By Hank Coleman
Posted in Savings Account
For members of the military, and for civilians as well for that matter, there is no shortage of investment options. In fact, the problem is quite the opposite. There are so many investment options available that it can be confusing as to which investment product is best.
While both a Roth IRA and the federal government’s version of the 401(k) retirement plan, the Thrift Savings Plan, offer great investment opportunities, they are both very different investment products with different tax consequences that have to be considered. So is a Roth IRA or TSP a better investment option for members of the military?
A Roth IRA is a version of the Individual Retirement Account (IRA) in which individuals invest a portion of their salaries or other income sources after the income has been taxed.
A Roth IRA is retirement account that can be as diverse in the investments it contains as you want. Although most Roth IRA are built around mutual funds, they can also contain stocks and bonds, derivatives, Treasuries, certificates of deposit, real estate and other investments. Most people chose to let their retirement nest eggs be invested by professional money managers in the form of mutual funds, but there is even an option to invest the money yourself through a self-directed IRA, which like all IRAs, can be the Roth version of the investment plan.
Members of the military and federal government civilian employees can contribute to a defined contribution retirement plan, which the government calls the Thrift Savings Plan, in addition to their defined benefits pensions that they earn after retiring.
The Thrift Savings Plan (TSP) is almost identical to a civilian corporation’s 401 (k) retirement plan. The TSP is a tax deferred retirement plan in which an investor makes pre-tax contributions to the retirement account lowering his or her initial tax bill. Then, in retirement, income tax is paid on the TSP account’s withdrawals. Tax is owed on the principal, interest, any dividends and capital gains that the plan has at the time of withdrawal.
There are many differences in the two plans and you need to understand the intricacies to get the most out of your investments. Below is a list of the common features of both:
Roth IRA Thrift Savings Plan
|Roth IRA||Thrift Savings Plan|
|Min. Age to Withdraw||59 ½ years-old||59 ½ years-old|
|Mandatory Withdraw Age||Never||70 ½ years-old|
|Investment Options||Hundreds of Options||5 Index Funds|
|Taxed When||Before Invested||When Withdrawn|
|Leaving Military?||Contributions Can Continue||Contributions Must Stop|
This is the million dollar question and has been the subject of much debate. Sadly, the answer is that it depends. Specifically, it primarily depends on your tax situation. When will you be in a lower tax bracket? Should you pay your taxes now when you are just starting out in your career when you will most likely be in a lower tax bracket? Or, should you pay your taxes when you withdraw your nest egg funds in retirement?
Because Thrift Savings Plan contributions are not currently matched by the government for members of the military, the argument for investing in TSP first is diminished. A good portion of a service member finds his or her income not taxed as ordinary income, housing allowance and food allowance, for example.
For most members of the military, only base pay is taxed, which is considerably lower than the total amount of compensation. Because of this, many members of the military find themselves in a lower tax bracket during their working years. It may make more since for them then to pay taxes now by investing in a Roth IRA instead of later in life when they may find themselves in a higher tax bracket.
It is a tough choice to decide whether a Roth IRA or TSP is right for any one individual service member. Only through careful consideration and crunching the numbers with your tax bill, both present and future, will you come to the best conclusion for your own individual situation.
Hank Coleman is a Captain in the U.S. Army, freelance writer, and the founder of personal finance sites such as Military Money Might. His writing has been featured on The Motley Fool, Military.com, and many others. You can follow him on Twitter at @HankColeman.