Maximizing Your Thrift Savings Plan Contributions In A Combat Zone
Quick review: the military’s Blended Retirement System offers matching contributions to your Thrift Savings Plan, and in 2018 you can contribute up to $18,500.
Your contributions can go into your Roth TSP or into your traditional TSP (or in any combination of the two up to a total of $18,500). As long as you contribute at least 5% of your base pay into your TSP every month of the year, then the Department of Defense will match up to 5% of your base pay all year long.
Better yet, that DoD match does not count against your $18,500/year elective deferral limit. Here’s the tax code reference from the TSP website with more details:
Of course if you’re in the military’s legacy High Three pension system then you’re also eligible to contribute that same $18,500 to your Roth or traditional TSP. You don’t get the DoD match but the IRS tax codes still applies.
[Note: in this post, we’re not going to rehash the debate about High-Three versus opting in to the BRS. See the related links at the bottom– especially if you’re eligible to opt in to the BRS.]
That’s it for the quick review. Now we’re going to describe how to level up on TSP contributions.
Because so many military families have learned the basics of contributing to the TSP, we’re getting a lot of questions about maximizing those contributions during deployments to combat zones. Military pay in a combat zone is exempt from federal and state taxes, and servicemembers are also eligible for much higher contributions to the TSP. I’ll get into the gory details during this post, but for now I’ll mention that the annual additions limit of the tax code is $55,000/year. That limit applies even when you’re not in the combat zone for the entire year!
Later in this post I’ll also answer the question that most of you are thinking right now:
Hey Nords, I just checked my Leave and Earnings Statement and, golly dude, I’m not getting paid $55K this *year*– let alone during this deployment. I have expenses, too. Where the heck are people getting the money for this?!?”
We’ll address that issue in excruciating detail (military families are extremely creative) but the basic response is “Do the best you can with what you have.” You’ll be surprised at how much the DoD and the IRS will help you reach that $55K goal, and this post includes the links to make sure it applies to you.
Let’s be clear: I would not volunteer to deploy to a combat zone just for the tax-free pay (and the special pays) and the higher contribution limits to retirement accounts. I would not even do it to pay off student loans or consumer debt. Yet that combat zone is why you joined the military, and as long as you’re there then you might as well make the most of your pay advantages.
But that leads to a good question.
Why would anyone want to contribute $55,000/year to their TSP?!?
Short answer: the TSP has some of the world’s largest passively-managed index funds with some of the world’s lowest expense ratios. Depending on how you contribute, you can get tax-deferred compounding and tax-free withdrawals. You don’t even have to wait until age 59.5 to tap your TSP.
The TSP is one of several investing answers, but it should be a big part of every military family’s asset allocation plan. (Some might decide it’s the best part.) In the combat zone, you’re putting tax-free pay into the TSP. This not only offers a huge compounding advantage but also means that you have more money to contribute to your TSP account instead of “contributing” it to the U.S. Treasury’s income-tax fund via withholding and tax returns.
Finally (stay with me here) combat deployments are not exactly fun. (Not even submarine deployments.) We personal-finance bloggers talk boldly about frugality versus deprivation and work-life balance, but let’s not kid ourselves: this deployment will be more work than life, and a lot more deprivation. As long as you’re embracing the suck, you can still extract some value from the pain by investing as much as you can toward your FI life goal.
For a few of us, maximizing TSP contributions *during* a deployment is a great way to minimize lifestyle expansion *after * a deployment. Yeah, you worked hard and you deserve a nice reward. Instead of a dollar-gobbling depreciating pile of pickup truck, how about sleeping better at night knowing that you’re on track for financial independence? Give yourself a small victory-lap party, sure, but avoid the temptation of the hedonic treadmill by putting most of that money where it’s hard to fritter away.
No worries, this post includes a detailed year-round example. I also have a spreadsheet for you to edit with your own numbers.
Next question: where are these combat zones?
