May 2012
Interpreting the new Roth Thrift Savings Plan
The Thrift Savings Plan (TSP) will soon give your spouse a new way to save for your retirement. Heard of a Roth IRA? Well here comes the Roth TSP.
What is the difference between a TSP and a Roth TSP?
When you pay the taxes. TSP contributions reduce taxable income today and taxes are due when you take the money out. Roth TSP contributions do not reduce taxable income today but if you meet the IRS requirements (five years since your initial contribution and waiting until you are 59 1/2) then your withdrawals are tax-free.
Let’s look at an example. Your spouse’s base pay is $50,000 of which you contribute $5,000 into the TSP. Come tax time the IRS only taxes you on $45,000 of income. With a Roth TSP, if you put $5,000 into your Roth TSP, you are still taxed on the full $50,000 you earned.
Now, fast forward to age 59 1/2. Both accounts have been growing tax-free over the years and let’s say you have a balance of $200,000. You want to use $15,000 to go on your dream retirement vacation. If you have a TSP you will withdraw about $20,000, withhold $5,000 in taxes, assuming 25% tax bracket, and then have $15,000 to spend. If you have a Roth TSP, and it has been established for five years, you withdraw what you need and there are no taxes due on the $15,000.
Now, what is the difference between a Roth TSP and a Roth IRA?
How much you make and how much you can save. A Roth IRA allows you to contribute $5,000 per year, $6,000 if you are over 50. A Roth TSP allows you to save $17,000 per year, $22,500 if you are over 50, a very big difference. If your adjusted gross income as a couple is over $183,000 you cannot contribute to a Roth IRA. There are no income limits to being eligible to contribute to a Roth TSP.
So, what should you do?
It is not possible to know for certain if you are in a higher tax bracket now or if you will be in a higher tax bracket when you are retired. If we knew that we could calculate if a TSP or a Roth TSP makes the most financial sense. What we do know is that there are tax advantages to military pay which may put you in a lower tax bracket today and therefore make it more desirable to do the Roth TSP. When you are retired, if your spouse has earned a military pension you know that will be taxed. Consider being diversified from a tax perspective and funding the Roth TSP so that you have some tax-free income as well.
But, don’t get too excited. TSP announced the Roth will be available May 7, 2012, but Defense Finance and Accounting System (DFAS) announced the Roth TSP will be available in June or October, depending on your branch of service. Marine Corps will have access in June 2012 and Army, Navy and Air Force will have access in October 2012. Do your homework, pull out your paystub and make a plan for when it becomes available.
What is the difference between a TSP and a Roth TSP?
When you pay the taxes. TSP contributions reduce taxable income today and taxes are due when you take the money out. Roth TSP contributions do not reduce taxable income today but if you meet the IRS requirements (five years since your initial contribution and waiting until you are 59 1/2) then your withdrawals are tax-free.
Let’s look at an example. Your spouse’s base pay is $50,000 of which you contribute $5,000 into the TSP. Come tax time the IRS only taxes you on $45,000 of income. With a Roth TSP, if you put $5,000 into your Roth TSP, you are still taxed on the full $50,000 you earned.
Now, fast forward to age 59 1/2. Both accounts have been growing tax-free over the years and let’s say you have a balance of $200,000. You want to use $15,000 to go on your dream retirement vacation. If you have a TSP you will withdraw about $20,000, withhold $5,000 in taxes, assuming 25% tax bracket, and then have $15,000 to spend. If you have a Roth TSP, and it has been established for five years, you withdraw what you need and there are no taxes due on the $15,000.
Now, what is the difference between a Roth TSP and a Roth IRA?
How much you make and how much you can save. A Roth IRA allows you to contribute $5,000 per year, $6,000 if you are over 50. A Roth TSP allows you to save $17,000 per year, $22,500 if you are over 50, a very big difference. If your adjusted gross income as a couple is over $183,000 you cannot contribute to a Roth IRA. There are no income limits to being eligible to contribute to a Roth TSP.
So, what should you do?
It is not possible to know for certain if you are in a higher tax bracket now or if you will be in a higher tax bracket when you are retired. If we knew that we could calculate if a TSP or a Roth TSP makes the most financial sense. What we do know is that there are tax advantages to military pay which may put you in a lower tax bracket today and therefore make it more desirable to do the Roth TSP. When you are retired, if your spouse has earned a military pension you know that will be taxed. Consider being diversified from a tax perspective and funding the Roth TSP so that you have some tax-free income as well.
