Originally Posted by Keyboard Ninja
I've read both sides of the argument, and it gets harder to decide every time I think about it.
TSP has the low fees of course, but with me being in the lowest tax bracket wouldn't I stand a better chance of maxing out my ROTH IRA first, then putting the rest into TSP? I've read that I should just max my TSP (with no company matching), then invest the rest into a Roth IRA.
Run a spreadsheet. It's tedious but it's the best way to answer a complicated question.
Set up a TSP contribution of $5K/year at an expense ration of 0.015% (not a typo, that's 1.5 basis points) against an equivalent fund. Your "equivalent fund" would have to be an equivalent amount
in a Roth IRA (with tax-free compounding and untaxed withdrawals) at the fund's expense ratio. The fund's expense ratio will be higher than the TSP's, so since the two funds have equivalent assets & returns then the difference in their performance will be the difference in their expense ratios.
The Roth contribution would be less than the TSP's contribution. The TSP contributions are pre-tax dollars while the Roth contributions are after-tax dollars. In that case the Roth contribution would not be $5K but a number more like $4.5K (depending on your other tax deductions). Figure out the taxes and account for them. It makes a difference.
The TSP account's contributions and gains are only tax-deferred, not tax-free like a Roth. The TSP funds have to be withdrawn someday and the distributions could push you into a higher tax bracket even before you start paying taxes on the withdrawals. This is why some claim that the Roth is a better deal.
Putting $5K of before-tax dollars in the TSP at a lower expense ratio beats the snot out of putting less than $5K of after-tax dollars in a Roth at a higher expense ratio. The payback for this compounding is that the TSP account is going to have to be withdrawn someday and those distributions will be fully taxed.
However your TSP can also eventually be rolled over to an IRA. As an ER, you might be able to execute a multi-year Roth IRA conversion that would pay those TSP taxes at the same rate as the money that went into your Roth. Spouse and I are currently doing this with our conventional IRAs at a 15% tax rate, which is lower than what we'd be paying at RMD.
The conversion option means that the tax impact could be the same whether it happens after withdrawal (TSP) or before the contribution (Roth IRA). The only remaining difference would be comparing the TSP's expense ratio to the Roth's. Again I suspect it's hard to beat the TSP's low expenses.
Unfortunately this logic also assumes that today's tax rates (what you're paying before you put it into the Roth) will be the same as tomorrow's tax rates (what you're paying on the TSP distributions or the Roth IRA conversions). It's widely expected that tomorrow's taxes can't possibly get any lower than today's, which is why the Roth IRA is touted as a better deal. Again the difference may be that taxes would have to get a lot uglier to overwhelm the effect of the lower expense ratio. This may not be such a difficult hurdle if your "equivalent fund" is a Vanguard product with an expense ratio of 0.09%.
Or tax laws could change over the next few decades. Many pundits think that Congress will be tempted to find a way to make Roth withdrawals taxable after all-- either through means testing, "excess profits" legislation, or a reduction in Social Security.
Spouse and I are going to bet on the TSP. Up until now we've been converting her conventional IRA to a Roth, doing a bit every year up to the top of the 15% income-tax bracket. But her Reserve retirement is effective in December, when she's going to roll over the rest of her conventional IRA into the TSP. (It's not well known but it's on the TSP's website.) When she starts getting her pension at age 60 (in 2022) she'll roll the TSP back to a conventional IRA and start converting it to a Roth-- a little each year to the top of the 15% bracket (or whatever bracket we're in at that point). I suspect that the TSP's 0.015% expense ratio versus the 0.25%-0.5% expense ratios that we're paying on our index ETFs will have a bigger effect than rising tax rates. But we could be wrong.
BTW once you begin earning those righteous 2LT bucks, you'll be able to max your contributions to both your TSP and your Roth IRA...