Surprisingly, they don’t all involve actual combat. I hope.
DoD and the Internal Revenue Service work with Congress to define combat zones. Here’s the text straight from the IRS press release:
The term ‘combat zone(s)’ is a general term used on IRS.gov and includes all of the following hostile areas where military may serve: actual combat areas, direct combat support areas, and contingency operations areas.”
I was surprised to learn that Djibouti, the Philippines, and even the Sinai Peninsula are eligible for combat zone benefits. (Yeah, they’re also awesome blogger keywords.) The distinction is not whether you’re shooting but rather whether you could be shooting or whether you’re helping other people shoot. You’re also supposed to be getting imminent danger pay or hostile fire pay.
According to the IRS, there are three options:
- Service in an active combat area as designated by Executive Order, and receive special pay for duty subject to hostile fire or imminent danger as certified by DoD.
- Service in a support area as designated by DoD in direct sustainment of military operations in the combat zone, and receive special pay for duty subject to hostile fire or imminent danger as certified by DoD.
- Service in a contingency operation as designated by DoD, and receive special pay for duty subject to hostile fire or imminent danger as certified by DoD.
Read the fine print in the IRS notice, but if you’re getting that pay on deployment then you’re probably eligible for the tax code’s annual additions limit of $55,000/year to your TSP.
What’s the Annual Additions Limit?
What does that limit look like? Here’s another section of that table from the TSP contributions limits page:
Here’s the important fine print from that chart:
This limit… includes employee contributions (tax-deferred, after-tax, and tax-exempt), Agency/Service Automatic (1%) Contributions, and Matching Contributions.”
In other words, that $55,000 limit now includes your DoD BRS agency/matching contributions. You’re not actually contributing all $55K from your own pay.
How to reach the $55,000 Annual Additions Limit
1. Because that $55K limit includes the BRS agency/matching contributions, you have to dial back your contributions to allow for DoD’s 5% match of your base pay. To make things even more complicated, you’ll have to spread your 5% contributions across all 12 months of the calendar year or you’ll miss some of the match.
2. Here’s another good deal: by the definition of the combat zone, you’re getting more special pay (at least hostile fire or imminent danger pay). You lived without that money when you were in the U.S., and you can probably live without spending it in a combat zone. Since it’s tax-free, you can set your MyPay (or Marine OnLine) contribution percentage to 100% to contribute all of it to the TSP.
3. Some of you have planned ahead for the next good deal: bonus money. I am not a lawyer or a CPA or a CFP, and you’ll have to read your bonus contracts very carefully to make sure you’re eligible, but here’s the link: if you sign a bonus contract in a combat zone eligible for CZTE pay, then it’s not taxable.
Let’s be clear again: I would not volunteer to re-enlist or sign a bonus contract in a combat zone just for the tax-free pay. (Yes, I actually do get reader questions about how to volunteer for this.) I would not even do it to pay off student loans or consumer debt. Yet if you’re planning to obligate the service anyway, or if you’re eligible to sign up for the BRS Continuation Pay bonus between 8-12 years of service, then as long as you’re in the combat zone you might as well make the most of your pay advantages.
Suddenly that $55K number might be a lot closer.
4. Here’s another fine-print point which the BRS has highlighted: these annual addition limits are per calendar year, not just for the deployment. Let’s unpack that concept for several more paragraphs.
When you deploy to a combat zone (as defined above) then the IRS lets you use the annual additions limit for the entire calendar year– even for the days of the year when you weren’t in the combat zone. Your pay is only tax-free when you’re in the combat zone, but you still have the Internal Revenue Code’s annual additions limit all year long to continue contributing (taxable) pay.
If your deployment stretches from October 2018 to March 2019 (ouch, holiday seasons) then you’re eligible for the annual addition limit of $55,000/year in 2018 and again in 2019. Your pay was only untaxed while you were in the combat zone, but you get to use the annual additions limit twice in two calendar years.
