Are In-Plan conversions for the TSP good news?
Recently, the Federal Retirement Thrift Investment Board (FRTIB) announced that In-plan Roth conversions for the TSP are coming in 2026. What they are suggesting is that one can take their Traditional TSP monies and, inside the TSP, convert those monies to a Roth TSP account. The recent news also indicated that participants would need to use outside money (i.e., not from the TSP) in order to pay the tax bill on the conversion.
Answer: Depends (classic catch-all answer). But it really does. Roth conversions can be a powerful tool for the right person. At a high level, the idea…quite simply…is to pay taxes when your tax bill is the lowest. Tadaaaa. If only it were that easy.
The basic idea is to convert all, or a portion, of your pre-tax Traditional TSP to a Roth TSP. Same concept as converting a pre-tax Traditional IRA to a Roth IRA. The amount you convert will be treated as ordinary income. Thus, you’ll pay taxes in the year of conversion (but you won’t pay the 10% penalty).
After conversion, the money will grow tax-free in your Roth TSP (or Roth IRA). Withdrawals will be tax-free in retirement. This is providing you meet certain criteria. You would consider this move if your analysis leans toward the idea that you’ll be in a lower tax bracket now (when you pay the tax on the conversion) and a higher tax bracket later (when you withdraw the monies and avoid paying any taxes). Typically, conversions can be a good idea to consider when your income drops you to a lower tax bracket. For example, you retire from service as a GS-14 and you don’t work for a few years. All other things being equal, your tax bracket may drop (because your income has dropped). These “down years” prior to collecting other sources of income like social security or required minimum distributions (RMDs) can be a good time to consider conversions.
Another good time to consider conversions can also be when the market drops. For some, a conversion can make sense during this timee. This is because they can then reap the benefits of a market recovery with money in their Roth IRA. Here the growth is now tax-free.
But here’s what could be really interesting about In-plan Roth conversions for the TSP. This is for those who never started the Roth TSP but wish they had. Maybe they are early-to-mid career with a decent sized Traditional TSP. And they have yet to make the jump to a higher pay grade (like a GS-13).
For example, let’s say Wyatt is 7 years on the job. He’s a GS-12 with $100,000 in his Traditional TSP. Wyatt is pretty confident he’s staying with his silver-starred agency. He’s even looking to head to FLETC to be an instructor in the next year or so. This would be a promotion to a GS-13. It would also give him plenty of room to grow past a 13 later in his career.
Wyatt and his wife, Josephine, currently fall in the 22% tax bracket based on their income (2024 Married Filing Joint: $94,301 to $201,050). They’ve made the family decision to have Josephine stay home for a few years with the kids. So naturally their income is lower than usual during these years.
However, with Wyatt wishing to promote later in his career his income will rise significantly. Likewise, Josephine will return to the work world after the kids are a bit older. She’ll make significantly more than Wyatt as a marketing executive for Charles Michael Financial (<– see what I did there with my Dad joke creativity). They anticipate their combined incomes will place them squarely in the 32% tax bracket during this time and for years to come.
Well, it might be a good idea for Wyatt and Josephine to consider a Roth in-plan conversion here in 2024 (I know they aren’t available now; this is just an illustration). All things being equal, Wyatt and Josephine could convert the $100,000 in Wyatt’s Traditional TSP to a Roth TSP. They would do this via the in-plan conversion feature. Wyatt and Josephine would essentially lock in their current tax rate of 22%. This allows them to pay the tax now at a lower rate, as compared to where they may be in 4 years (or deep into retirement) when their income places them in the 32% tax bracket.
Essentially, they’ve saved 10% in taxes by doing the conversion now at the lower tax rate. Quite a win for their family! (Note: this is a simplified example that assumes that the family will never be in a lower tax bracket than 22%; which may or may not be accurate. Again, this example is purely for educational purposes).
A Nifty Idea
I’ll go deeper on Roth conversions in the future. But in the meantime, here’s a nifty MoneyArmor™ Move to think about. And I’m purely throwing this out for fun. It’s not advice, just something for you to chew on besides turkey.
What if you added a line item to your budget and titled it: “Cash for Possible Roth Conversions”. Start throwing some cash to it each month. No way I can tell you how much…or can I (insert thrilling and adventurous Goonies music here). I’ll circle back to this in a second, standby.
Let this savings line item stay in your budget over the next 12-36 months or however long it takes for the TSP to actually implement this Roth in-plan conversion functionality. Now, here’s the thing. You may or may not be in a good position to do a Roth conversion someday. But since we know this is coming and since you know even if the TSP screws this up royally and you want to do Roth conversions OUTSIDE of your TSP, then at least you’ll have a little cash set aside for the conversion. Paying the tax bill from outside cash, say cash sitting in a bank savings account, is usually the most effective way to complete the conversion anyway.
Now how much do you save? Normally, you’d have to drug me like B.A. Baracus getting on an airplane to do something as crazy as tell someone – WHO I DON’T KNOW – how much to save for a Roth conversion.
But we’re just throwing out ideas for fun here. So what you could do is evaluate, with your financial planner, if a Roth in-plan conversion is right for you sometime in 2026/2027 when this functionality possibly comes to life in the TSP. If I’m you I’d consider waiting until much later to even consider doing an in-plan conversion with the TSP until I’m sure they have the infrastructure in place to ensure a smooth conversion (not that they have a history of less than optimal technology solutions or anything). Plus my wife has a strict “no purchase” policy the first year anything new comes out. And she’s often right…about a great many things.
Now Pivot
Anywhooo, if you’re sitting in a follow-car sometime in 2027 and you and your financial planner determine that In-plan Roth conversions for the TSP are NOT for you…then…wait for it…just change the title of your budgeted line item to: “Italian Vacation”!! Genius right?! So that’s how you figure out how much to save. Price out a fantastic vacation to a place you’ve always wanted to go visit with that special person (or you could even take your savvy financial planner that gave you this idea who has a passport and will travel), throw in an inflation adjustment for fun, and start saving.
Listen, there is no way to otherwise know what amount you should save for In-plan Roth conversions for the TSP. Or even if you should save for a Roth in-plan conversion, unless you share a cup of coffee and a chocolate frosted doughnut with your planner and run some numbers.
We’ll see how this develops over the coming months and what questions get answered by the TSP. Like can you still do a conversion once you are retired? Is Die Hard really a Christmas movie? Do we trust the TSP to report the conversions to the IRS properly? And can Gladiator II be anywhere near as good as the original? All important questions…stay tuned…
Be the Hero for You and Yours!
