Now is the Time to Seize the Day
By Carol Schmidlin
Last January, the feature articles in our newsletter were “Celebrating the 20th Anniversary of the Roth IRA”, and the highlights of the “Trump Tax Plan”. Our webinar for that month was “Roth TSP, Peaks and Pitfalls”. Well now a year has gone by and we are nine months away, September 2019, from TSP implementing the TSP Modernization Act, which was passed into law November 2017. As I was looking back, I realized that now is the time to seize the day for a great number of you that are trying to make positive changes for your future by instilling proactive tax planning into your retirement strategies. During this month’s webinar we will focus on Roth TSP Peaks, with none or very little pitfalls.
So, you may be thinking, what does the title of this article have to do with getting excited about the TSP Modernization Act. Well, it so happened that as I was getting more and more excited about the opportunities that await you, a song from Newsies The Musical, “Seize the Day” began playing non-stop in my head. I had the opportunity to watch the Newsies musical many times between November and December, as my son, Evan played Crutchie, and after watching the incredible cast of performers give it their all night after night of dancing, singing and hooking the audience into this story, this musical got ingrained in me. As I was thinking about the tax planning opportunities and outcome potentials that are available to you, “Now is the Time to Seize the Day” could not escape me.
Contributing to a Roth account means paying the tax on the seed (contributions), in today’s known tax rate environment, with the goal of having growth. Thus the longer you delay starting these withdrawals the larger harvest (growth) you will have to draw tax-free income from.
Prior to the implementation of the TSP Modernization Act, TSP participants having both traditional TSP and Roth TSP balances can not specify where to take a withdrawal from, because currently it comes out from both balances on a pro rata basis. For example, if 80% of your account is in your traditional balance and 20% is in Roth, any withdrawal you take will be 80% traditional and 20% Roth. This would certainly create a problem for those federal employees retiring before 59 ½, that need to take distributions from their TSP. Many federal employees are eligible to retire before attaining age 59 ½ and can access TSP without incurring a 10% early withdrawal penalty. Specifically, for those that separate service in the year they turn 55 or after, or for Special Category Employees (SCE) that separate service in the year they turn age 50 or after, can take withdrawals from traditional TSP and avoid a 10% early withdrawal penalty. The catch is that there is still a 10% penalty for the Roth portion because, in order for distributions from the Roth account to be tax-free they need to be considered qualified: (1) The Roth TSP account must be established for at least five years and (2) you must be 59 ½ or older. This would mean that prior to the TSP Modernization Act being implemented, a withdrawal from TSP would come out pro rata from the traditional balance and the Roth balance. The result would be no 10% penalty on the traditional portion, but of course fully taxable and the Roth portion would suffer a 10% early withdrawal penalty. And since it is not a qualified withdrawal (5 years and age 59 ½) a portion of the Roth balance will be taxed.
Under the new rules that are scheduled to go into effect September 2019, you’ll have the option to take a withdrawal from just your Roth balance, just your Traditional balance, or both. These options will be available for all types of withdrawals. Although there are ways to work around the current withdrawal limitations, they can be very confusing. The new rules will make the TSP Roth a great strategy for pro-active tax planning. This may be more important than ever due to the state of our federal budget.
According to www.usdebtclock.org the National Debt is getting ready to top 21.9 trillion. In addition, our nation’s unfunded liabilities are currently 116 Trillion, with Medicare leading the way, followed by Social Security.
In the 2018 Long-Term Budget Outlook, the Congressional Budget Office (CBO) states “If current laws remain generally unchanged, CBO projects federal budget deficits and debt would increase over the next 30 years, reaching the highest level of debt relative to Gross Domestic Product (GDP) in the nation’s history so far.”
The chart below indicates we are currently at 78% of GDP, the highest level since shortly after World War II. If current laws generally remain unchanged, CBO projects the federal debt would approach 100% by the end of the decade and 152% by 2048.
The CBO 2018 Long-Term Outlook explains that in order to put the budget on a viable path, lawmakers would have to make major changes to tax policies, spending policy’s or both. Our nation cannot continue at this pace without change. Many people believe, along with me, that the low tax environment that we are currently in will soon be ending.
So why am I promoting, now is the time to seize the day? The “Tax Cuts & Job Act” signed into law on December 2017, reduced tax brackets and is allowing many citizens to pay less in taxes. This law is scheduled to sunset in 2025, which would allow seven years to do tax planning for your future through Roth TSP contributions, Roth IRA contributions, and Roth conversions. For 2019 federal employees can fund Roth TSP up to $19,000 a year, plus catchup if age 50 or over, of an additional $6,000. And now have a more compelling reason to do this based on the changes in TSP withdrawal flexibility that will go into effect in September giving you the ability to take withdrawals where it best suits you in the future. For those of you that have attended one of my retirement classes, you have heard me talk about a Road Runner episode. Wyle E Coyote is of course planning a way to kill the Road Runner, and in this particular episode he is sitting in a shed building a bomb on a train track. When he looks out the window and finds there is a freight train approaching, he makes a quick decision to pull down the shade, thus ignoring what is approaching. We as Americans quite possibly have a freight train approaching on us in the form of taxes. We have choices. We can simply ignore the train and hope that it will go away, or we can do things now that will safeguard our future against the threat of rising tax rates.
Carol’s son Evan performing as Crutchie in Disney’s Newsies the Musical at The Grand Theatre, a Road Company
production, 2018
This material is for informational purposes only. It is not intended to provide tax, accounting or legal advice or to serve as the basis for any financial decisions. Individuals are advised to consult with their own accountant and/or attorney regarding all tax, accounting and legal matters.