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It is always a jarring time for you and your family when you get notified that you will be deploying.  As your mind races about your job, your family, and your mission, it can seem like there are thousands of things for you to do, and often there actually is!  A deployment can also be a time of opportunity, for you personally and financially.  One of the benefits afforded to you as a servicemember deployed to a combat zone is that the income you earn as a member of the military in the combat zone is excluded from income taxes (you still pay social security and medicare taxes).  The tax-free nature of the income means more of what you are paid will go into your bank account.  From here you can use it to pay down existing debt, invest in your retirement future, and fund future purchases.  It also means you can take advantage of the tax code to limit the tax bite on future withdrawals from your retirement accounts.  What we are talking about is converting your tax deferred savings to a tax advantaged account, specifically a Roth IRA conversion.

A Roth IRA is a tax advantaged retirement account where money that has already been subject to tax is invested and grows tax free.  When the money is withdrawn from the account in retirement, the account holder pays no income taxes on the contributions or the earnings on those contributions. This is different from a traditional IRA account, which is a tax deferred retirement account.  In a traditional IRA, the contributions you make are considered pre-tax, meaning the contributions are excluded from your income in the year you earned it.  The contributions then grow tax-deferred, but when the money is withdrawn, the account holder pays taxes on the amount withdrawn.  The idea being that when the money is earned you will be in a higher tax bracket than you are in when the money is withdrawn.  Both are excellent vehicles to save for retirement and which one is appropriate for you will be dependent on your personal situation.  However, if you have a traditional IRA and will be deploying to a combat zone tax excluded area, it may make sense for you to convert some or all of your traditional IRA to a Roth IRA in the year you are deployed.

Click here to see if you are a good fit to do a Roth conversion.

The reason it may make sense is this; you want to pay taxes on your retirement savings when your taxable income is low, and it is harder to have a lower taxable income then when your income is excluded from taxes!  Let me provide an example to show you how this can be advantageous to you.  Let’s say in Year 1 you earned $75,000.  In Year 2, you are deployed to Afghanistan for 10 of the 12 months and still earn $75,000 for the year, however, since you were in Afghanistan for 10 of those months, only $12,500 (2/12 X $75,000) is taxable income.  This leaves you an excellent opportunity to now convert some of the tax-deferred savings to the tax advantaged savings account.  The table below shows your tax situation for both years, assuming a traditional IRA balance of $50,000 at the beginning of Year 2:

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As you can see from the table, even with converting all $50,000 from tax deferred to tax advantaged, you still had a lower tax liability in Year 2 than you did in Year 1.  Essentially the cost of converting was the $7,050 you would pay in taxes in Year 2.  However, now that the $50,000 is in the tax advantaged account, it will continue to grow tax-free, and any withdrawals you make from the Roth account will be tax free.  So, how advantageous would this be when you actually withdraw the money in retirement?  The table below helps illustrate this advantage by comparing the account values after growing for 30 years and the taxes paid if you leave it in the traditional versus converting it to the Roth.

¹Value is the growth of $50,000 at an annual rate of return of 5% for 30 years.

²Taxes calculated based on 12% income tax rate

For a “cost” of $7,050, you could potentially realize savings of over $18,000 in future taxes, even though you are in a lower tax bracket at withdrawal than you were when you performed the conversion.  You still achieve tax savings because you get 30 years of growth tax-free with the conversion!  This example assumes a tax rate at withdrawal of 12%, which may or may not be accurate, as we just don’t know where taxes will be down the road.  If tax brackets are higher in the future than they are now, you would see the tax liability on the tax deferred account go up, making a Roth an even more advantageous option.  This also does not even take into account the fact that since you have already paid taxes on the Roth money, the government gives you more flexibility on when and how you can use that money.

                This is a generic and simplified example, your situation may not be quite as clear, but if you have money in a traditional IRA and are deploying to a combat zone, you owe it to yourself and your family to talk with a financial or tax professional and see if you can use your current military situation to better your future situation in retirement.