Even if you just have a series of short deployments to combat zones during the years, the IRS is still going to let you use the annual additions limit all year long. You’re certainly paying the price for the benefit– use as much of it as you can.
Note that if you’re stationed in Qatar (another awesome blogger keyword) for two years, then you may be able to use the annual additions limit in three different calendar years. “See the world” with tax-exempt pay and higher TSP contribution limits.
5. Here’s another method that readers have shared with me: sell some investments from your taxable accounts. You’re going to want to seek professional tax advice from a CFP or a CPA, but this can save you quite a bit on capital-gains taxes.
Here’s the theory: your combat-zone income is tax-free so your taxable income for the year is very low. When you’re in a low income-tax bracket, your tax rate on long-term capital gains is… zero. For example, a married couple filing jointly pays no capital gains tax if their total taxable income is $77,220 or less.
This means you’ll raise your TSP contributions (in MyPay or Marine OnLine) as high as you can. Meanwhile you’d sell some of your investments in taxable accounts (within that 0% long-term capital gains limit) and use that money for living expenses. The net result? You’ve shifted a huge amount of money to the TSP and avoided a whole bunch of capital gains taxes.
6. One more idea, although it borders on irresponsible: if you’re a junior officer who’s taken out a career starter loan during college, then I’d be tempted to maximize my TSP contributions and live off the balance of that loan. You’d essentially be borrowing money at 1%-2% per year to invest in the TSP and then paying it back over a longer term. This is extraordinarily risky (high volatility, loss of principle, leveraged debt) but potentially profitable over a decade or longer.
Let’s cover one more piece of fine print about that annual additions limit, and then we’ll get to the example.
The Roth TSP annual contribution limit is still $18,500
(Even when you’re eligible for the $55,000 annual additions limit)
Here’s that crucial fine print where the TSP computers can cut you off:
Tax-exempt contributions made to the traditional balance of a uniformed services account while deployed to a designated combat zone do not count toward the tax code’s elective deferral limit. However, any Roth TSP contributions are subject to the Internal Revenue Code limit even if they are contributed from tax-exempt pay.”
When you’re contributing to your Roth TSP (and you should), then you have to stay below the $18,500 Internal Revenue Code limit until December’s contribution. This means that your $55,000 annual additions limit is going to put $18,499.99 in the Roth TSP (with your last contribution of the year coming in December) and the rest of your contributions will go into the traditional TSP. Of course the DoD BRS agency/match contributions are always going into your traditional TSP (see paragraph 7.b.(12) of that link), so between you and DoD you’ll end up with another $36,500.01 in your traditional TSP account.
As soon as your Roth TSP contributions hit $18,500, no matter where you are or when it is during the year, the TSP computer system will cut you off. Any excess contributions from your pay will be used to reach the $18,500.00 limit but the TSP will kick the rest of the excess back to DFAS. Even worse, the TSP will shut you down at the elective deferral limit of $18,500 and lock you out of contributions for the rest of the calendar year.
The Example: contributing $55,000 to the TSP from a combat zone with the DoD BRS match
This example comes from a series of e-mails with the Federal Retirement Thrift Investment Board (the government agency which runs the TSP) and the DoD BRS office. I’ve shared those e-mails with other military financial bloggers and they may be writing their own posts on the subject.
This is one of the examples used at the FRTIB for the training of TSP employees, and they’re reportedly working on more comprehensive guidance for servicemembers. (I’m not sure when it’ll be released but I’ll update this post.) I’ve already asked the BRS office to connect us bloggers with the FRTIB so that we can continue the conversation and get specific links to the tax code.
The DoD BRS office also asked me to pass on:
Individual service member who are impacted by this should contact the TSP call center or a tax adviser for guidance on the impacts of IRS regulations on their contributions.”