But, don’t get too excited. TSP announced the Roth will be available May 7, 2012, but Defense Finance and Accounting System (DFAS) announced the Roth TSP will be available in June or October, depending on your branch of service. Marine Corps will have access in June 2012 and Army, Navy and Air Force will have access in October 2012. Do your homework, pull out your paystub and make a plan for when it becomes available.
April 2012
Top 10 things to know about the Thrift Savings Plan
10. This is your spouses’ plan, so why should it matter to you? Odds are you will outlive your spouse and will need a secure retirement to provide for your life expectancy. As of 2010 there are 40,000 people in the US over the age of 100 and 85% of them are women1.
9. Why contribute to your TSP? Even if your spouse earns a military retirement it may not be enough. As it stands military retirement is 50% of base pay after 20 years, increasing 2.5% per year thereafter2. If your spouse retires in 2012 at 20 years as an O5 this is approximately $45,000 per year pre-tax, depending on inflation, pay raise assumptions and how you calculate the retirement. As an example, if you were a 20 year active duty O5 with dependents living Colorado Springs you just got a 63% pay cut from your previous compensation of $121,608.
8. The good news! You probably need to save less than families that don’t have a military pension. If you want to live on approximately $100,000 pre-tax at age 65, how much should you have saved today to be on track for that? Assume you are 35, you are on track for a 20 year military pension, you should have about $90,000 saved for retirement based on the above hypothetical assumptions. If you are 45 you should have about $278,000 saved. This assumes a 15% savings rate for retirement and a projected annual growth of 5% to achieve your goal at age 65, including Social Security. If you don’t think Social Security will be around for you in the same form it is today, start saving about 5 - 10% more.
7. The most your spouse can contribute to the TSP is $17,000, $22,500 if over age 50, in 20123. If you contribute the maximum, this comes out to $1,416 pre-tax per month, $1,875 if over 50. A little trick that I like to use is to max it out over 11 months and have approximately an extra $1,000 of take-home pay in December, a consistently expensive month. If your spouse is deployed to a tax-free combat zone they have the potential to save $50,000 to the TSP in 2012!
6. If your spouse has not filled out Form TSP-3 at the time of their death, the money in the TSP will go to you. If you are not alive it will go to your kids, if any kids have passed to their offspring. If you don’t have kids then to your spouses’ parents equally. If this is not how you want it or you have a non-traditional family, make sure to fill out Form TSP-3.
5. Your retirement assets are excluded in the calculation of your Expected Financial Contribution (EFC) when applying for financial aid for college. So, any money in your TSP will not be counted as an asset you are expected to contribute.
4. The TSP has 10 investment options. The Government (G), Fixed Income (F), Small Cap (S), Common Stock (C), International (I) and the Lifecycle Funds (L) - Income, 2020, 2030, 2040 and 2050. The L funds are just different combinations and weightings of the G, F, S, C, and I funds. While they are called funds, they are not actually mutual funds. You cannot buy the C fund in your own Roth IRA and they are only available in this form through the TSP. These are trust funds that are managed by BlackRock Institutional Trust Company.
3. The TSP is an investment account, not a savings account. You need to understand what your risk tolerance and time horizon is for retirement to determine how you should be invested.
2. The Thrift Savings Plan is introducing a Roth TSP in spring 2012. The TSP vs. the Roth TSP will be addressed next month in detail but this may be a very good option to consider for your family’s retirement savings.
1. Be the financially secure 65 year old couple that you admire today. Start saving now and be a happy family for years to come. Remember, the best financial gift you can give to your kids is that they won’t have to take care of mom and dad.
January 2012
Saving for Your Retirement while your Spouse is in the Military
2012. The year that you are going to invest in yourself. The year you are going to save money so you are not sitting at the kitchen table at age 60 saying, “How are we ever going to afford to retire?” Your active duty spouse has access to all sorts of retirement benefits. The two heaviest hitters available are the military pension and the Thrift Savings Plan (TSP) which will both be featured in a future article. Depending on how you are using those resources, odds are they won’t be enough on their own. So, what are you doing to save for yourretirement?
