IRA Rothification Offers A Path To Tax Free Withdrawals
What is “Rothification” and what does it mean for those of us saving for retirement? The root word for Rothification is “Roth,” which is a type of retirement plan or IRA where all contributions come from money already taxed. Thus, Rothification is the shift of retirement savings from a pre-tax base to an after-tax base. The government likes the concept of a Roth because it can get its hands on the money (i.e. tax) sooner than it allows with a traditional IRA or pension plan traditional. In a traditional plan, contributions are made from pre-tax dollars, and all income in the traditional plan is tax-deferred; the government has to wait until you start withdrawing your savings before they can collect taxes on them.
Imagine that you started saving for your retirement through the traditional TSP 30 years ago, in 1991, when you entered the federal public service. During that entire 30-year period, Uncle Sam (and many state tax authorities) couldn’t get that money. When you retire, you will begin to gradually withdraw this money to supplement your FERS pension and your social security. The government only gets a little bit of taxpayer dollars at a time for maybe another 30 years. When it comes to taxes and spending, the government is not too keen on deferred gratuities, and a significant number of lawmakers want to eliminate pre-tax pension contributions.
Early versions of the Tax Cuts and Jobs Act (TCJA) of 2017 contained provisions that significantly reduced the amount of the optional deferral for pension plans. The optional deferral amount is the amount that can be deferred from taxes in a traditional pension plan. These provisions were not incorporated into the final version of the bill and the amount of the optional carry-over now stands at $ 19,500.
There is more Rothification in the future. On May 5, the House Ways and Means Committee unanimously adopted and sent to the entire House, the 2021 Safe Retirement Protection Act. Experts have called this legislation SECURE 2.0 and Son of SECURE. Those as old as me are waiting for someone to try the SECURE nickname and Gidget Go Hawaiian. What would this law do if passed? 1) It would allow SIMPLE and SEP Roth IRAs; 2) It would allow employer matching contributions (in plans like the TSP) to be paid into Roth accounts. Today, all matching contributions must be paid into traditional accounts.
Is this Rothification tendency bad? Not necessarily; if withdrawals from Roth plans and Roth IRAs qualify, there is no tax on income accrued during the life of the account. For withdrawals to be considered eligible two things must be true: 1) You must have had the Roth account for at least five years (for example, if your first contribution was made in 2021, you would meet the five-year requirement. on January 1, 2026); and 2) You must be at least 59 and a half years old when you withdraw the money.
But wait! Let’s see by a show of hands the readers who think that Congress will keep the promises made to savers in 2021 when it is 2051 and Uncle Sam is strapped for income. A future Congress could move to tax, or partially tax, withdrawals from Roth accounts. We need to keep our eyes open and protect our retirement savings.
But there are some things in SECURE Meets Godzilla (I’m sure someone will call the act that before it’s all over) that are undoubtedly positive.
• The age for making your first Minimum Required Distribution (RMD) would be raised to 75 from 72.
• IRA catch-up contributions (currently $ 1,000) would be increased each year based on inflation.
• Older people (60, 62 and others have been floating) will be allowed to make larger catch-up contributions than those between 50 and regardless of the age agreed upon by Congress.
• The penalty for not obtaining an RMD would be reduced from 50% to 25%.
Remember, however, your high school civics class where you learned how a bill becomes law. Going through the House Ways and Means Committee is an early, though important, step in the passage of Son of Secure. If you have feelings about the proposed changes to retirement savings, do not hesitate to contact your elected officials.
Cancel a Roth contribution; Recharacterization
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Yes, it’s good to spend your TSP in retirement
How to estimate a special FERS pension supplement
Calculation of the service credit for sick leave at retirement
FERS retirement package: FERS 2021 guide and TSP manual