Roth Conversion that are tax free

[FIREarly]

As someone actively w*rking and contributing to TSP (like 401k), once retired, isn't there a maximum amount that can be withdrawn tax free each year? +/-$12,000?

If that's possible, might it make sense to invest 1% in Traditional TSP and the rest in Roth TSP?

This is not to ask for advice on if Traditional or Roth TSP is better. It's merely to ask if a "small" amount of TSP in retirement may go through a Roth conversion tax free each year?

 

[skipro33]

Withdrawals from your Traditional TSP are fully taxable as ordinary income when they are withdrawn; they do not receive any favorable tax treatment like a long-term capital gain or a qualified dividend.

 

[TheWizard]

Withdrawals from your Traditional TSP are fully taxable as ordinary income when they are withdrawn; they do not receive any favorable tax treatment like a long-term capital gain or a qualified dividend.

True, but the first $X,000 of Ordinary Income results in zero income tax for the year.
X varies depending on single or married...

 

[pb4uski]

Yes, if you have NO other income then a withdrawal equal to the standard deduction would result in no tax.

I have a friend whose only retirement income is SS and a duplex that basically breakseven after expenses and depreciation and he has enough headroom that he can withdraw ~$14k a year tax-free.

 

[Koolau]

^^^^^^^^

Depending upon tax deductions, it may be possible to take even more tax free, though I'm not sure what those deductions would be for someone with otherwise relatively low income.

 

[ziggy29]

If you have enough deductions and such limited income that you can perform some Roth conversions and remain below the threshold for income tax, you can do it, but that's a really low bar. But in theory that can be done if you are (for example) living entirely off of savings and Roth-type investments and have very little taxable interest/dividend income, and the conversion amount doesn't kick you over the standard deduction amount.

That said, TSP doesn't allow Roth conversions in the plan so you'd have to roll over "traditional" TSP funds to another custodian who would allow it.

 

[Koolau]

That said, TSP doesn't allow Roth conversions in the plan so you'd have to roll over "traditional" TSP funds to another custodian who would allow it.

Yeah, that's what I ran into with my 401(k). I had to transfer funds to tIRAs from the 401(k) before I could do conversions. No longer doing conversions, so not an issue.

 

[PhrugalPhan]

If you have a TSP you are in the Federal government. I don't know all the rules, but don't you have a pension (assuming you work there long enough) when you retire from the Fed. employment? Assuming that, you will have a pension in retirement that will most likely take up all the free earnings space (the +/- $12,000 amount), meaning everything you will withdraw will be taxed at some percentage. Then once you have social security payments added in you will be pushed into higher tax brackets, possibly having IRMAA penalties as well. The only way I see withdrawing from TSP to convert can be tax free is if you have very high medical expenses one year or you don't have a pension (by retiring early or you leave the Federal workforce for other work).

 

[ziggy29]

If you have a TSP you are in the Federal government. I don't know all the rules, but don't you have a pension (assuming you work there long enough) when you retire from the Fed. employment? Assuming that, you will have a pension in retirement that will most likely take up all the free earnings space (the +/- $12,000 amount), meaning everything you will withdraw will be taxed at some percentage. Then once you have social security payments added in you will be pushed into higher tax brackets, possibly having IRMAA penalties as well. The only way I see withdrawing from TSP to convert can be tax free is if you have very high medical expenses one year or you don't have a pension (by retiring early or you leave the Federal workforce for other work).

That is likely the case once you are receiving the pension (even in FERS), but if you are doing this after "retiring" from federal service but before you start collecting the pension, it is just as "doable" as it is with any job.

 

[skipro33]

True, but the first $X,000 of Ordinary Income results in zero income tax for the year.
X varies depending on single or married...

That's called the standard deduction. All earned taxable income is considered taxable, with the first $14,600 deducted from the gross income earned for 2024, an increase of $750 from 2023.

 

[FIREarly]

If you have a TSP you are in the Federal government. I don't know all the rules, but don't you have a pension (assuming you work there long enough) when you retire from the Fed. employment? Assuming that, you will have a pension in retirement that will most likely take up all the free earnings space (the +/- $12,000 amount), meaning everything you will withdraw will be taxed at some percentage. Then once you have social security payments added in you will be pushed into higher tax brackets, possibly having IRMAA penalties as well. The only way I see withdrawing from TSP to convert can be tax free is if you have very high medical expenses one year or you don't have a pension (by retiring early or you leave the Federal workforce for other work).

To my understanding, after reading this, investing in the Roth TSP to pay taxes legally up front might be the better option.

 

[SecondCor521]

^^^^^^^^

Depending upon tax deductions, it may be possible to take even more tax free, though I'm not sure what those deductions would be for someone with otherwise relatively low income.

Itemized deductions would work. Large medical expenses (paid out of savings if low income) is probably the likeliest, or maybe a combination of SALT and charitable giving.

A larger standard deduction would work. MFJ, over 65, blind, or any combination of those.

Nonrefundable credits would work. Child tax credit (unlikely) or credit for other dependents (supporting Mom, Dad, MIL, FIL), AOTC/LLC, energy credits (including EVs), maybe the mortgage interest credit.

 

[Koolau]

Itemized deductions would work. Large medical expenses (paid out of savings if low income) is probably the likeliest, or maybe a combination of SALT and charitable giving.

A larger standard deduction would work. MFJ, over 65, blind, or any combination of those.

Nonrefundable credits would work. Child tax credit (unlikely) or credit for other dependents (supporting Mom, Dad, MIL, FIL), AOTC/LLC, energy credits (including EVs), maybe the mortgage interest credit.

Thanks for fleshing this out. I hadn't thought of some of those.

 

[FI_RElater]

I think you are thinking too hard of ZERO when you should be thinking of difference.

When working, we had been as high as thirty plus percent federal (plus state) tax.
Getting money into retirement plan (401k or a regular TSP) without taking the tax hit was FAR better.... as in retirement we've been in 12% to later the 22% (with average tax hit below that).
Remember that the costs of going INTO a retirement plan are at the higher marginal rate (or sometimes, when at the cusp, a mix of the two rates), whereas the money coming out is at the effective tax rate (considering all sources).

Those very early in career, assuming at very low tax rates (say 12% and below), might be able to put into Roth IRA and take advantage of long time tax free growth. Otherwise, putting money into regular 401k or TSP while avoiding the high tax hit and later in retirement doing Roth conversions comes out far ahead.
Been there, and did Roth conversions, and now have Roth, taxable, and still regular IRA (as rollover) with which to do withdrawals for income in retirement.
[ Hint: most of the IRA came out at 12% but went in at twenty to thirty something percent and, because taxes weren't paid before, there was much more of it to be able to convert ]

 

[pb4uski]

^^^ +1 and for us the cherry-on-top was that we lived in a state with state income tax when we deferred that income and now live in a state with no income tax so we save another 5-7% on conversions and withdawals.