I AM A STAY AT HOME SPOUSE…
All retirement savings plans require earned income to participate, except if you are a non-working spouse. There is an exception called the Spousal Traditional IRA or Spousal Roth IRA that allows a non-working spouse to contribute $5,000 a year, $6,000 if you’re over 50. If you make too much money, these aren’t available to you starting at $173,000 of Adjusted Gross Income in 2012. The non-deductible IRA is available regardless of income. Think this won’t make a difference? If you’re 30 and contribute $5,000 to a Roth IRA for the next 30 years and invest it at 7%, you will end up with about $472,000 at age 60. Of this $472,000, only $150,000 is from your contributions. How is this? The 8th wonder of the world! Compounding interest. But, the key word is “compound.” Leave it alone. Allow it to grow. Ever grown a tree? It didn’t happen overnight and it definitely won’t happen by digging up the seed every week to just “check and see how it’s doing.”
I AM SELF EMPLOYED OR HAVE AN AT HOME BUSINESS…
In addition to the options above, you can do more. Not only are you earning extra income for your family, but you can give a big boost to your family’s savings while taking a bite out of your tax bill. The appropriate option depends on if you have employees and how your business is structured. To make this determination, you will most likely need to work with a professional, so feel free to contact me with questions. Two options are to set up an IRA for the business and contribute 20% of your net earnings as a pre-tax deduction. If you want to really maximize the tax advantage you can establish a Solo(k). This is a 401k for one person and you can contribute $17,000, $22,500 if you are over 50, as well as a 20% profit-sharing contribution based on your net earnings. Sounds confusing but worth it to understand if you are self employed.
I AM WORKING AS AN EMPLOYEE OF A COMPANY…
Your employer probably offers a retirement plan and it is most likely a 401k or a SIMPLE IRA. You can make a pre-tax salary deferral of $17,000 in 2012, $22,500 if you are over 50 in a 401k. Those amounts are reduced to $11,500 or $14,000 if you are over 50 in a SIMPLE IRA. If your employer offers a match, make sure to take full advantage. Check if your employer offers a Roth 401k. (A Roth version of your spouses’ TSP is coming second quarter of 2012.) The Roth 401k could be a great option to get the tax bill out of the way now and have tax-free income at retirement. Good news, you can’t “make too much money” and be disqualified with a Roth 401(k). Also, if your spouse has a military pension and a TSP those are both pre-tax. It is nice to have pre-tax and after-tax money when you are entering retirement.
I AM A STAY AT HOME SPOUSE…
All retirement savings plans require earned income to participate, except if you are a non-working spouse. There is an exception called the Spousal Traditional IRA or Spousal Roth IRA that allows a non-working spouse to contribute $5,000 a year, $6,000 if you’re over 50. If you make too much money, these aren’t available to you starting at $173,000 of Adjusted Gross Income in 2012. The non-deductible IRA is available regardless of income. Think this won’t make a difference? If you’re 30 and contribute $5,000 to a Roth IRA for the next 30 years and invest it at 7%, you will end up with about $472,000 at age 60. Of this $472,000, only $150,000 is from your contributions. How is this? The 8th wonder of the world! Compounding interest. But, the key word is “compound.” Leave it alone. Allow it to grow. Ever grown a tree? It didn’t happen overnight and it definitely won’t happen by digging up the seed every week to just “check and see how it’s doing.”
I AM SELF EMPLOYED OR HAVE AN AT HOME BUSINESS…
In addition to the options above, you can do more. Not only are you earning extra income for your family, but you can give a big boost to your family’s savings while taking a bite out of your tax bill. The appropriate option depends on if you have employees and how your business is structured. To make this determination, you will most likely need to work with a professional, so feel free to contact me with questions. Two options are to set up an IRA for the business and contribute 20% of your net earnings as a pre-tax deduction. If you want to really maximize the tax advantage you can establish a Solo(k). This is a 401k for one person and you can contribute $17,000, $22,500 if you are over 50, as well as a 20% profit-sharing contribution based on your net earnings. Sounds confusing but worth it to understand if you are self employed.
I AM WORKING AS AN EMPLOYEE OF A COMPANY…
Your employer probably offers a retirement plan and it is most likely a 401k or a SIMPLE IRA. You can make a pre-tax salary deferral of $17,000 in 2012, $22,500 if you are over 50 in a 401k. Those amounts are reduced to $11,500 or $14,000 if you are over 50 in a SIMPLE IRA. If your employer offers a match, make sure to take full advantage. Check if your employer offers a Roth 401k. (A Roth version of your spouses’ TSP is coming second quarter of 2012.) The Roth 401k could be a great option to get the tax bill out of the way now and have tax-free income at retirement. Good news, you can’t “make too much money” and be disqualified with a Roth 401(k). Also, if your spouse has a military pension and a TSP those are both pre-tax. It is nice to have pre-tax and after-tax money when you are entering retirement.
