As a US servicemember, you have the opportunity to save BIG for your future retirement. But saving for retirement can get confusing. There’s a veritable alphabet soup of terms and acronyms. Let’s try and simplify it for a change.
Here are the most common types of retirement accounts you’ll encounter:
· 401k - an employer sponsored retirement program. Instead of pensions, employers offer employees more control with their retirement planning through 401k programs. 401k plans have certain tax advantages. This plan is common in the private sector.
· Thrift Savings Plan (TSP) - this is the military and government employees version of the 401k. It is an employee sponsored program. There are tax advantages to contributing to your TSP, which I’ll explain below.
· Individual Retirement Account (IRA) - This is a retirement account, usually held at a financial institution like a stock brokerage or bank. Note that it is individual, not employer sponsored. Again, there are tax advantages for investing in this type of account (see below).
Just to make it more confusing, any of three account types above can have the word “Roth” put in front of them (Roth 401k, Roth TSP, Roth IRA). The difference between Traditional retirement plans and Roth retirement plans is when you are taxed on the money.
· For Traditional, you are not taxed when the money goes into the account (today) but you are taxed when you withdraw the money (contributions and growth) in retirement (usually after age 60).
· For Roth accounts, you pay your taxes when the money goes into the account (today), but the money then grows and is distributed back to you tax free in retirement. This can be advantageous for those with a very low tax rate. Most military members fall into this category, as many of our entitlements (BAH, BAS, etc) are allowances and therefore are untaxed. Additionally, when we deploy to a tax free combat zone, all of our pay and benefits is not subject to income tax.
The IRS has two broad categories for retirement accounts.
· Employer sponsored - these are accounts offered by your employer to you, usually instead of a pension. Examples are 401k, Roth 401k, TSP, and Roth TSP. The contribution limit for these types of accounts is $17,500 for 2013.
· Individual retirement accounts - these are accounts that you can set up as an individual making income. Examples are Roth IRA and IRA. The contribution limits for these types of accounts is $5500 for 2013.
Note that in the eyes of the IRS, these are two completely separate contribution limits! You could contribute the full $17,500 to your employee sponsored account and $5500 to your IRA for $23,000 of total retirement investment for 2013.
For instance, servicemembers can contribute $17,500 to your Roth TSP AND contribute the full $5500 to your Roth IRA. You can contribute to both plans every year up to the maximum for each type of plan. This is a powerful savings and wealth creation tool for military members.
For the majority of those who serve, you’ll have a choice between
· Roth TSP and Traditional TSP
· Roth IRA and Traditional IRA
Because of your extremely low tax rate (usually not above the 15% bracket), I recommend you investigate the Roth option for both your TSP and IRA. This is especially true when you’re deployed, because of the Combat Zone Tax Exclusion.
Military servicemembers have access to one of the greatest retirement plans in the world through the TSP. The TSP offers extremely low cost index funds which provide broad diversification across domestic and international stocks, unique fixed income products, and bonds.
In 2012, for every $10,000 you had invested with TSP, only $2.70 came out in fees. The rest of the returns went directly to you. Those are some of the lowest fees available to investors worldwide and only TSP participants have access to them. By investing in the Roth TSP, you can pay the taxes now and watch your investments grow tax free, knowing that when you tap them years down the line they’ll still be tax free and low fee.
By using a combination of Roth TSP and Roth IRA, you can set yourself up for retirement and financial independence without even waiting 20 years for a military retirement pension.
Remember: save early, save often, save as much as you can; keep educating yourself, and you will see your wealth grow.