This guest post is brought to you by Marine Corps veteran Rob Aeschbach, who’s started a new career as a personal financial planner.
The Thrift Savings Plan does not offer matching contributions for service members, but the IRS does in some cases. Here is what you need to know about how the government will pay you up to $1,000 if you put away $2,000 for retirement.
If you’re reading this blog then we probably already agree that saving money for retirement is a good thing. Maybe you’re already doing a good job saving, or maybe you’d like to save more but don’t think you can. The point of my post today is to let you know about a part of the income tax system that helps you save, and specifically helps active duty service members due to the nature of the military pay system. And that’s a good thing because the vast majority of people in uniform will never qualify for military retirement pay.
While I think the Thrift Savings Plan (TSP) is an awesome savings vehicle, there is no savings match for military personnel. Some civilian federal employees qualify for matching contributions to the TSP, and many other civilians get an employer savings match for contributions to their 401(k) (while not exactly a 401(k) plan, the TSP mostly looks and acts like one). But recently I looked at the “Credit for Qualified Retirement Savings Contributions”, and I figured that it is effectively a matching contribution for junior service members.
The good news is that the credit is available to you regardless if you put your savings in the TSP or an IRA. The bad news is that there are pretty low maximum income limits to qualify for the tax credit.
That’s where the military pay system comes in. Part of your military pay is non-taxable, specifically your Basic Allowance for Subsistence (BAS), and your Basic Allowance for Housing (BAH). That is good for some reasons (you don’t pay tax on it), but bad for other reasons (your computed retirement pay doesn’t account for BAS and BAH). In this case it is a good thing, since your BAH and BAS don’t count against you in computing your retirement savings credit.
What does this mean for you? It means that if you are enlisted, or an O-3 or below, you might be able to save more for your retirement than you think.
How does this work? If during the tax year you made a ‘qualified contribution’ to a retirement account, then you fill out Form 8880 [PDF] with your taxes. A ‘qualified contribution’ generally means a Traditional or Roth IRA, a 401(k), or the TSP. Then use the chart on the form to find out what percentage credit you get based on your income and filing status. The credit is 10%, 20%, or 50% of the first $2,000 that you saved for retirement. The largest credit you can get is $1,000.
Let’s look at an example using 2011 numbers. Sgt Donut is an E-5 stationed at the Pentagon, and he lives with his wife in Northern Virginia (like me), an area with high housing costs. The BAH for a married E-5 in the D.C. area was $1,881 per month in 2011. Base pay (with greater than 4 years of service) was $2,448.30 a month, and monthly BAS was $325.04. So his gross pay in 2011 was $4,654.34 a month, or $55,852.08 annually — but only 53% of that is taxable.
Now take a look at IRS Form 8880 [PDF]. With a taxable income of $29,379.60 and ‘married filing jointly’ status Sgt Donut qualifies for the maximum tax credit. Sgt Donut happened to set his TSP contribution at 10% of base pay, so in 2011 he saved $2,937.96 in the TSP. When he did his taxes he got $1,000 back with his tax refund. Effectively he contributed $1,937.96 to his TSP account and Uncle Sam kicked in another $1,000 for him.
The major downside to this tax credit is how low the income limits are, especially for single people. All of your taxable household income counts toward the limit, including your spouse’s income if you are filing jointly. In my example, Sgt Donut’s wife does not have a job, and they have no other source of income. Other income items that might disqualify you from this credit include dividends and interest on taxable investments, capital gains from the sale of your house, alimony received, or government payments to you for a partial DITY move.
What should you do with that money? The short answer is to save it, that’s what the credit is for. In Sgt Donut’s case he is only saving 5% of his gross pay for retirement. If Sgt Donut is like most service members, he won’t stay in long enough to earn a military pension, so he should probably be saving more of his pay. What he can do is increase his TSP contribution to 13% of base pay, and decrease his federal income tax withholding by a similar amount; he can do that by claiming more W-4 tax exemptions. Now he’s boosted his retirement savings to 6.8% of his gross pay, but his paycheck stays about the same since he’s receiving the tax credit spread throughout the year, rather than in a refund check at the end of the year.
By planning ahead you can save a little bit more each month for retirement than you thought; for some people that extra, unexpected $1,000 tax refund check might be too tempting to spend rather than save.
Here is a 2011 pay chart that shows what combination of pay grade and service will qualify you for the retirement savings credit, assuming you have no other income (click to enlarge):
Rob Aeschbach served 12 years on active duty in the Marine Corps, and recently retired from the Marine Corps Reserve. He’s started a new career as a personal financial planner at MilitaryFinancialPlanner.com.
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