Making Your Benefits Count!!

To Roth… or Not to Roth?

Fedadvisory — Sun, 26 May 2024 05:23:23 +0000

by Richard Bavetz, FRC℠ | May 26, 2024

Let’s face it. Does anyone really believe taxes are going down? Taking it one step further… does anyone want to make less money next year? What about the year after that? Isn’t it true that we all want to get a raise next year and none of us want to lower our lifestyle when we retire?

Achieving Parity® is the minimum goal; making in retirement what you made while working, means you get to keep all your stuff. What if you could get a raise for staying home? Even better!

Everyone who truly thinks this through will realize that deferring (delaying) our income taxes into the future goes against what we believe will happen, what we want to happen, and what we’re all working so hard to achieve… a successful retirement outcome.

The Thrift Savings Plan (TSP) Roth option provides several unique advantages that can be especially beneficial if you anticipate higher taxes in the future, or if you plan to make more money in the future.

Tax-Free Withdrawals in Retirement

Future Tax Savings: Contributions to the TSP Roth are made with after-tax dollars, meaning you pay taxes on the money before it goes into the account. The significant benefit is that qualified withdrawals, including earnings, are tax-free. This is particularly advantageous if tax rates increase over time, as you won’t owe taxes on the growth or distributions. Do you believe tax rates will go up over time?

Predictable Tax-Free Income: Knowing that your withdrawals will be tax-free provides greater predictability and security in retirement planning, especially when tax rates are rising.

State Income Tax Considerations: Some states do not tax Roth TSP distributions, which can be an added benefit if you live in or move to a state with high-income taxes. This can further enhance the tax advantages of Roth TSP accounts in retirement.

No Required Minimum Distributions (RMDs) if Transferred to Roth IRA

Roth TSP RMDs: While Roth TSP accounts are subject to RMDs starting at age 72, transferring your Roth TSP to a Roth IRA can eliminate this requirement. Roth IRAs do not have RMDs during the account holder’s lifetime, allowing your savings to continue growing tax-free and providing more flexibility in managing your retirement funds.

Control Over Withdrawals: This transfer can give you more control over your retirement withdrawals, potentially reducing your taxable income in retirement and allowing for better tax planning.

Legacy Planning: Roth accounts can be a powerful tool for estate planning. Since they do not require RMDs, a Roth account can be passed on to heirs, who can benefit from continued tax-free growth. Moreover, the inheritable nature of a Roth TSP or IRA, makes for a far better outcome for all non-spouse beneficiaries.

Tax-Free Growth

Compounding Benefits: All earnings in a Roth TSP account grow tax-free, significantly enhancing the growth potential of your investments over time. This is especially beneficial over a long investment horizon, where compounded returns can substantially increase the value of your account.

Maximized Net Retirement Savings: Tax-free growth means the full value of your investment returns remains in your account, leading to potentially higher net retirement savings compared to a traditional account where earnings are taxed upon withdrawal.

Hedging Against Tax Rate Uncertainty

Protection from Rising Taxes: If you believe that tax rates will be higher when you retire than they are today, Roth accounts provide a hedge against this risk. By paying taxes now at the current lower rates, you avoid the risk of having to pay potentially higher rates on your retirement savings later, ensuring that you have a source of tax-free income in retirement.

Diversified Tax Strategy: At the very least, having a mix of tax-deferred (Traditional) and tax-free (Roth) accounts can give you flexibility in managing your taxable income during retirement. This lets you strategically withdraw from different accounts to minimize overall tax liability.

Matching Contributions

Government Matching: For Federal Employees Retirement System (FERS) participants, the government provides matching contributions up to 5% of your salary. While the matching contributions are placed in the Traditional TSP (and thus are taxed upon withdrawal), the personal contributions to the Roth TSP still benefit from this employer match, effectively increasing your overall retirement savings.

Flexibility in Retirement Spending

Reduced Tax Impact on Social Security: Withdrawals from Roth accounts do not count as income to determine the taxability of Social Security benefits. This can help keep your overall taxable income lower, potentially reducing the portion of your Social Security benefits that are subject to tax.

