Which One Is Better: TSP or Roth IRA?

The government created the Thrift Savings Plan to help federal employees save for retirement. However, federal employees can also put money away in a Roth individual retirement account. If you can invest in both accounts, it's a tough decision because both plans offer a strong combination of tax benefits. The best account for your money depends on your tax situation and the time remaining until you retire.

Tax Deduction

The TSP is better while you are working. When you invest in a TSP, the entire investment is tax-deductible. You get to put money away for retirement while cutting down on your current tax bill. The Roth IRA must be funded with after-tax dollars. You don't get a tax deduction for your investment in a Roth IRA so you will owe more income tax for the year vs. investing in a TSP.

Retirement

The Roth IRA is better for retirement. When you make a withdrawal from your Roth IRA in retirement, the entire withdrawal is tax-free. You never have to pay income tax on your investment gains in the Roth IRA. The TSP only delays tax on your income. When you make a withdrawal from your TSP, the entire withdrawal is taxable. This gives the Roth IRA a better long-run return on your investments as you don't need to deduct taxes from your gains.

Matching Contributions

When you put money in your TSP, the government matches some of your investment. As of 2012, the government gives a partial match on up to 5 percent of your annual income for your TSP. This is free money that goes straight into your retirement account. You don't get any match on your Roth IRA investment because it is a personal retirement account. You should always maximize your matching contribution in the TSP before investing in a Roth IRA. The extra money far outweighs any potential tax savings in the IRA.

Bottom Line

Once you've taken full advantage of the TSP match, the choice for your investment becomes less clear. The TSP is better if your taxes are high today and you expect them to be much lower in retirement. It is better to use your deduction against the higher tax rate. The Roth IRA is better the further away you are from retirement. A longer investment timeline means your money has more time to grow and you will get more out of the Roth IRA tax-free growth. There isn't a clearly better option. It depends if you want to take your tax savings today or delay them until retirement.