Tax-Advantaged Retirement Savings for Military: Thrift Savings Plan, IRAs, Roth and Traditional

The Thrift Savings Plan

I’ve written pretty extensively about the Thrift Savings Plan, but here’s the short version. It’s not short, sorry.

TSP is the federal government’s employer-sponsored tax-advantaged retirement savings account. It is similar to a 401k that might be offered by a civilian employer. You contribute money to TSP directly from your military or federal government paycheck. Once you put money into your TSP account, you can select from any combination of TSP’s five funds, or pick a Lifecycle fund that automatically rebalances over time to meet the objectives of that fund.

Contribution Limits

Both TSP and IRAs have limits on how much you can contribute each year, but the TSP limits can be a little trickier in certain situations.

For 2021, the regular TSP limit (which is technically called the Elective Deferral Limit) is $19,500. There’s also a catch-up contribution limit if you are age 50 or above, which is $6,500 (2021), for a total of $26,000 in “regular” contributions if you are 50 or older.

There’s also something called the Annual Addition Limit, which is $58,000 in 2021. The Annual Addition Limit is a limit on all the money that anyone can put into that account, so that’s where any government matching funds are counted.

But there’s also a special rule for people who are working in a Combat Zone Tax Exempt location, which is the formal name for what we usually call a tax-free area. If you are CZTE, you can contribute beyond the regular limits and up to the Annual Addition Limit, with some special rules for how that happens. If you are thinking about getting into that Annual Addition Limit area while you are CZTE, I strongly recommend you first read Doug Nordman’s excellent article and then sit down with someone who really, really understands it to plot out your strategy.

Individual Retirement Arrangements

IRAs are personal, tax-advantaged retirement accounts. They’re not tied to your employer, though you must have earned income to contribute to an IRA. You can set up an IRA with your bank, a brokerage company, or other places, and each choice has pros and cons.

IRAs have their own contribution limits, totally separate from the contribution limits for employer-sponsored accounts like TSP. For 2021, the limit is $6,000 per person, per year, with an additional $1,000 for those who are age 50 or older.

Spousal IRAs

One important feature of IRAs is that while it requires earned income to contribute, non-working spouses may make contributions based upon their spouse’s income. So if Sally Sailor earns at least $12,000 a year, Sally can contribute $6,000 to an IRA and Sally’s spouse can also contribute $6,000 to an IRA. The ability to contribute to these “spousal” IRAs is an important part of a family’s retirement savings strategy for non-working spouses.

Traditional Versus Roth Accounts

Now that you have a good handle on TSP vs. IRA, I’m going to mix it up by throwing in the fact that both types of accounts have two different types of tax treatment available: Traditional or Roth. This tax treatment has nothing to do with what kind of account it is. This is confusing to a lot of people. Let’s see if this graphic helps.

Traditional Retirement Savings Accounts

Traditional retirement savings accounts are pre-tax, or tax-deferred. Contributions are not included in your taxable income for the year that you make the contribution. If you make a pre-tax contribution to an employer plan, the amount doesn’t show as earned income on your W-2 tax statement for that year. If you make pre-tax contributions to a non-employer plan, you deduct that amount on your income tax return. 

When you take money out of a traditional retirement account, you owe taxes on the entire amount: the original contributions, plus the earnings. It is taxed at your income tax rate at the time you take the money out of the account.

If you are a higher earner, there are income limits on the deductibility of traditional contributions to your Individual Retirement Arrangements. A quick internet search of “traditional IRA deductibility income limits” will bring you the most up-to-date information.

Roth Retirement Savings Accounts

Roth retirement savings accounts are post-tax. You pay the taxes on the money when you earn it. Contributions are included in your taxable income for the year that you make the contribution.

When you take money out of a Roth retirement account, you do not pay any taxes on the contributions or the growth/earnings. This can be very beneficial in a lot of situations.

Not every employer offers a Roth option for their employer-sponsored accounts, but there is a Roth option in TSP. 

There’s an income-based limit on Roth IRA contributions. If you are a higher earner, check on whether you are eligible to contribute to a Roth. A quick internet search of “Roth IRA income limits” will bring you the most up-to-date information.

Frequently Asked Questions About TSP and IRAs

There are lots of questions about TSP and IRAs, and Roth and traditional account. Which one is best for your situation? What should you do? Unfortunately, the short answer to many of those questions is “It depends.”

“Should I be contributing to an IRA instead of TSP?”

If you are in the Blended Retirement System (BRS), and are receiving matching funds on your TSP contributions, you should make that 5% TSP contribution first. If you have a non-working spouse who can’t contribute to their own employer-sponsored plan, an IRA for that spouse should be your next priority. After that, there can be arguments made for either choice. The most important thing is that you are saving and investing somewhere.

Depending on your ultimate goals, you may want to be trying to max out TSP and IRAs. While there are many other ways to save for retirement, the tax advantages of these plans are valuable.

“Why do I want an IRA if I have TSP?”

There are a couple of reasons you may want to have an IRA even though you have TSP. Maybe you’ve reached the contribution limits for TSP. Or you really want to invest in something that’s not available in TSP. Or you just want to diversify, for a number of different reasons.

“Should I do Roth or traditional contributions?”

Oh, that is a complicated question. There is no right answer, even for a specific situation. The only way to know what to do is to be able to accurately predict your tax situation in retirement, and what changes will be made to our tax system between now and when you empty the account. (And if you can do that, then you probably don’t even need to be worrying about this.)

So, you make the best decision with the information available right now. There are a lot of very good arguments for saving in Roth accounts, but there are also some good arguments for saving in traditional accounts, too. What is right for you is going to depend on a variety of factors, including your current tax situation, what your future looks like, how retirement savings will impact other tax factors like credits, etc. Personally, I kind of default to “Roth unless you have a good reason to do traditional.”

I know I have not covered all the possible questions. Please ask them in the comments, and I’ll make this article even better!