January 22, 2013

This is purely a hypothetical question right now, but TSP administrators announced earlier this month that they will study the steps necessary to implement an option that would allow participants to convert their current regular TSP holdings into a Roth TSP account, after paying the required taxes to do so. The announcement read:

“The President approved the American Taxpayer Relief Act of 2012, on January 2, 2013. This law allows the TSP and other qualified plans to give participants the option to convert their traditional account balances to a Roth balance. The amount converted would be taxable to the participant. We are currently waiting for tax reporting guidance from the IRS and will be studying the actions required to offer a conversion option. After that review, we will make decisions on whether to proceed.”

In addition to considering the affordability of the taxable amount participants might convert and weighing future personal income tax rates, participants will also have to take into account possible changes in the U.S. federal tax structure too. If, twenty or thirty years from now, there are so many Roth millionaires who are no longer paying what Congress and the White House might consider a “fair share” of taxes, Congress might look to expand the tax code by instituting a national consumption or sales tax, or a “Value Added Tax.” By doing so, they would be able to regain a portion of that “tax-free” Roth TSP or Roth IRA income. Similar to state sales taxes, income-tax-free Roth monies wouldn’t be able to escape a national consumption-based tax.

I hope to write more on this topic in future posts.