A reader asks:
I’m in the National Guard. I’ll be deployed for about 45 days into a combat zone. I’m signing up for the BRS and I’m contributing my 5% in order to get the DoD’s 5% match.
I’m employed in the civilian world by a corporation that contributes 6% of gross pay into my 401(k). I can also make 415(c) after-tax contributions to my 401(k) up to the annual addition limit.
Contributing the full $18,500 employee elective deferral happens pretty quickly for me, and pretty early in the year. I then continue with my after-tax contributions to reach my full $55,000 annual addition limit. That’s the total of my pre-tax deferral ($18.5K) + employer’s 6% contributions + my after tax 415(c) contributions.
Now there’s the new wrinkle of the BRS with my Combat Zone Tax-Exempt pay. My goal? Minimize taxes, whether that be now or in the future.
I’m in an income-tax bracket now where pre-tax contributions into my tax deferred 401k makes sense. I know exceeding the $18,500 limit is permissible when CZTE enters this equation. If I’m not mistaken this must be done so with contributions to a traditional TSP: tax free money into a tax deferred account which I will pay taxes on when I reach RMD age. It could make sense that I take the tax free money and put it into my Roth IRA and my wife’s Roth IRA. This would allow tax free money to be distributed tax free in the future. However, I don’t think this would take full advantage of the situation to raise the limits of my employee contributions.
The problem is, I’m not fully seeing the picture as to how combat zone tax free money is most beneficially used since if it were to go into a Roth TSP, the $18,000 limit between the 401k, Roth 401k, Roth TSP and TSP remains the same.
Even writing this kind of turns my brain into a knot of confusion. What is the best way to approach this?
We get this question a lot, and you’ve figured it out (despite the brain knots). I’ll run through what we’ve learned from other servicemembers who’ve been through a similar deployment.
First, I’m impressed by your employer’s generous contributions, and that you don’t have to spread out your contributions over 12 months to earn a full match. And you have after-tax 415(c) contributions too! This is unfortunately rare among 401(k) plans.
Next, I’m going to guess that your employer’s fund choices have higher expense ratios than the TSP. In other words, if the tax advantages and contribution rules are the same between your 401(k) and your TSP then you’re going to want the TSP’s lower expense ratio. Admittedly by the time you’re done contributing $55K this is going to seem like tinkering at the edges, but these contributions might have to live with their expense ratios for 20-40 years.
Finally, your $55K annual addition limit is tracked differently than the $18.5K elective deferral limit. The TSP website’s contribution limits table has a lot of fine print, starting with these sentences:
Annual Addition Limit:
This limit is per employer and includes employee contributions (tax-deferred, after-tax, and tax-exempt), Agency Automatic (1%) Contributions, and Matching Contributions. For 415(c) purposes, working for multiple Federal agencies or services in the same year is considered having one employer.
The annual addition limit is the gross total of your contributions, at $55K per employer. For your civilian employer it includes your contributions plus any civilian employer matches. With the federal government there’s your contributions, plus the DoD 1% agency contribution, and plus the other 4% of the DoD match.
In addition, the DoD’s total 5% TSP match is spread out across the year. If you hit a TSP contribution limit before December then you’ll miss out on the monthly TSP matches for the rest of the year. Ideally you’d want to make 12 monthly TSP contributions there as well. That’s summarized in the same TSP contribution limits table. There are four paragraphs of fine print under that table, and at least three of them also apply to your situation. You’ll have to consider them in your contribution plan as well.
You’re right about putting the tax-free pay in your two Roth IRAs. You’d have “only” $11K of contributions ($5500 to each Roth IRA), and you’d deprive yourself of the DoD match in your TSP for those months. Your Roth IRA funds probably have higher expense ratios than the TSP’s funds, too.
You’re going to have to do some contribution math, and it could get messy. You’re going to have to figure out how much everyone else is putting in your 401(k) and your TSP so that you know your limits of your personal contributions.
In addition you’re going to have to plan for surprises, like changes to the dates you’re receiving tax-exempt pay or any bureaucratic problems of opting into the Blended Retirement System and getting January’s BRS matching contribution. You can see more screenshots of opting into the BRS here.
The good news is that if you bump into a TSP limit then the TSP computers will take enough of your final contribution to hit the limit and will then kick back the excess. Many readers have verified that this is how the TSP system handles excess contributions.
