Roth Conversions and Your TSP

4.10.26: Audio automatically transcribed by Sonix

4.10.26: this mp3 audio file was automatically transcribed by Sonix with the best speech-to-text algorithms. This transcript may contain errors.

Speaker 1:
Welcome back to the Federal Retirement Show. I'm your host, Val Majewski with American Benefits Exchange. I really appreciate you taking the time out of your busy schedule to join us, to view our content. That's what it's here for. It's for you, the federal employee that's looking for accurate information when it comes to your benefits and retirement situation. Now, I highly recommend if you like this video, go and view our other content. We've got over 170 episodes for you to browse and peruse and, and go through it. If you've got a question that we're not addressing today, because every episode we talk about a specific topic, chances are we've answered it in the past. So go view our other episodes and, and if for some reason your question was still not answered, reach out to us. You can go to our website, federal retirement Show.com fill out our form One of our experts around the country. If it's not me personally, will be reaching out to answer your questions. And maybe, yeah, we will create another episode about it. Because if it matters to you, then it probably matters to another federal employee out there, or maybe a whole bunch of federal employees out there that also want to get that question answered. And that's how a lot of our situations, a lot of our content, uh, a lot of our topics started with as conversations with federal employees just like you.

Speaker 1:
And that leads us to today's conversation and today's topic. Today we're talking about Roth conversions and your TSP Roth conversions and your TSP. Now first of all, I want to define what is a Roth conversion. Because you may or may not know what a Roth account is. Let's even go back there. What is a Roth account or a Roth IRA or the Roth bucket within your TSP? And I'll back up even further. If you didn't know, you have two buckets that you can put money into in your TSP, you have the traditional bucket, which is the pre-tax bucket. And that's the standard bucket, right? That's like the default option. And then you have the Roth bucket, which is the post-tax bucket or the tax free bucket. Now which one do you choose. That's up to you. You go into your pay system when you decide how much money comes out of your paycheck into TSP, and you can decide if it's going to go into the traditional bucket or into the Roth bucket. Now, like the term sounds, Roth conversion, what does that mean? That means if you have money going into your traditional account, you can convert it to Roth, or if you have a traditional IRA out there or an old 401 K or whatever, if it is a traditional pre-tax account, you can convert it to a Roth account. So you can take a taxable account.

Speaker 1:
And when you convert to Roth now it becomes a tax free account. And we're going to get into that process here in a second and talk a little bit more detail about it. But that's essentially what a Roth conversion is. You're converting from traditional pre-tax money, money that needs to be taxed. And now turning it into tax free money, Roth money. Some people call it a backdoor Roth. I'll get in. I'll talk about that as well in a second. But a Roth conversion allows you the opportunity to take taxable money and convert it to Roth. And throughout this process, people are like, well, why wouldn't everybody do that? Right? And why doesn't everybody just take traditional money, money that has to be taxed and turn it abracadabra, you know, magically into tax free dollars? The the negative is you've got to pay the taxes on that money that you convert. And if you have a significant amount of balance or significant amount of money in your traditional account, it can be a big tax bill and a big tax burden if you converted all of it. We're also going to discuss partial Roth conversions as a way to mitigate gate that tax liability over time. So here's what we're looking at. Tsp. They came out with the Roth bucket in the mid 2000 right. So in between 2000 2010 right around 2005 they came out with a Roth option for you all.

Speaker 1:
Now as of January of this year, they came out with the ability to convert your traditional funds within TSB to Roth dollars. Now there's still the option that you can do it outside of TSP. And that's something that I see a lot of federal employees typically do. And that's what they've done in the past because the option did not exist within your TSP. Now, as of January of this year, if you did not know, you were not aware you had the ability within your TSP to convert from traditional to Roth. And that can be done online. You make that request again. What is the negative of that? We talk. It's paying the taxes. So how does this process work within TSP. And then we'll also talk outside of TSB. So within TSB you go to the dropdown, you can choose Convert to Roth and you have the ability. The minimum that you convert is $500. And the minimum that you have to leave behind is $500. Now, $500 in each category because TSB, if you've noticed on your statement, if you have a traditional balance or any of your balance, it's kind of broken down in the sections, right? You have your contributions, you've got the tax exempt amount, you've got the 1% matching, you've got, you know, all of these things, the 1% automatic contribution. So it's broken down into sections.