Integrated with Federal Benefits

TSP’s Low Fees: The TSP is known for its low administrative and investment fees compared to other retirement savings plans. This cost efficiency allows more of your contributions and investment earnings to remain in your account, boosting your retirement savings.

Ease of Management: Being part of the federal benefits package, managing your Roth TSP alongside your other benefits like Traditional TSP, Federal Employees Retirement System (FERS) pension, and Social Security can simplify your retirement planning.

Seek Professional Guidance

Consult with a Professional: Federal employees have a robust set of benefits designed to maximize retirement income. By taking full advantage of these resources and planning strategically, a Federal Worker can secure a comfortable and financially stable retirement. Playing it smart by working with a professional to assist in your retirement planning can make a huge impact on the success of your planning. Don’t wait until the last year to start planning.

Consider advisors specifically trained in Federal Benefits such as a Federal Retirement Consultant℠ (FRC℠). An FRC℠ is a professional specializing in Federal Employee Retirement planning and advice. Because they are certified in the Federal Employee Benefits plan, they can offer personalized advice on maximizing your retirement income as well as utilizing all of the benefits offered, based on your specific situation.

Conclusion

The Roth TSP offers substantial advantages, particularly in a rising tax environment. By providing tax-free growth, tax-free withdrawals as protection against rising tax rates, the potential to avoid RMDs by transferring to a Roth IRA, and the flexibility to manage your tax strategy, the Roth TSP enhances your ability to secure a more tax-efficient retirement. Combined with the low fees and integrated benefits of the TSP, it becomes a powerful tool for federal employees looking to maximize their retirement savings and financial security. These advantages can lead to significant tax savings and financial security in retirement, making Roth accounts an attractive option for many TSP savers looking to maximize their retirement outcomes in a potentially high-tax future. It’s time to Get Excited!

Rick Bavetz is a Federal Retirement Consultant℠ and has been helping Federal Employees understand their employee benefits for over 15 years. He has also been teaching the employees of various Federal Agencies how to maximize the outcomes of their Federal Service by utilizing the Federal Employee Benefits plan to its fullest.

Some federal agencies Rick has worked with:

Veteran’s Affairs, EEOC, USDA, FAA, FTC, DEA, DHS, the Dept of the ARMY & NAVY, DCMA, CBP, SSA, IRS, and others.

The Federal Benefits Advisory (FBA) is not affiliated with, endorsed or sponsored by the Federal Government, the Social Security Administration or any other U.S. Government agency. The information provided herein was obtained from official sources and may contain or refer to concepts that have tax, accounting, estate planning, or legal implications. It is not intended to provide tax, accounting, or legal advice or to serve as the basis for any financial decision. Individuals are advised to consult with their own accountant and/or attorney regarding all tax, accounting, and legal matters. While the information provided is gathered from official sources and the accuracy is deemed reliable, it is not guaranteed. Federal Retirement Consultants℠ (FRC℠) are experienced financial professionals who can demonstrate their competence and knowledge of federal employee retirement systems and related benefits. The designation requires comprehensive training, ongoing continuing education, and annual testing to ensure accurate delivery of up-to-date plan benefits information to federal agencies and their employees.

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Retirement Affects Credit

Fedadvisory — Sat, 30 Mar 2024 11:58:07 +0000

Federal employees who have excellent credit scores can expect their scores to decrease after they retire from federal service. A drop of income, a result of transitioning from a higher income in the form of a salary to a lower income in the form of retirement income, will not necessarily affect a retiree’s credit score directly.

But the actions of “scaling back” one’s lifestyle in retirement and paying off existing loans such as mortgage can result in lower credit scores.

The credit score referred to is the FICO score. FICO stands for Fair Isaac Corporation, a company which has developed a numerical score used to predict how likely an individual is to pay back a loan. FICO scores range from 300 to 850. Usually, a higher FICO score makes it easier to qualify for a loan and may result in a better interest rate on the loan.

The FICO score should matter to the average retired individual, even if a retired individual is less likely to apply for a mortgage, for a short-term loan, or for other forms of installment debt. FICO scores are also used in a range of insurance and healthcare decisions, from setting car insurance premiums to whether an individual is accepted to live an assisted living facility.