Until we get the IRC references from the CPAs and the lawyers, please feel free to refer to this post with the DoD BRS office, DFAS, the TSP, and your pay/personnel office. This example is how the system is supposed to work. The BRS software implementation in the DFAS and TSP computer networks has hopefully fixed any glitches from 2017 or earlier.
At the end of this example I’ve included a screen capture of a spreadsheet and a link to the Google Sheet where you can tweak your own numbers.
Here’s a scenario for a servicemember who:
- Opted in to the Blended Retirement System.
- Contributes at least 5% to their TSP every month (for the full DoD matching contributions).
- Deploys to a combat zone to receive combat zone tax-exempt pay…
- … and their deployment is only part of the year (March – September). They’re back home on 1 October.
Here’s the FRTIB response, edited for easier blog-post reading:
I think are a lot of ways that a service member can do this and I’ll give an example.
Disclaimer: this is not advice and merely an example of one service member making contributions while in a combat zone.
1. Service member who makes $48,000/year in basic pay and receives a $30,000 retention bonus while in a combat zone.
2. The elective deferral limit is $18,500 and the annual additions limit is $55,000.
Using these numbers, if the service member contributes 5% in January-February and 5% again in October-December, they will have contributed $200 per month of their own money and received agency/matching 5% of $200 per month.
If that happens, the service member will have contributed $1,000 towards the elective deferral limit (their own contributions) and $2,000 towards the annual additions limit (their own contributions and employer contributions).
That leaves the seven months in the combat zone to figure out how to contribute.
In this exact scenario, it likely makes sense to contribute to Roth up to the elective deferral limit less contributions made in January-February and October-December because those contributions will be tax-free going in and tax-free coming out so long as all of the other tax requirements are met.
In that case, there is $17,500 left towards the elective deferral limit ($18,500 minus the $1,000 contributed in the months while not in a combat zone). That divided over seven months is $2,500 per month of which there will be an additional agency/matching 5% contribution of $1,400.
This brings the total contribution to the TSP to $20,900 meaning the service member can contribute an additional $34,100 of tax-exempt money to their traditional account. That amount over a seven month period is $4,871 per month.
These amounts will allow for both the elective deferral and annual additions limit to be reached and the maximum amount of matching to be reached (5% of $48,000).
Of course, this service member could adjust the numbers to increase the contributions while not in a combat zone and decrease the amount while in a combat zone.
However, if the service member reaches the elective deferral limit before they leave the combat zone, they will not be permitted to make any contributions when they return.
As you may have concluded by now, that has to be spreadsheeted to be clearly understood.
Here’s the link to that Google Sheet for maximizing BRS contributions to the Thrift Savings Plan from a combat zone.. Please note that to edit this spreadsheet you’ll have to copy it (“File | Download as…”) to your own device and then edit your copy.
What If You’re Still In The Legacy High Three Pension System?
The rules are still the same for your combat zone contributions, only you don’t have to worry about DoD’s BRS agency or matching contributions.
Remember to stay below the Roth TSP contribution limit, as I mentioned up in the BRS section. Here’s another way of saying it, from page #3 of this TSP fact sheet:
Tax-exempt contributions made to the traditional balance of a uniformed services account while deployed to a designated combat zone do not count toward the tax code’s elective deferral limit. However, any Roth TSP contributions are subject to the IRC limit even if they are contributed from tax-exempt pay.”
When you’re contributing to your Roth TSP (and you should), then you have to stay below the $18,500 IRC limit. This means that your $55,000 annual additions limit is going to put $18,499.99 in the Roth TSP and the remaining $36,500.01 of your contributions will go into the traditional TSP.
This comment just came in my Facebook messages:
“Hello, I read your article about maximizing TSP in a combat zone. I ran into an issue earlier this year. Before deploying in June, I had contributed about $18,300 to traditional TSP and $200 to Roth. When I arrived I was unable to make any more contributions to Roth, but I was able to contribute to Traditional. Why is this?”
That’s a tough problem.