Speaker 1:
So the minimum that you can convert again is $500. The the minimum that you can leave behind is $500 in each section. So let's just say you only had $500 in one of those little sections, like the tax exempt amount. You only had $500 there. Well, you could not convert that amount because there needs to be $500 left in the end. So that's something that you can look at in your statement. If you're confused about that, let's take a look at your statement. Go to our website. Again, federal retirement Show.com fill out the form and we can review all of that with you. Just make sure you have a good understanding. But in general, let's say you wanted to convert a certain amount. Let's say you had a good balance in your account and you wanted to convert for an example, $100,000. And let's just say you had enough in there and you are going to have plenty to leave behind. So it's, it's a possibility. You can do this. You can convert $100,000. How does that work? Well, again, magic, right? It's like abracadabra. You take taxable money and instantaneously you're moving it over, you're converting it and it's now tax free dollars. So 100,000 moves from one pocket to the other, taxable to tax free. And even if you did not have a Roth balance before you had all traditional balances within your TSP, your first conversion will create now a Roth bucket for you.

Speaker 1:
And that money is now tax free. Now, what's the problem with this? When you convert that money that you converted from traditional to Roth? You've got to pay the tax on it. Now, I like Roth conversions because it takes taxable money and makes it tax free. I'll talk about the benefits, but the only negative, in my opinion, is you're going to have a tax liability at the end of the year. You're gonna have a tax bill. Now some questions we get. Yeah. Can I just have that withheld. Can they just withhold the tax if I'm going to convert 100,000 and I'm in the 20% tax bracket. Can't they just take out 20,000. And now I'm net converting 80,000. That's not how it works with NTSB. And you've got to pay the tax. Any tax liability that you're going to owe, you have to pay out of pocket with outside dollars. And you're going to get a 1099 for it and you're going to pay the tax. It's going to be part of your taxable income at the end of the year, whatever you convert. So in this case $100,000. Hopefully it would not increase your tax bracket. It doesn't bump you up into a higher tax bracket, hopefully, but you can strategically convert an amount that's not going to really negatively affect you in that kind of way.

Speaker 1:
And that's something you can talk to a professional about a tax expert or CPA. Um, just somebody who's aware of your situation in detail. So you can see how much you can convert without causing a major tax liability or a big tax problem for you. But what are the positive results? Positive results are when you convert that money, that money went from taxable to tax free. That's the big benefit. Now all the earnings and the interest that you gain over time because hopefully your account will continue to increase all that's going to be tax free because you've prepaid Uncle Sam. You've got him out of your pocket for that portion of the money, and you withdraw the money down the road. It's going to all be tax free. All the earnings that you've earned since the time of conversion. Now tax free because you've converted to Roth prepaid the tax and you've gotten that liability out and you've prepaid Uncle Sam. Awesome stuff there, right? I think that's a huge benefit. That's probably the biggest benefit. And if you're you're older or younger and you take advantage of this, the sooner that you can prepay those taxes, the more tax free earnings that you're going to make on that account over time. So now I use this example and I don't have an illustration up, but it's like, do you want to pay tax on the seeds or on the harvest? Do you want to pay tax on the seeds of the harvest? Let me let me give you an example.

Speaker 1:
Let's say you you plant a field of corn, right? And now you've got these little seeds that you put in there, and it creates this huge harvest of corn, huge harvest that you've gained, you know, tenfold 20 fold of what you put in the ground. Now, would you rather have paid pay tax on the seed, the little bit of seed that you're putting in or now all the harvest, everything that you've harvested at the end of the season, you've got to pay tax on all the growth that you saw. So would you rather pay a tax on the beginning or on the end? Now, the problem is you've the reason why people put it into the traditional and through tax deferred account because it's like, hey, I'm going to pay tax down the road and maybe I'm going to be in a lower tax bracket when I retire or when that that harvest grows to whatever size it does, I'll be in a lower tax bracket because when I retire, I'm going to be making less money and I'm thinking I'm going to be in a lower tax bracket. So yeah, I don't mind paying taxes on the harvest because I'll be in a lower tax bracket. That's one way of thinking. But there's no guarantee of where taxes are going to be when you retire.

