To convert or not to convert that is my question

[FM980]

To convert or not to convert that is my question. I am just over six years before I hit 60 and I plan on retiring fulltime on my TSP and two pensions. The expected taxable income at that point without TSP is expected to be in the 12% tax bracket. Due to my spouse's age, we will not be looking into withdrawing anything from those accounts until she hits her RMD age and I will be well into my retirement years. Unfortunately, everything is pre-tax, and I am concerned with what we plan on drawing from TSP each year will push us into the 22-24% tax bracket, especially if we decide to make any substantial draws to support a second home or RV.

I understand from talking with the TSP support desk that there is no process at this time to convert, but I do want to be prepared when and if it happens. I would assume if one were to do such a thing they would do it over a period of years to stay within or under the 24% tax bracket complicating the math a bit. Does anyone have some suggestions on how I might calculate if it would worth looking into converting my existing TSP balance and paying the tax now so that I can better manage my taxable income in future years?

 

[evilanne]

I recommend converting, especially for married couples since if something happens to either one of you, the surviving spouse's taxes will likely increase since the tax bracket is much smaller for a single person. I don't know if we will ever be able to do conversions within TSP but you can take a partial withdrawal to rollover a portion of TSP into a Traditional IRA and then gradually do conversions to a Roth IRA. It is a rather simple process with outside IRA accounts (you can transfer cash or specific holdings within your account). I converted one IRA to my Roth this year and did partial TSP withdrawal to a separate IRA that I plan to convert to Roth over a period of years. I haven't figured out a good way to calculate other than looking at it on a year by year basis. There are some Financial Independence/Early Retirement calculators that may be useful--I know I came across one that did address conversions but it wasn't helpful for my situation. You might find more information in a early retirement forum. If you have someone that does your taxes, you may want to discuss with them this year.

 

[Scraps]

One thing to consider is where you will be living in retirement and whether or not there is a state income tax there. I live in Virginia but may be retiring to Texas. Texas has no state income tax, Virginia does. If I were to do the conversion, I would have to pay Virginia taxes on the conversion. It just doesn't make sense.

 

[Boghie]

I would look at funding the Roth TSP option now rather than the conversions. Although, at your income level that is probably not a real smart idea. The only positive would be that part of your retirement income stream will be untaxed and thus you could massage your retirement income to avoid the tax man to some small extent.

The value of Roth accounts is the ability to never pay tax on the compounding growth. You need time to make it viable. At your ages you will not have huge amounts of compounding growth unless you invest in a very risky allocation - and, in that case you might have to manage a decline.

 

[dhstdog]

My understanding is you will pay taxes on your TSP Roth to include the governments matching funds that went to the TSP Roth.

 

[Boghie]

My understanding is you will pay taxes on your TSP Roth to include the governments matching funds that went to the TSP Roth.

Yeah, but it is still a great investment vehicle if you have time on your side. Let us take the example of someone in the 25% tax bracket.

If you are 21 years old and throw $300 into a Traditional account you will save $75 in federal tax plus lets say $15 in state taxes. So, investing $300 costs you $210 and you have saved $90 today. Let it ride in the C Fund for 42 years till you retire at 63 and it becomes $16,200. Now, since you were smart enough to invest early and big you pull it out for a Vegas Roulette game. Put it on black. Plenty more were that came from - and you can really impress the strippers or whatever with that bet!!! That withdraw at 25% Federal tax and 5% State tax costs you $4,860.

Now, lets say you put that $300 in a Roth TSP account instead. You current net pay does not decline by $210, but by $300. Yowser. Less beer, movies, and music - but one must sacrifice now for the future!!! Every damn pay period you are taking a $90 dollar lump to the head by not investing in a Traditional TSP account. So, where does that get you at age 63. Basically $4,860 richer. You don't have to pull $22K to impress strippers with your $16K bet - you just have to waddle drunkenly to the ATM and yank $16K. Your benefit of paying the tax early is $4,860 while the opportunity cost of the $90 in free money was $510 so the net is $4,350.

That ain't chump change...

But, the benefit of a Roth option quickly recedes as the time-frame shortens, or your willingness to take investment risk reduces, or your current tax bracket goes up. In the end, it is the time-frame of the investment that matters most.

 

[evilanne]

My understanding is you will pay taxes on your TSP Roth to include the governments matching funds that went to the TSP Roth.

Government matching funds are always traditional--not taxed until withdrawn. Boghie make a good point of contributing to Roth now rather than doing conversions...although it didn't get included, one proposed amendment to recent tax bill talked about getting rid of conversions but they did limit any re-charactsrizations (undoing prior conversion). It is always possible that at some point they could change the rules in the future. Your current tax and future tax situation, including state taxes if applicable, as well as your anticipated RoR need to be considered in making any decision. There are many variable and things can change so really it is your best guess given available information...be thankful for having such high class problems

 

[Boghie]

Government matching funds are always traditional--not taxed until withdrawn. Boghie make a good point of contributing to Roth now rather than doing conversions...although it didn't get included, one proposed amendment to recent tax bill talked about getting rid of conversions but they did limit any re-charactsrizations (undoing prior conversion). It is always possible that at some point they could change the rules in the future. Your current tax and future tax situation, including state taxes if applicable, as well as your anticipated RoR need to be considered in making any decision. There are many variable and things can change so really it is your best guess given available information...be thankful for having such high class problems

Wow, EvilAnne...

You are 100% correct. Do you want to count on a politician 40 years from now honoring a promise of a politician today. Nope and double nope. It would be technically impossible for some political slug to retroactively tax all contributions made to a Traditional account over the past 40 years. They could increase the income taxes at your retirement because they have a bridge to nowhere to build but you have already taken advantage of the promising politicians offer.