Maximizing Your TSP When You are Deployed
by John Cooney on Nov 13, 2018
As a service member, hopefully you are already familiar with the Thrift Savings Plan and how it can play a role in financially securing your retirement. Do you know though, that when you are deployed to a combat zone and eligible for tax-exempt status, it becomes even more advantageous? The strategy outlined below shows how you can contribute to your TSP and never pay taxes on the contribution or its earnings!
Your specific financial situation may not be best for executing this strategy. It is important to talk to an on-post financial counselor or a resource like Military OneSource to see if your situation is a good fit for contributing to the TSP. Two situations that should be addressed before investing in the TSP are paying off any high interest debt you may be carrying (think credit cards) and ensuring you have an adequate emergency fund to provide financial security if you were to lose your source of income. A standard rule of thumb for an emergency account is three months of expenses for a dual income household and six months of expenses for a single income household. Using your time in a tax-exempt combat zone can be an excellent opportunity for shoring up these two areas.
When contributing to a TSP, you can choose to have these contributions made from pre-tax income (traditional) or post-tax income (Roth). In a non-tax-exempt circumstance, the taxation of contributions are shown below:
Traditional contributions are excluded from income in the year they are earned, and both the contribution and the growth (earnings) are taxed when withdrawn from the account. With the Roth, the contributions are included in income in the year they are earned, but when those contributions and the growth (earnings) are withdrawn, they are tax-free income to the taxpayer. Traditional contributions are advantageous when you are in a high tax-bracket now, but expect to be in a lower tax bracket when you withdraw the funds in retirement. The Roth works the opposite, it is advantageous when you expect to be in a higher tax bracket in retirement than you are in now.
When you are receiving tax-exempt pay, the dynamic changes, because you are no longer are being taxed on the income in the year you earn it. The taxation on contributions from tax-exempt are below:
Since Roth contributions are post-tax contributions, they grow and are withdrawn tax-free. Since the income itself is tax-exempt, that means you get triple the tax benefits; you aren’t taxed when you earn it, you don’t pay tax on the growth, and you don’t pay tax when you withdraw it in retirement!
The same dynamic exists with contributions to an Individual Retirement Arrangement (IRA). If the IRA you are contributing to from tax-exempt income is a Roth IRA, you will also get the triple tax benefit. What does this mean to you? It means you can make a major contribution to your future financial security while deployed from using a combination of the Roth TSP and a Roth IRA. Let’s look at an example. A 30-year-old soldier, deployed to a tax-exempt income zone contributes $18,500 to her Roth TSP and $5,500 to her Roth IRA (Note: IRS 2018 contribution limits in 2018 are $18,500 for the TSP and $5,500 to an IRA for personnel under 50 years of age). She then lets this contribution stay in her TSP account as it grows for 30 years until she hits 60 years old. At a modest annual return of 5%, this soldier would have a balance in her TSP and Roth IRA of $103,726 dollars, all of which she could withdraw tax-free! If you have more than $24,000 to put towards retirement while you are deployed, guess what, the TSP allows that too! A deployed service member can contribute more than $18,500 to their TSP, all the way up to $54,000 in 2018. Amounts above $18,500 cannot be contributed to a Roth account, so it would only get two times the tax benefit, not the three times the Roth receives.
My recommendation for anyone in a tax-exempt income status, who is not carrying high-interest debt and has an adequate emergency fund is that they should utilize their tax-exempt status in the following priority:
- Contribute up to $18,500 into your Roth TSP; then
- Contribute up to $5,500 into your Roth IRA, then
- Contribute up to $35,500 into your tax-exempt TSP
The TSP has many advantages for service members, but these are magnified when serving in a tax-exempt status. If you are on a deployment, or getting ready to deploy in the future, the time to talk to a financial planner is now, so that you can get your financial house in order and take advantage of this opportunity to setup your future self for financial success.
Deploying? Let's discuss a strategy for your TSP.
