Roth v. 401k?

[kork13]

Hello, I'm a 21-year-old graduating college this May, when I will commission as an officer in the US Air Force. I'm unsure about how to contribute to my retirement savings... Do I focus my savings in my Roth IRA (already at ~$13k), or should I shift focus to the Thrift Savings Plan (the 401k equivalent for federal employees), which will become available to me when I commission?

I've already developed a spending plan for myself, and have determinted I will have about $600/month to save toward retirement. So my main question... should I put all of that into the tax-deferred TSP, or focus on maxing out my Roth contribution, then put what's left into the TSP? I know it's a question of tax efficiency, but I don't understand it all well enough to know which way is better for me to go...

Also, for the benefit of anyone else who reads this, the TSP is essentially the same as a 401k, so the question really is about tax-free savings versus tax-deferred. Any help would be appreciated. Hopefully more people than myself can find your responses helpful...

[cptacek]

I think it depends on if the TSP has a match or not. If the TSP does not have a match, then max out the Roth IRA first, then contribute to the TSP. If the TSP does have a match, put in enough to get it, and then max out the Roth IRA.

[Seeker]

I don't know specifically how TSP works, but I can tell you that:

Roth IRA's represent money you set aside for retirement that you have already paid income taxes on (ie. they have no place to be reported as a deduction on either state nor federal income tax returns). Thus you pay taxes now.

Traditional IRA's represent pre-tax money. Thus they are reported on the forms that get sent to state and federal and you do not pay taxes until you withdraw (when you are retired and have less operating expenses).

---

At your age, you will also need to look at saving outside of retirement. Will you want to purchase a house at some point? Might you want to get a college degree after the military?

You may want to look at other financial investments as a means of future needs and not tie up 100% of your extra money into retirement savings.

[Like2Plan]

Hello, I'm a 21-year-old graduating college this May, when I will commission as an officer in the US Air Force. I'm unsure about how to contribute to my retirement savings... Do I focus my savings in my Roth IRA (already at ~$13k), or should I shift focus to the Thrift Savings Plan (the 401k equivalent for federal employees), which will become available to me when I commission?

I've already developed a spending plan for myself, and have determinted I will have about $600/month to save toward retirement. So my main question... should I put all of that into the tax-deferred TSP, or focus on maxing out my Roth contribution, then put what's left into the TSP? I know it's a question of tax efficiency, but I don't understand it all well enough to know which way is better for me to go...

Also, for the benefit of anyone else who reads this, the TSP is essentially the same as a 401k, so the question really is about tax-free savings versus tax-deferred. Any help would be appreciated. Hopefully more people than myself can find your responses helpful...

kork13,
From TSP website on TSP Features for Uniformed Services Understanding Matching Contributions

Who is entitled to receive matching contributions?

Under the law that extended the TSP to the uniformed services, the secretary responsible for each service may designate critical specialties for matching contributions. Members serving in those specialties who agree to serve on active duty for 6 years may be eligible for matching contributions during the 6-year active duty obligation.

The matching contributions apply only to amounts contributed from basic pay and not from any incentive pay or special pay. If you do not contribute basic pay to the TSP, you will not be eligible to receive matching contributions. Matching contributions apply to the first 5 percent of pay that you contribute each pay period. Your contributions are matched dollar-for-dollar on the first 3 percent of pay you contribute each pay period and 50 cents on the dollar for the next 2 percent of pay.

As of the date of this Web edition, matching contributions had not been authorized by any of the uniformed services. Your service will notify you if you are eligible to receive matching contributions.
A lot has to do with whether or not you get a match. Up 'til now, the military has not been able to get a match on contributions, but it looks like that might change for some.

From next year onward, in your career your income will probably be the lowest it is ever going be and your income taxes the lowest they will ever be. Without a match, the only advantage to the TSP is to defer paying income taxes on the amount you contribute.

TSP Features for Uniformed Services

I would go with max out the Roth and then contribute whatever is left to the TSP unless it turns out you get a match. If you get a match, contribute up to the amount that is matched and then whatever remains into the Roth.

BTW, have you checked out USAA, yet? I was chatting with a customer svc rep a few weeks back and at the time they mentioned they were offering pre-commissioning loans (at a very competitive rate) to folks who have contracted with the military. Link to USAA-- Who is Eligible to join?
They offer many services --it might be worth a look to check them out.