Speaker 1:
Do you know historically what the highest marginal tax rate was? It was during World War Two or shortly thereafter it was 94%. Now, granted, I hope we never get up that high, but historically we're in very low tax brackets. So if we don't know which way taxes are going to go, and I give a lot of talks around the country, I've asked this question to federal employees, say, which way do you think taxes are going to go in the future? Up, down or stay the same? Now nobody zero. People have said, I think taxes are going to go down in the future. A very few have said, I think they're going to stay the same, but the majority of people think taxes are going to go up. That's just based on a feeling, based on thought, based on history. We're at historically a lower tax bracket than we've been in the past. So you can say, I'm going to I'm going to wait. I'm going to pay taxes in the future because I'm going to be making less money and I'll be in a lower tax bracket. But that lower tax bracket could. And again, I'm not knowing this for a fact, but could actually be a higher percentage than it is right now. Let's say you think I'm going to be in the 12% bracket. Well, the 12% bracket in the future could be the 24% bracket.

Speaker 1:
You never know. So knowing what you can pay today, pay the taxes today. Let that money then grow. It's all tax free, no matter how high or even low taxes get in the future. You've prepaid the tax. It's tax free in the end. Pretty awesome. Okay, so paying tax on the seeds. Are you taxed on what's in your account now. Not on what it's going to grow to. Could it be a big benefit for you now. I'm not this is not a, a pitch to convince you to do a Roth conversion, but it's just giving you the the ability to do so. And looking at how now you can do it within TSP. You can convert. There's some restrictions. Like I said, it's pretty, pretty small restriction, but you just have to pay those taxes out of pocket. Now you can also convert if you're eligible to, to get money out of your TSP. If you're still working and you're 59.5 or older, or you've been separated from service, you can do a Roth conversion outside of TSP. So a lot of federal employees that I talked to, when they are eligible to do so. Want to move their money outside of TSB now? Everybody's situation is different. I'm not saying it's right for you and that's what you have to do. But a lot of folks that I talk to are eager and anxious to get their money out of TSB when they're eligible to do so, and from there, no matter what IRA account they put their money into, they can convert from there.

Speaker 1:
And why is this called sometimes a backdoor Roth? Now, if you know anything about Roth accounts or let's say Roth IRAs, when when you move your money outside of TSB, so you move your money outside and you set up a Roth IRA or traditional IRA. So you move your traditional balance, or if you had Roth balance already, you move that into the corresponding IRA. So traditional TSB would move into a traditional IRA and a Roth TSB would move into a Roth IRA. Well, now let's look at that traditional money. And if you know anything about Roth accounts, there are limits on how much you can put into a Roth account per year. There are limits on how much you can earn. In order to put into a Roth account in a given year. So if you want to put in more money, you can't, because there's a limit of how much you can put into a Roth IRA. If you want to put into a Roth, but you make too much money, unfortunately, you cannot contribute to a Roth IRA. If you make too much money. So and those limits vary based on time. So if you have questions about that, reach out to us.

Speaker 1:
We can give you those exact limits depending upon when you're watching this episode. But the way a Roth conversion works, it does not matter how much money you make. You can do a Roth conversion. It does not matter how much you want to convert. You can convert to a Roth IRA. So it bypasses the Roth IRA limits and the Roth IRA earnings test in order to contribute to a Roth. So that's why it's sometimes called a backdoor Roth, a Roth conversion. So you can move your money outside of TSP and the traditional monies you can convert to Roth. And there's different ways you can do it. You can do it in one lump sum, which not a whole lot of folks do. Or you could do it partially over time, which is a way to mitigate that tax liability over the years. So in the same example, you wanted to do $100,000 conversion. And this is either within TSP or outside of TSP. You can partially convert 20,000 a year for five years, let's say. And instead of paying tax on the 100,000 on the big conversion, you can pay 20,000 in the first year. On the first portion, you convert your number two, you convert another 20,000. You pay tax on only 20,000 for that conversion, you're three, four, five and so on. You only pay tax on what you're converting.

Speaker 1:
And now ultimately, after five years, in this example, you've converted all 100,000. But you've lessened the blow as far as taxes by only doing 20,000 a year instead of all 100,000 upfront. And maybe it's, hey, I can do $49,250 until I go into the next tax bracket. Great. We could do that amount. Maybe you skip a year, maybe it was a great year. You had other incomes and things like that. Rental income. Investment income things. And you just said it's not a good year to convert. All right. You can skip a year. It doesn't have to be uniform and it doesn't have to be consecutive years. You pick and choose what you want to do. And the whole benefit. Again, I'm going back to the beginning is you're taking taxable money and you're turning it into tax free dollars and all that interest that you're going to earn outside or as a result of or after the conversion is going to be tax free as well. Now there's another benefit, a couple benefits. Actually, now that it's Roth and tax free dollars, you no longer owe, RMDs required minimum distributions. So if you're familiar with this traditional IRAs, the traditional portion of your TSP. Once you're separated from service, you owe. Rmds required minimum distributions based upon your your year of birth. For those that are younger now, yours is going to be age 75? Unless they increase the limits.

