Military Finances 201: TSP to Allow Internal Roth Conversions

In general, we're fans of TSP. The investment options are pretty good, and the expense ratios are amongst the lowest available. One of the things we don't like about TSP is the inability to convert pre-tax (often called Traditional) balances to Roth balances inside TSP. That is about to change.

When Will the Change Take Place?

The FRTIB (the people who manage TSP) announced that the ability to make Roth conversions will go into effect in 2026. The exact date hasn't been announced.

Why Do I Care About the Ability to Convert to Roth Balances Inside TSP?

The ability to covert is not necessarily a great thing. It's a good benefit because it will allow you to convert now. Under current rules, you can't make conversions inside TSP. You have to transfer to an IRA to make the conversion. And...you can't transfer to an IRA while you are still in the military (except the rare case where you've turned 59 1/2 while still on Active Duty). So, you have to wait until retirement/separation to convert to Roth. And while you're waiting, the account is growing (hopefully) tax deferred instead of tax free. Now you'll be able to convert while on Active Duty and, at least theoretically, pay a lower tax bill when you convert and over your lifetime.

When I Have the Option, Should I Convert to Roth Balances inside TSP?

You probably know the answer to this question. It depends. In general, we want to convert to Roth when our tax rate is lower than it will be when we need the funds. Just remember to include all your taxes. That would mean you should consider your Federal Income Taxes, State Income Taxes and Medicare Premiums (not a technically a tax, but they increase when your income increases).

You should seriously consider doing Roth conversions when you deploy to a combat zone as the Combate Zone Tax Exclusion will likely put you in a low tax bracket. If you're a resident of a state without an income tax now (not that that is the case for many military members...) and when you're retired you know you'll be in a state with an income tax, it might be the time to convert to Roth.

Are There Downsides to Converting to Roth Now?

While not necessarily a downside, at present it appears that you won't be able to withhold taxes from the converted amount. Generally speaking, we'd prefer to not pay the tax from the converted amount, but some won't be able to fund the taxes from other sources.

If you're not careful, the conversion could put you into a higher tax bracket. This isn't unique to a Roth conversion inside TSP though.

What Don't We Know About the Ability to Convert to Roth Inside TSP?

As mentioned, we don't yet know the anticipated start date other than sometime in 2026.

So far, the FRTIB hasn't addressed tax-exempt balances (funds contributed to pre-tax/Traditional TSP while deployed to a combat zone). These funds are difficult to move under current rules and the ability to convert them to Roth would simplify things (and be tax free).

Military Finances are Different

As mentioned above, you could have a tax-exempt balance in your TSP. That only applies to current and prior military members. It doesn't even apply to GS employees that deploy to a combat zone. We're pretty sure your typical issue, one-each financial advisor won't know anything about tax-exempt balances. And that's not the only unique military issue a financial advisor needs to understand. That's why we think that if you're an Active or Retired Senior Military Officer or NCO, you should work with a financial advisor or planner that deals with your unique issues each and every day. If you'd like to see how we work with current and former military members, use the button below to schedule a free, initial consultation.

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