[kork13]

Like2Plan:
Yes, I already use USAA as my bank--they're excellent, I use them for everything (banking, credit card, insurance, investments). I've actually already gotten that "career-starter" loan... When I got it last Feb, it was $30k at 1%, investing almost $20k of it, using the rest to buy a car, which should hopefully last me ~8-10 years. I've actually heard that some other banks are also willing to give similar loans to any recent college graduate, you just have to ask about it...


Seeker:
What would you say is a good way for me to save for major stuff, like a house, outside of retirement? I know that I need to (and want to), but I'm not sure where to put money for stuff like that... Regular savings account, money market fund, CD's, or something else? I currently have about $8k in regualar mutual fund investments, but is that a good way to go about saving for stuff like that?

[jIM_Ohio]

You need to look at 3 things which have little to do with each other:

1) taxes and tax rates. You can defer taxes now (putting more money in your pocket now) or pay taxes now and invest after the taxes are paid. Pros and cons to both techniques. I do a little of both. 7k into 401k pre tax and 5k into Roth post tax.

2) withdraw rules. When can you get to the TSP money for withdraw? Age for penalty free withdraws is?? Roth, you can get earnings out starting at age 59.5 tax free

3) investment choices. What are the choices in the TSP plan? For the Roth, the choices are much more plentiful.

[Like2Plan]

TAX payments to TSP
You pay the 10% penalty on withdrawals from the TSP before 59.5 unless one of the following apply:
* Paid after you separate from service during or after the year you reach age 55
* Made because you are totally and permanently disabled (#1)
* Paid as substantially equal payments over your life expectancy
* Annuity payments
* Ordered by a domestic relations court
* Made becasue of death; or
* Made in a year you have deductible medical expenses that exceed 7.5% of your adjusted gross income (#1)

(#1) TSP doesn't certify to the IRS that you meet theses exemptions when your taxes are reported--You have to provide the justification to the IRS when you file taxes.

The penalty tax does not apply to that portion of a TSP distribution (including the taxable distribution of a loan) which represents tax-exempt contributions from pay earned in a combat zone.

However, if you made any tax-exempt contributions to the TSP (i.e., contributions from pay subject to combat zone or qualified hazardous duty tax-exclusion pay), the portion of your withdrawal that represents the tax-exempt contributions will be exempt from tax. However, earnings attributable to tax-exempt contributions are taxable when withdrawn.

If you receive a payment where the contributions were both tax exempt and taxable, your distributions will be paid in the same proportions as your tax deferred and tax the tax-exempt portion balances).

[Like2Plan]

Also, another consideration is if you will have some pay tax-exempt as a result of serving in a combat zone or qualified hazardous duty area
IRS Armed Forces Tax Guide for more info


Tax-Exempt Contributions

When you serve in a combat zone or qualified hazardous duty area, most compensation you receive for active service is excluded from your gross income on your IRS Form W-2, regardless of whether you contribute any of it to the TSP. All of an enlisted member's and warrant officer's compensation is eligible for the combat zone tax exclusion. Officers, however, may exclude no more than the highest rate of basic pay paid to each service's senior enlisted member (and any hostile fire/imminent danger pay received by the officer).

In some cases, members who are serving outside a combat zone or qualified hazardous duty area (but are directly supporting operations in such a zone or area) can also qualify for the combat zone tax exclusion.

You receive no direct tax benefit from contributing pay to the TSP which has been excluded from gross income; however, the earnings on those contributions are tax-deferred.

When you make a withdrawal, money is taken from your total account balance proportionally from your taxable funds and your tax-exempt funds. The amount attributable to tax-exempt contributions will not be taxable.

Your service will notify the TSP whenever your contributions are from tax-exempt money. The TSP will then account for your tax-exempt contributions and, as indicated above, will ensure that these amounts are not reported to the IRS as taxable income. Consequently, those contributions will not be subject to taxation when you withdraw them. Your quarterly participant statement will show your tax-exempt balance separately.

Your service can tell you more about combat zone/qualified hazardous duty area service and whether you qualify for the tax exclusion. (See also IRS Publication 3, Armed Forces' Tax Guide.)