TSP In-Plan Roth Conversions – A New Tool in the Toolkit

You may remember a previous article I wrote an article about 3 and 1/3 reasons to consider rolling over your TSP.  At the time, I said To Do a Roth Conversion was a 1/3 reason because TSP was scheduled to launch that feature in early 2026.  As of last month, TSP did so you can now convert your Traditional TSP accounts to Roth accounts without moving your money out of TSP.

Here is what you need to know when considering a Roth conversion.

WARNING:  I called Roth conversions a tool in the title for a reason.  Think of it like a hammer.  A hammer can be used to build, but can also be used to break.  Roth conversions can be used strategically to increase your wealth, but they do have tax consequences.  These tax consequences could also be harmful to your wealth.  Make sure you understand all the implications before completing any conversions.

Quick Review – Account Types

Traditional TSP – Contributions are tax deferred when you contribute.  They grow tax deferred in the account.  You pay taxes when you withdrawal the money from the account.  Subject to Required Minimum Distributions later in life.

Roth TSP – Contributions do not get a tax deferral (considered ‘after-tax’ dollars).  Contributions grow tax free.  Withdrawals are also not taxed.  There are no Required Minimum Distributions from Roth accounts.

What’s A Roth Conversion?

A Roth conversion is the process of moving money from your Traditional account to your Roth account.  Sounds simple enough.  I’d like to have more money that won’t be taxed in the future.  But, there is a catch and it’s a big one…you pay tax on any of the converted money in the year you do the conversion.

Tax Planning 101

For most people, the goal for taxes is to pay all they owe, but not any extra.  I’ll add that this should be across your lifetime not just in any single year.  The challenge is, as we’ve seen in recent years, the tax code is written in pencil and changes often.  That doesn’t mean we shouldn’t try.

Things to consider when doing your tax planning:

• Current marginal tax rate
• Future income and tax rate
• Future pension income (if applicable) and Social Security
• State tax implications – now and in the future – this could be a big consideration if you don’t pay state taxes while in the military but expect to move to a high-tax state after separation or retirement
• Marital status now and in the future
• Who will inherit the account when you die?

This is where having a broader tax strategy really pays off.  I wrote about building one a few years back if you want to dig deeper into the planning side: https://nextmissionfinancialplanning.com/tax-strategy/

How It Works Within TSP

While I didn’t actually do a conversion, I did walk through the process on the TSP website.  It is straightforward with lots of warnings and disclosures around the tax implications which is great to see.  You indicate how much you’d like to convert ($500 minimum).  It then gives you the taxable amount. [Note:  if you have tax-exempt funds from you tax-free deployment contributions, these will be converted pro-rata with your regular contributions and earnings].  It also has a calculator available to figure out what your tax bill will be for that conversion.  They provide some disclosures, then a review screen, and then you can submit.  All in all, straightforward.

The Real Question:  Should You Do A TSP Roth Conversion?

The “sweet spot” for Roth conversions is usually between retirement and claiming Social Security when your income is lower because you’ve stopped working.  Depending on the size of your Traditional accounts, this can cut your lifetime tax bill by hundreds of thousands of dollars.  This isn’t always the case for military retirees though.  Senior military retirees continue to have pension income even after they stop working.  That can mean there isn’t as big of a gap to fill with Roth conversions within your target tax bracket.

Again, here is where the income mapping helps and understanding your tax situation can really help.  I was able to do a Roth conversion the year after I retired from the military because my business expenses helped lower my taxable pension income.  At the time, I couldn’t do it within the TSP, but the decision calculus was the same.

A Few Scenarios Where It Might Make Sense Sooner

• Lower income year (deployments qualifying for combat zone tax exclusion)
• You’re early in career, lower rank, lower tax bracket – this could include converting the government matching funds each year for those under the Blended Retirement System
• You’re separating or retiring and taking time off before the next job
• You have a big tax-deductible event coming (business loss, etc.)
• You’ve fully retired and your income is low

Before You Pull The Trigger

Run Your Numbers and Build A Plan – Do a deep dive on your projected future tax situation.  Is this a 1-year gap where it will make sense to do a big conversion?  Will your tax situation be relatively similar for a few years so you can spread the conversions over multiple years?  This will lower the tax hit in any one year.  Think in terms of filling up lower level tax brackets.

Make Sure You Have The Cash For The Tax Bill – The bill won’t be due until the next April, but make sure you have the money set aside.  It’s best if you can fund this from savings or possibly taxable assets you need to sell.  If you’re over 59 ½, you can take an additional distribution from the account.  Remember that will be taxable also.  If you’re under 59 ½ and take a distribution from your Traditional TSP, you’ll pay taxes and a 10% penalty.

State Taxes Matter – If you’re in a state where you pay income tax, your conversion could add additional taxes.  This could also make converting while in the military a good deal if you think you’ll relocate to a state with a higher income tax after separating or retiring.

Adjusted Gross Income (AGI) Impact – Roth conversions raise your AGI.  AGI is used to determine many other things in the tax system including student financial aid, many deductions and credits, and IRMAA Medicare Surcharge for those over 63 to name a few.  The ripple effect to these things could make the TSP conversion go from a great idea to a bad one quickly.

The 5-Year Rule – If you’re under 59 ½, each Roth conversion has a 5-year clock associated with it.  If you withdrawal the converted money before 5 years has been satisfied you’ll pay a 10% penalty on the withdrawn funds.

The Bottom Line

The TSP Board delivered on their pledge to bring in plan conversions to the TSP on time and in an easy to do way.  This provides another great tool for your financial management and planning toolkit.  But like most tools, TSP Roth conversions can be used to build your wealth, but if you’re not careful it can do damage.

Final Piece of Advice – If you’re considering doing a Roth conversion of any significant size, get a second opinion from a knowledgeable financial planner or tax professional.