If you contributed $18,500 to the TSP before deploying then you’d already hit the elective deferral limit ($18,500 in 2018) before arriving in the combat zone. The TSP computers and DFAS would have locked you out of further contributions.
Now that you’re deployed, neither the TSP nor DFAS would have automatically restarted your contributions. Perhaps someone from your pay office (or DFAS) noted your combat-zone status and restarted the contributions. Since you had already reached your annual contribution limit (and they had to turn it back on) for some reason the TSP system wouldn’t accept new contributions to the Roth TSP. I’m not sure why but I’ll ask the DoD BRS office and the TSP staff.
I’m sorry this happened. Those servicemembers who’ve opted in to the new Blended Retirement System are advised not to front-load their TSP contributions so that they can receive the monthly DoD BRS match all year long. This appears to be a similar issue with the TSP computer system.]
Note for “older” servicemembers
If you’re age 50 or older, then your 2018 limits include a $6000/year “catch up” contribution.
You active-duty folks shouldn’t smirk at this clarification– you’d be surprised how many Reserve and National Guard servicemembers are in their 50s. That should tell you something about how challenging & fulfilling the Reserve & Guard can be if you’re feeling a little burned-out on active duty.
A Friendly Little Note From The IRS
Several servicemembers (and their frustrated spouses) have mentioned receiving IRS letters asking the servicemember to verify their deployment to a combat zone. One family was still receiving IRS letters about a 2016 deployment while the servicemember was deployed again in late 2017.
This letter is automatically generated by an IRS computer which tries to match the tax return to some sort of report that the servicemember has deployed to a combat zone. (Pro tip: this report to the IRS does not seem to come from DoD.) You’re welcome to call the IRS to confirm, but it’s not always easy to get a human to help you respond to the letter. I’m not sure that an IRS human even sees the letter before it’s mailed to you.
Your best response to the letter 2761 request for your combat zone service dates is a written letter. If you want to be proactive then you can send the letter as soon as you return from deployment. (No operational security issues there!) You can also notify the IRS by e-mail about your combat zone service, but again I’d wait until you’re home for OPSEC. Spencer over at MilitaryMoneyManual also has more suggestions about documentation and tracking the deployment dates. As he suggests, save copies of your Leave and Earnings Statements which cover the duration of the deployment.
The whole point of volunteering this information to the IRS is to give them your information to create an entry in your taxpayer account database telling the agency that you deployed to a combat zone. That way when your tax return arrives at the IRS months later, the computer will already have a flag in the system to confirm your service. Ideally it won’t spit out a form letter.
One more special note: an extended deadline to contribute to your IRA
During my research for this post, I learned that you may even be able to contribute to last year’s IRA. Seek professional advice from a CFP or a CPA before you do this.
Your Call To Action:
Once again, if you’ve opted in to the BRS then make sure you’re contributing at least 5% of your base pay to the Thrift Savings Plan for the BRS match. Even if you’re still paying off debt, it makes sense to contribute to your TSP to at least get DoD’s free money in your TSP.
When you know your deployment dates, download that spreadsheet and make your TSP contribution plan. It’d be great if you had the income or assets to reach the annual additions limit of $55,000 per year, but do the best you can.
Whatever you decide to contribute, make sure you stay below an annual contribution of $18,500 in the Roth TSP or you’ll be locked out of additional contributions for that calendar year. When you’re in the BRS, that limit lockout will keep you from earning DoD BRS matching contributions for all 12 months of the year.
Where To Learn About The Military’s New Blended Retirement System (All the official sites and videos plus 32 posts by eight different bloggers– everything we’ve written over the last couple years.)
Thrift Savings Plan Contributions In A Combat Zone With The Blended Retirement System
Contribution Limits of the Thrift Savings Plan + 401(k) + IRA = ?!?
How To Maximize The BRS If You Decide To Opt In
Early Withdrawals From Your TSP and IRA After The Military