggressive investor? Because if your account is going to be basically worth the same, I don’t see the point.

Terry Gerton I’m speaking with certified financial planner Art Stein of Arthur Stein Financial. Art, are there any other advantages to having money in a Roth TSP?

Art Stein Yeah, Terry, one other thing is that when you’re retired and taking money from your investments, if you’re on Medicare, the amount you pay monthly for Medicare, your Medicare premiums depends upon your income. So it may be that if you need to take money from your investments to live on, being able to take some of it from a Roth, because it reduces your income, you could be below a limit which would reduce your Medicare premiums. And of course, there are no required minimum distributions on a Roth TSP or a Roth IRA. So that can also reduce your income taxes in return.

Terry Gerton So Art, what would drive TSP to create this then?

Art Stein I will leave it up to them to answer that question. But listen, God bless them, they’re giving another option. They’re not saying that people should do it, and it’s like the mutual fund window on the TSP, which many people are not even aware of, but it’s another option that they’ve given with people that they’re competing with IRAs, really, because a lot of people who wanted to do a conversion would transfer their TSP balance to an IRA and then do a conversion into a Roth IRA. They couldn’t do that in the TSP. And the TSP was trying to make it attractive for people to keep money in the TSP when they’re retired, and that’s fine. So it’s another option. It’s a good thing. But we need to keep in mind that a lot of people will not benefit from this, and if they do it anyway, they could end up with less money. And that’s why the TSP says, and I will repeat it, please don’t do this unless you’ve spoken to your tax advisor or financial planner or both, because there are a lot of moving parts and we’ve just mentioned some of them.