Speaker 1:
But once you hit that age, the government's going to require that you start taking money out to satisfy your RMD. Or you can get penalized. It's a way for you to start taking money and paying tax on those dollars. Roth accounts Roth IRAs converted into Roth accounts. They no longer owe RMDs. Pretty awesome. So you you've prepaid the tax. You've bypassed the need to withdraw money at a certain age. Also, if you pass away and you still have money in those accounts, that money goes to your beneficiary or beneficiaries tax free. So it's a way to mitigate taxes for your loved ones that are going to inherit your money if there's money left over. So I'm a big fan of tax free dollars. I'm a big fan of, uh, not giving Uncle Sam more than you have to. And if you can prepay it, get them out of your pocket. Right. Sam, out of your pocket. As far as retirement and now going forward, you can earn interest and you can grow your account as large as possible. And all of it is going to be tax free because you convert it to a Roth. So if you do have questions about this, I will say again, go to our website, Federal Retirement Show.com fill out the form. One of our experts. If it's not me personally, we'll be reaching out to review all of your benefits and discuss any specific questions that you have, including if it's about Roth conversions, I highly encourage you.

Speaker 1:
As I mentioned in the beginning, go back and view our previous episodes. There's a lot of content in here, a lot of great information. You can spend hours, days. The episodes are 5 to 30 minutes long. You can listen to it in the car on the way to work, on the way home. And I give you one challenge. I say this after every episode. I'm saying, share this with a colleague. If you like our content. The only way that we're going to get in front of more federal employees is if more federal employees watch our episodes, watch our show, and if you like what you see and you think it'll help somebody that you work with, refer them to it. So you got to watch the federal retirement show. There's 170 plus episodes. There's a lot of great information. If you have questions, they'll answer them for you. You gotta just reach out. So thank you in advance for passing this information on to your colleagues so we can reach more federal employees. I really appreciate, as I said earlier, you taking the time out of your schedule to view our content to join us. Again, my name is Val Majewski with American Benefits Exchange. You've been watching the federal retirement show, and we look forward to seeing you on a future episode.

Speaker 2:
You check your account balance and realize you have no idea where your last paycheck actually went. Bills are piling up. That nagging anxiety kicks in and you wonder, how did I even get here? If that hits too close to home, you're far from alone. And April just happens to be the one month of the year the entire country stops to do something about it. I'm Jim Carroll here for the retirement radio network powered by immorality.

Speaker 3:
Financial literacy is so important because it's what you're going to base the rest of your life on resource wise.

Speaker 2:
John Ford of CNBC bringing up an obvious but important pointer about money and finances. April is National Financial Literacy Month. It started back in the early 2000 when Congress realized too many Americans were leaving school without the first clue about how to manage a paycheck, a credit card, or a financial future. Fast forward to 2026, and the problem hasn't gone away. In fact, nearly half of us adults still give themselves a C minus or worse on money knowledge. And as CNBC's Bertha Coombs tells us, one of the best investments you can give yourself learning how to manage your money.

Speaker 4:
You know, we all work very hard for our money, and we should learn how to make our money work for us. And I think if you invest in knowing how to manage your money, that it will pay off as you get older, it'll pay off in your life.

Speaker 2:
It's about knowing enough to stop making the same expensive mistakes and finally starting to make decisions that move your financial life forward. So here are five quick financial wins you can achieve this month. Review one monthly bill and see if you can cut, renegotiate or cancel it. Follow that with pulling up your free credit report and spot any surprises. Next, set one small savings goal. Even 20 bucks a paycheck counts. Don't forget to learn just one new money concept, like how compound interest actually works for you instead of against you. And maybe the most powerful one. Sit down with your partner and or your kids and have one honest conversation about money. No judgment. Just a real talk. While Financial Literacy Month won't fix every financial bump in the road you may have, it can be the month you finally stop feeling helpless about money and start feeling in control. So pick one thing. Do it this week. Because the best time to get smarter with your money was 20 years ago. The second best time right now in April for the retirement radio network powered by Omairalive. I'm Jim.

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