I recently received a question from a reader, an active duty Marine, about the Thrift Savings Plan versus an IRA. I’m not making this up like I did that other time.
Rob, I have a dumb question: is the TSP considered a “traditional IRA” or does it just act like one? Here’s why I ask:”
Then he quoted the IRS website on IRA Contribution Limits:
Your traditional IRA contributions may be tax-deductible. The deduction may be limited if you or your spouse is covered by a retirement plan at work and your income exceeds certain levels.”
I’ve been fully funding my Roth IRA for years, and contributing to TSP, which is more than my Roth amount … am I hosed? Thanks, Nick”
At least 90% of what we do in financial planning is related to taxes.* And everything about taxes is simple and straight-forward, right?
It’s not? Then that’s why this is not a dumb question. In fact, there are so many combinations of accounts and limitations, it’s often best to ask for help from a professional financial planner.
Decoding the IRS
The reason this is related to taxes and we have to go to the IRS website is because they are giving you a tax break – or ‘loophole’ depending on your political persuasion – if you save for retirement. But you have to follow certain rules, utilize certain accounts, make no more than a certain amount of money, save no more than a certain amount, and so on. It doesn’t help that pretty much anything written by the IRS is hard to understand.
Let’s recap Nick’s situation. Nick has been contributing to a Roth IRA for years. By “fully funding”, he means he’s saving the maximum annual amount allowed by law. For both 2014 and 2015 that maximum amount is $5,500 if you’re under the age of 50. Nick is also contributing several hundred dollars a month to the TSP out of his active duty pay. As an active duty service member, the IRS considers Nick to be “covered by a retirement plan at work,” whether or not he is over 20 twenty years of service and eligible to retire with a military pension.
The first thing to realize is that we’re talking about 2 different kinds of accounts: IRA and TSP. IRA accounts are held for you by savings or investment institutions like USAA, Fidelity, or Vanguard, or even your credit union. Your TSP account is held by the Federal Retirement Thrift Investment Board, a government agency.
Traditional vs. Roth
For both IRAs and the TSP there are 2 flavors: (1) Roth and (2) traditional, or non-Roth. The Roth versions of both accounts came later; that’s why the non-Roth accounts are called ‘traditional’. The difference between them is when you get taxed. You can get a current tax break for contributing to traditional IRA and TSP accounts now. Then everything you withdraw later in retirement is taxed as income. You can see the effect of contributing to the traditional TSP on your LES. The amount under “FED TAX Wage Period” is less than your taxable pay, which includes base pay, sea pay, and incentive pays. When you contribute to a traditional IRA you can often deduct that amount from taxable income on your tax return, depending on your household income. The effect is the same: you pay income tax as if you were never paid that money (in the current tax year).
When you contribute to Roth accounts, IRA or TSP, there is no immediate tax benefit. When you withdraw your funds in retirement, however, it is all tax-free, including the growth and earnings. To focus on the current tax aspect, for the moment we’ll disregard withdrawal schemes and criteria; for the most part things are really simple if you withdraw after you are aged 59 ½.
Most service members then can save four different ways: traditional IRA, Roth IRA, traditional TSP, and Roth TSP. I think Nick’s confusion stems from the TSP not getting mentioned much in the media, or on the IRS website.
The max you can contribute to your IRA accounts, traditional or Roth is $5,500 for the year. That’s even if you have multiple accounts. For example: say you have a traditional IRA at NFCU, a Roth IRA at USAA, and a Roth IRA at Vanguard. The most you can contribute to those 3 accounts is $5,500 combined, e.g., $1,000 + $1,500 + $3,000.
The TSP is completely unrelated to your IRAs, and has different limits. Regardless of the contributions you make to the TSP, your max for the IRAs is $5,500. You can contribute up to $18,000 to the TSP if you’re under 50 and not in a combat zone. Again, that is for traditional and Roth combined.
Part of Nick’s question, and the part of the IRS website he refers to, is about deductibility of traditional IRA contributions. I said above that you can deduct IRA contributions from your taxable income; but if you are covered by a retirement plan at work the deductions go away once you get to a certain level of income. The retirement plan the IRS cares about is the military pension, not the TSP. You’re considered to be covered by a retirement plan regardless of how much time you have in the military.
The phase-outs for deductibility start pretty low. For someone filing taxes as ‘single’, the deductibility of IRA contributions starts going away at $61,000 and disappears at $71,000. You can still contribute to a traditional IRA, but without the tax deduction. That’s only for traditional IRAs, however. Nick said he’s contributing to a Roth IRA, which has no current tax deduction, so this limit does not apply.
For contributing to Roth IRAs, there are much higher income limits, starting at $116,000 for singles.
Let’s go back to Nick’s question, which really has 3 parts:
is the TSP considered a “traditional IRA”
No, the TSP and an IRA are 2 completely different things.
does the TSP just act like a “traditional IRA”?
A traditional IRA can provide current tax deductions, just like the traditional TSP, but they have different limitations, and the tax deduction happens by 2 different methods: income deferral vs. income tax filing.
am I hosed?
I think he’s good to go because: (1) he’s not looking for a current tax deduction with a Roth IRA, so his Marine pension is irrelevant with regard to deductibility, and (2) his TSP contributions don’t count toward the IRA limits.
Does this situation apply to you? A financial planner familiar with military pay should be able to give you a complete answer once he or she knows more about your situation. Contact me for a free consultation to see how I can help you.
* completely made-up statistic. But still, you get it.
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