Roth in-plan conversions arrive for TSP, but consider tax implications first

Beginning Jan. 28, the Thrift Savings Plan now allows participants to convert traditional (pre-tax) balances into Roth (after-tax) balances inside the TSP itself. This long-awaited change gives federal employees and retirees more flexibility over how and when they pay taxes on retirement savings.

While the mechanics of the change are straightforward, the implications are not. A Roth in-plan conversion is a tax event and not just a retirement planning decision. Once it is made, it cannot be reversed. Knowing this beforehand helps you choose effective planning tools and avoid costly errors.

Why this change matters

Until now, federal employees who wanted to convert pre-tax TSP savings to Roth generally had to move money out of the TSP and into an IRA. That process introduced multiple steps, more paperwork and additional risks.

With in-plan conversions, participants can:

• Convert eligible traditional TSP balances to Roth without leaving the plan
• Retain access to the TSP’s low-cost structure and protections
• Simplify administration by keeping retirement assets consolidated

A simple way to think about the decision

Consider a simplified scenario.

A federal employee has spent decades contributing to the traditional TSP. Most of the account has never been taxed. The new in-plan conversion feature creates a clear option: pay the tax now or pay it later.

Let's quickly review some common questions.

The benefit of converting is future flexibility: tax-free qualified withdrawals and no required minimum distributions on Roth balances. The cost is immediate: higher taxable income today. 

Reviewing the conversion impact

When a conversion occurs:

• The converted amount is added to taxable income for that year
• There is no tax withholding through the TSP
• Taxes must be paid using funds outside the TSP

Depending on timing and income, a conversion can:

• Push your income into a higher tax bracket
• Increase Medicare premiums in future years
• Change how much Social Security income is taxable
• Require estimated tax payments to avoid penalties

None of these outcomes are hypothetical. They are mechanical results of how the tax code works, and bringing in a tax professional who keeps up with such policies is crucial. 

Why should I care about staying inside the TSP?

The ability to convert inside the TSP is not solely a convenience feature. It preserves several advantages that can be lost when funds are moved out of the plan.

Keeping assets inside the TSP means:

• Continued access to institutional-level expense ratios
• Simpler account structure and oversight
• Avoidance of rollover errors that can trigger unintended taxes
• Fewer custodians and reporting requirements

For many federal employees, the TSP is the foundation of their retirement plan. In-plan conversions allow tax strategy adjustments without dismantling that foundation.

Why this is Not a do-it-yourself tax decision

Because Roth in-plan conversions directly affect taxable income, they cross into tax planning territory. This decision should not be made in isolation or based on general rules of thumb.

At Capital Financial Planners, Roth conversion strategies are reviewed with participation from our Certified Public Account. We’ve added this layer of oversight to help federal employees and retirees understand:

• How much can be converted without crossing unintended tax thresholds
• Whether the tax can be paid comfortably from non-retirement funds
• How conversions interact with current income, retirement timing and future required distributions
• Whether a multi-year approach is more appropriate than a single large conversion

The goal is not to pursue conversions simply because they are possible. Rather, it is to ensure that tax decisions are coordinated with long-term retirement objectives.

Greater control means greater responsibility. Avoid handling it solo.

Roth in-plan conversions give federal employees more control, but they also require more responsibility. The decision affects taxes immediately and cannot be reversed later.

Before initiating a conversion, the most important step is not choosing an amount. It is understanding the tax impact of that choice in the context of the full financial picture. With proper planning, in-plan conversions offer flexibility. But failing to consult a tax professional may lead to needless tax costs. 

Neil Cain is a certified financial planner with Capital Financial Planners. To discuss your investments, including your TSP, register for a complimentary Retirement Readiness Meeting.  For topics covered in even greater depth, see our YouTube Channel.

This material is for general information and educational purposes only and is not intended to provide specific advice or recommendations for any individual. Investing involves risk including the loss of principal. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Traditional TSP account owners have considerations to make before performing a Roth conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth account and income limitations for future contributions to a Roth account. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth account.