Many Americans including retirees have over the last few years (especially during 2020 and 2021 when home values increased, and mortgage interest rates decreased) taken on more mortgage debt. As more retired Americans carry mortgage debt and car insurance premiums increase, FICO scores remain important.

According to FICO data, FICO scores increase as individuals get older, peaking when individuals at a score of 762, when individuals are in their early 70’s. After age 70, the average score falls to 756. According to most lenders, FICO scores that are in the “good” range – between 660 and 780 – are important. A score between 660 (getting into the “fair” range) should be of most concern.

While retirees typically have longer credit histories (thereby keeping FICO scores at least in the “good” range), there are certain actions that a retiree may perform that could cause a deep drop in the FICO score. These actions include closing out multiple old credit card accounts (even if the credit card account is inactive) too rapidly. Income and employment data are not included in the calculation. But an individual’s FICO score tends to be higher if the individual has a mixture of diverse types of loans. This mixture includes mortgages, credit cards and other types of installment debt including auto loans and student loans.

What Retirees Should Do to Keep Their FICO Scores Up
There is no secret formula for building a strong FICO score. The following are a few suggestions that can help build and maintain a strong FICO score:

(1) Making installment loan payments on time every time a payment is due;

(2) Not spending close to the credit card limit for credit cards; (3) Having and maintaining a long credit history;

(4) Applying for a loan and a credit card only when necessary; and

(5) Fact checking one’s credit reports (the credit reports issued by Equifax, Experion and TransUnion) and removing any incorrect information and closing out credit cards no longer used.

There are some financial advisors who counsel their clients to pay off as much debt as possible (including a mortgage) before they retire. However, for a growing number of retirees, paying off a large debt is not an option because of their lack of “liquid” savings held in passbook savings and money market accounts. According to the Federal Reserve Bank of New York, over the past 20 years senior citizens have accumulated debt faster than any other age group. Total household debt for those individuals over age 60 has more than quadrupled to $4 trillion over the past 20 years, according to Federal Reserve data.

Many federal employees have asked the question whether they should use their Thrift Savings Plan (TSP) and/or individual retirement arrangements (IRAs) to pay off their mortgages, home equity lines of credit and any other debt such as credit cards and student loans once they retire from federal service.

The answer is no for two reasons:

(1) A lump sum withdrawal from the traditional TSP is fully taxable.

The TSP automatically withholds 20 percent in federal income tax when a lump sum withdrawal is requested. The TSP does not withhold state income taxes from a lump sum withdrawal. The TSP participant is responsible for paying any state income taxes due. When requesting a lump sum traditional TSP withdrawal to pay off an existing debt, the TSP participant therefore needs to take into consideration federal and state income taxes.

For example, if a TSP participant wants to pay off a $300,000 mortgage balance and the TSP participant lives in a state that has an 8 percent state income tax, then the TSP should request a $300,000/0.72 equals $416,667 lump sum withdrawal in order to pay the taxes due and to net (after paying the taxes due) $300,000. In case a lump sum withdrawal from the Roth TSP (or a Roth IRA) is requested, while there are no taxes due when a qualified distribution is made from the Roth TSP, any further tax-free growth in the portion of the Roth TSP account withdrawn will be permanently lost; and

(2) A lump sum withdrawal from the TSP or IRA means that the funds withdrawn will not be available to help pay for any future major expenses such as the cost of long term care.

For example, a retiree and/or retiree’s spouse has to go to an assisted living facility and/or nursing home and long-term care insurance was not purchased to pay the cost.

The combination of lower income during retirement coupled with higher interest rates and inflation can quickly make debt burdens unmanageable for many retirees. That is why retirees are advised to routinely monitor their debt by annually checking their credit reports (by going towww.annualcreditreport.com) and their FICO score (by going to www.myfico.com).

Re-posted from MyFederalRetirement.com
Written by Edward A. Zurndorfer
Edward A. Zurndorfer is a Certified Financial Planner (CFP®), Chartered Life Underwriter, Chartered Financial Consultant, Registered Health Underwriter and Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, located at 833 Bromley Street Suite A, Silver Spring, MD 20902-3019

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