Financial Independence with the TSP and IRAs

In a previous post we discussed how the actual annual TSP (Military 401K) contribution limit is $18,000.

Most military folks, and indeed the general public, don’t know you can max out your contributions at work and continue to save for retirement by using IRA’s, with all the tax benefits that come with these methods. This got even more confusing when the TSP instituted the “Roth Option.”

For years I have seen the “Roth” part of the TSP and conflated it with the Roth IRA. The TSP’s website and the IRS are not very clear as to whether you can contribute to both. Most American’s are never told to save more that 10% of their income, which is why there are no IRS examples for people trying to save 50%+ of their income from a full time job. Let me help dispel the confusion.

Subject to certain rules, you can contribute $18,000 to your TSP and $5,500 to your IRA, in either Roth or Traditional fashion.

HOW to use the TSP and IRAs

The TSP is classified by the IRS as a 401k, which falls into the broader category of Employer Sponsored Plans. These broadly include the 457, 403b, etc.  Contributing to the Roth TSP is not subject to income limit phase-outs, which is explicitly noted on the TSP’s website.

IRA stands for Individual Retirement Accounts; they are sponsored by you, not your employer.

For IRAa, the annual limits for those under 50 is $5,500.

However, while you may be able to contribute to an IRA after your TSP, at AIG’s approaching and over  118K ($186K married) your ability to go Roth IRA decreases and is eliminated.

I think where the confusion arises is when people consider tax-deferability. Most individuals on the military’s payroll will almost certainly be able to contribute to the TSP and an IRA. You may run into issues deferring your traditional contributions not made to an employee sponsored plan. If your Spouse works you may become income-limited for the Roth IRA option.
While contributing to an IRA after maxing your TSP may not be tax efficient due to income phaseouts, I think people have taken this to mean you cannot contribute to both.

IRS Pub 590A gives may clear examples of when your deferrals are limited by your coverage at work. These limits will likely come into play if you AND your spouse work, maximize your work sponsored plan, and still wish to use IRA’s.

Don’t take my word for it:

What does our family do?

Taking the most tax efficient path is a major goal for our family, especially since for the first two years of our marriage we will be dual income, with no kids. While I’ll break out our strategy in a later post, here is how I am structuring my 2017 contributions:

  1. Contribute the Maximum to our TSP and 403b ($18,000, or total compensation)
  2. Drive AIG to a level equal to deductions and credits using traditional contributions
  3. Use Roth Contributions after achieving Zero Federal Tax, and Zero State Tax
  4. Catch our additional retirement savings in Roth IRA’s
  5. Catch any additional savings in a taxable brokerage account (taxes = bummer, but possibly being able to save more than $47,000 = win!)

Here is my handy excel code for figuring if your AIG prohibits or limits taking an IRA deduction. Modified AIG is in cell Q5. Married filing jointly. Use tables in 590A to fill in your own values. Update by tax year.

For example, for AIG of 75,000:

Disclaimer: I am not a licensed tax or financial counselor of any sort. The opinions contained here are my own. Investing has implicit risk, past gains are no guarantee of future returns. You may lose money, including the principal. These opinions are my own, and are not endorsed by any of the armed services or the US Government.


Please follow and like us:

7 thoughts on “Financial Independence with the TSP and IRAs

  1. Can you please explain a little more about how you reach zero tax? I file head of household and my taxable income is going to be 73k in 2017.

    1. CH-
      I’m happy to explain more about my zero tax plan. I’ve got a post in the works but i’ll set you up with this:
      As Financial Sam notes, being married is one of the only ways to wealth in the US. The Tax code is heavily in favor of married people. double bonus for people with kids.

      This year Mrs MF will make less money due to time off for Baby MF. That will reduce our income from Mid $110K down to about $90K+. Our massive saving rate of 50%+ lets us max our TSP 401k and 403b, and contribute a little to Traditional IRA’s. That takes care of another 30K+, as the IRS treats the contributions as deferred income- we invest in the Traditional (not Roth) option at work.

      So now we are at 60K for AGI.

      Subtract out Exemptions for 2 ppl plus dependant & the Standard deduction and you are down to 36K. Some student loan interest cancels out our passive income, ie dividends.

      The Tax on 36K is equal or less than the Sum the Retirement savers credit (for AGI less than 62K, 10% of ~30K, or $3,000)) and the Child tax credit. Wiggle around a bit with tax loss harvesting and Trad vs Roth IRA’s and you end up with Zero Tax.

      Triple bonus if you convert last year’s Trad IRA to Roth for Zero Tax.

      Given these same numbers but filing as Head of Household I’m not sure if you can make it work in exactly the same way. My basic advice is that the IRS penalizes spending, and rewards high savings rates and being married.

      Should we shoot for Zero Tax by pushing our “income” closer to zero using our 401k, or should we be happy with an effective 15% tax rate and contribute to the Roth IRA/ Roth TSP, knowing that our retirement tax rate will be 15%? I guess its a question of priorities. I might try both, maybe in 2018.

      Does that make sense? Worth a Post? Im not a Tax Guy, am I wrong?

      1. Yes, thanks for the detailed response! We contribute 18k (Roth tsp) + 11k (Roth IRAs) every year. If I change my contributions to traditional pre-tax instead of Roth, is the immediate tax savings credit worth losing the long term benefits of Roth? I recently read a post on nerdwallet saying Roth usually beats traditional retirement accounts in the long run, even assuming you invest the traditional IRA tax savings in a taxable retirement account.

        1. CH-
          I guess it would depend on your current income and where you expect your income to be in retirement. Obviously, you are maxing your IRA and 401k. If you can get your AGI into the zone for the Retirement Savers Credit it could be worth the tax savings outright and a credit of $2,900 or more.

          Roth vs Trad over time is a tough question, but a 3K tax credit invested now WILL change the equation.

          You also can convert your past traditional contributions to Roth in future years if your tax rate falls into a more acceptable level.

          1. Thanks for the explanation! I am going to look into roth conversion and see if maybe we can do this in the future. Hard to give up the Roth benefits… but if we can get that Saver’s Credit, it seems worth it.

  2. Good stuff here! I’m torn between contributing to an after-tax account and having the flexibility to withdraw or put some in my and my wife’s IRA and having the tax benefit. But I’m leaning more towards IRA because I don’t want to be tempted to withdraw the $$$ and then having to pay fees.

    1. It is a conundrum, SMM. To start, I imagine you are maxing your 401k… this year I initially put some of my extra stash in an after tax account. This kept me more liquid. At the end of the year I sold most of my positions, was able to tax loss harvest some of my post Brexit gains, and then dumped the result into an IRA. Now, if I had just front loaded into the ira in the first place I might have been better off, but that is market timing in hindsite. Plus, thus way I got double tax benefits. Takes dicipline, for sure.

Leave a Reply

Your email address will not be published. Required fields are marked *