In 2018 you could start your contribution calculations with the $55K total limit and then subtract out DoD’s 5% matching contributions from your base pay. Of course you’d also set your Roth TSP base pay contribution to at least 5% (in order to maximize the DoD’s agency contribution and match).
When you look at your $55K total, it’s now made up of your Roth TSP 5% contribution + the DoD BRS 5%. You are correct that (by law) the DoD matching contributions will go to your traditional TSP, even if you’re contributing to your Roth TSP. That’s specified by federal law for 401(k) matching contributions, and it’s also in the DoD memo for the implementation of the Blended Retirement System (paragraph 7.b.(12) on page 17).
Those “base pay” calculations can get complicated. You have the annual pay raise in January 2018. In addition you have to forecast any longevity pay boosts (from a new column of the pay tables every two years) or any promotions that may occur during the deployment. That will change your 5% base pay contribution (make sure you put at least that much in the TSP every month) so it changes DoD’s matching contribution.
You can use the Roth TSP for the combat zone pay because it’s already tax-free contributions with tax-free withdrawals, and after you leave the combat zone you can continue to contribute to your traditional TSP. However, if you reach a contribution limit of $18,500 in your Roth TSP any time during the calendar year (before, during, or after the combat zone) then the TSP computers will cut you off. You wouldn’t be able to contribute anything else to either TSP account for the rest of the calendar year and you’d even lose the rest of the year’s DoD matching contributions. That’s in the first paragraph of fine print under the TSP contribution limits table:
If you are a member of the uniformed services, you should know that Roth contributions are subject to the elective deferral limit ($18,500 for 2018) even if they are contributed from tax-exempt pay. If you want to contribute tax-exempt pay toward the annual additions limit, you will have to elect traditional contributions for any amount over the elective deferral limit.
Because of that Roth TSP hard annual limit you want to stay just below $18,500 in Roth TSP contributions. Then you’d use your traditional TSP for the rest of your contributions (up to the TSP’s grand total of $55K). The more you can contribute during your deployment, the more tax-free contributions you’ll have in your TSP.
Of course you could also ignore the Roth TSP (initially) and make all of your contributions to your traditional TSP. However, those contributions in the combat zone are already tax-free so there’s no tax deferral. When you’re out of the combat zone (and receiving taxable pay again) then you’d continue making contributions to the traditional TSP, and that does give you a tax deferral.
Personally (after your military career) I feel that the Roth TSP is a lot easier to roll over to a Roth IRA than a traditional TSP (with its Roth IRA conversion). Better yet, when you convert your TSP to a Roth IRA you can still tap some of the funds before age 59.5 (free of penalty). Even better still, you won’t have to deal with RMD math (and potentially higher taxes) after age 70.5.
You could contribute most of your deployment’s tax-free pay to the TSP (including specialty pays, hazardous duty pay, imminent danger pay, the BRS Continuation Pay contract, and any bonuses). If you really dig into the tax planning then you might want to try to live off your personal savings during the deployment.
But again you’re tinkering at the margins.*
, and you can continue your contributions to the traditional TSP even after you return from the deployment. That $55K annual addition limit should stay in effect for the rest of the calendar year as long as you don’t hit the $18,500 limit in your Roth TSP. Other servicemembers have verified this from their experience.
This means your traditional TSP will have a mix of tax-deferred and tax-free contributions, which the TSP will continue to track for you. You could leave that money in the TSP until you start taking RMDs (because the expense ratio is so low) and you’ll know exactly what portions of your RMDs are taxable at your personal income-tax rates. If you choose to convert your traditional TSP to a Roth IRA then you’ll have to make sure that your Roth IRA custodian will accept the tax-free contributions from your TSP.
Your taxable income could be a lot lower in 2018. While you’re maximizing your contributions to your TSP accounts, it might also make sense to convert some of a traditional IRA account to a Roth IRA.
* After further discussions with a CFP on the TSP staff, after leaving the combat zone you can continue to contribute to your Roth TSP (as long as you don’t hit its elective deferral limit [$18,500 in 2018] before December). However if during your time in the combat zone you’ve exceeded a total of the elective deferral limit in combined contributions (Roth TSP + traditional TSP), then after you leave the combat zone you can no longer contribute to the traditional TSP. You can still contribute to the Roth TSP after leaving the combat zone, but only up to its elective deferral limit.
[Readers: have you made your BRS opt-in decision yet? You’re missing out on matching contributions. If you haven’t opted in then take a look at Kate Horrell’s comprehensive post of all the Dept of Defense info and analysis by eight other bloggers.]
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