If you’ve just joined the military or you’ve elected to be covered by the Blended Retirement System (BRS), you need to carefully think about your Thrift Savings Plan contributions.
Unlike those covered by the legacy retirement system, you’ll get something that they won’t. Employer matching. And it is very important to take full advantage of the matching. To take full advantage of the matching you have to understand it. So let me take a crack at that.
If you are covered under the BRS and meet eligibility requirements (been in the service for 60 days), the military will contribute 1% of your salary to the TSP. They will do this whether you contribute or not. For those who contribute and are eligible (in this case you must have 2 years of service…the contributions begin at the start of your 3rd year of service. If you opt in, your prior service counts towards the time needed) the government will match 100% of up to 3% of your salary and 50% of the next two percent of your salary. So if you contribute 5% of your salary the military will contribute 4% of your salary to TSP plus you’ll get the automatic 1% for a total of 5% of your salary.
What is important to understand and what most people don’t get, is that the military’s contribution will go into a tax deferred account regardless of what type of contribution you make…i.e. Roth or pre-tax. This is a critical distinction when it comes to tax and financial planning. Here is why.
Let’s face it. You get a set amount of income each month and each dollar can be used for one thing. In the case of your TSP, you can either contribute a set amount into a tax deferred account or take that same set amount, pay taxes on it and contribute the remainder into Roth TSP. And even though your tax rate may be low now, it may not make sense to contribute to Roth TSP if matching is involved. Let’s take a look at an example.
First, let’s lay out the assumptions.
- 5% of your annual income is $3,042 (O-2 with 3 years)
- You’re single, so you’re in the 22% tax bracket
- You can either contribute the full $3,042 to pre-tax TSP or pay the taxes and contribute $2,373 to Roth TSP.
- In the next 20 years the contributions and matching quadruple (7.2% return)
Here is the money you would have today and at the end of 20 years
|2018 Contribution||2018 Match||2018 Total||2018 Contribution||2018 Match||2018 Total|
|2038 Value||2038 Value||2038 Total||2038 Value||2038 Value||2038 Total|
On first glance, it would look like the Pre-Tax is the obvious best choice. But we still have to account for taxes. Before we do that remember though, it isn’t how much you pay in taxes. It is how much money you keep.
Let’s assume that your tax rate stays the same and we’ll ignore penalties. The calculation would look like this
- $24,336 - $5, 360 ($24,336 x 22%) = $19,005
- $10,952 - $2,409 ($10,952 x 22%) + $9,492 (Roth, not taxed) = $18,035
So, even though you pay more than 2 times more tax, the money in your pocket is more. But, most people think taxes will go up. What about that? Well let’s take a look at your break-even point. Harkening back to your high school algebra, we need to solve for “x” in the following equation
24,336 - (24,336)*x = 10,952-(10,952)*x +9,492
13,384x = 3,892
x = 29%
So, your tax rate would have to increase by 32 percent ((29%-22%)/22%) for the Roth contribution to be more beneficial. The extra $300 in matching plus the fact that the Roth matching funds are taxed on withdrawal make it hard to make up the difference.
What do I take from this? If you’re not deployed to a combat zone (we’ll cover that another day) then you should strongly consider contributing the first 5% of your salary to the pre-tax TSP to maximize the “bang for the buck” of the military’s contribution.