Individual Retirement Arrangements -- the IRS's formal name for what are commonly known as individual retirement accounts -- are individually owned, tax-advantaged retirement savings accounts. For most people, an IRA is an important part of a retirement plan, and it seems simple: You just open an IRA and put money in it, right?
Well, yes and no.
As with all things personal finance, IRAs involve variables and things that are confusing, with special considerations if you are military. So let's hit on the three main things to know about IRAs when you're a military member.
1. TSP and IRAs Have Different Contribution Limits
The military's Thrift Savings Plan and IRAs fall under different sections of the tax code, and their contribution limits are separate from each other. That means that you can put in the full amount of the TSP limit into TSP -- either the pre-tax traditional TSP or the post-tax Roth TSP -- and you can also separately put the full amount of the IRA limit into an IRA.
If you can't afford to max out both, which one should you contribute to first? Complicated question, but thankfully there are no wrong answers. Individual situations vary, but generally you should always contribute first to any plan that will give you matching funds. For folks in the Blended Retirement System, that would mean putting 5% of their income into the Thrift Savings Plan. Legacy Retirement System folks don't get a government match, and IRAs don't have matches, so those are equal.
2. Combat Exclusion Brings Extra Benefits
If you're currently in a Combat Zone Tax Exclusion location, your income is tax free. (Or most of it, depending on your income level.) Putting that tax-free money into a post-tax Roth IRA will result in one of the only ways to have truly tax-free retirement money: It doesn't get taxed when it goes in; it doesn't get taxed when it grows over time; and it doesn't get taxed when distributed. It's like a perfect game. Take advantage of it!
(The same trifecta applies to post-tax Roth TSP contributions when in a combat-exclusion location.)
3. The Saver's Credit Can Really Pay Off
The Retirement Savings Contribution Credit, commonly called the Saver's Credit, provides a tax credit to lower-income taxpayers who save for retirement. The Saver's Credit calculates the credit as a percentage of the total contribution made to IRAs and employer-sponsored accounts, such as TSP. The credit amount is based on tax filing status and household income, and can be as high as 50%.
Because a lot of total military compensation comes in the form of tax-free allowances such as Basic Allowance for Housing and Basic Allowance for Subsistence, military members may be able to take advantage of the Saver's Credit more than their civilian counterparts who have all of their income taxed.
However, the Saver's Credit is nonrefundable. That means that while the Saver's Credit can reduce your tax liability to zero, you won't get a tax refund of any amount of the credit that exceeds your tax liability.
IRAs are an important tool in your retirement savings toolbox. Take advantage of the ways that IRAs can be used with military income to boost your overall savings, and you'll be better prepared for whatever stage of life comes next.
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