Contributing Combat Pay to an IRA

I'm in the Army stationed in Iraq right now, and my income is tax-exempt while I'm here. If I end up being here for the full year, can I still contribute to a Roth IRA?

The answer is now different from the one I gave about a year ago. It used to be that tax-exempt income earned in a combat zone didn't count when determining whether you could qualify for an IRA, which requires earned income for you to contribute. So someone who was stationed in Iraq for the full year might not qualify to contribute to an IRA at all that year.

But President Bush just signed a new law on Memorial Day allowing tax-exempt pay from a combat zone to be included when determining IRA eligibility. The law is retroactive to 2004 and 2005, so you can contribute to an IRA for those years if you missed out because of the combat-zone exclusion.

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To contribute to the previous years' IRAs, contact the fund company or brokerage firm that will be administering the IRA and ask what documentation you will need to provide. T. Rowe Price, for example, requires the designation to be in writing stipulating that the IRA owner had combat pay that makes him or her eligible for the new contributions. Patrick Beagle, a certified financial planner specializing in military families, recommends keeping a copy of the W-2 showing the combat-related pay and a copy of the portion of the service records that show the combat time.

It's a good idea for anyone with combat pay to contribute to a Roth IRA, even if they weren't deployed for the full year and don't qualify for the retroactive contribution. If a lot of your income is tax-exempt now, you'll probably be in a much higher tax bracket after you retire and can really make the most of the Roth's tax-free withdrawals.

While you're in Iraq, also make the most of the special rules for your thrift savings plan, which is the federal government's version of a 401(k). Members of the military can invest 100% of their pretax base pay, up to $15,000 per year, plus all of their tax-exempt pay while serving in a combat zone, as long as their total contributions don't exceed $44,000 in 2006. When you withdraw the money, you won't be taxed on contributions from tax-exempt pay. For more information about the Thrift Savings Plan rules, see the government's TSP Web site.For more information about the special financial-planning rules and strategies for military families, see "Assets Deployed" in the July issue of Kiplinger's Personal Finance and At Your Service on Kiplinger.com. For details about the special tax rules for military families, see the IRS's Tax Information for Members of the U.S. Armed Forces.

As the "Ask Kim" columnist for Kiplinger's Personal Finance, Lankford receives hundreds of personal finance questions from readers every month. She is the author of Rescue Your Financial Life (McGraw-Hill, 2003), The Insurance Maze: How You Can Save Money on Insurance -- and Still Get the Coverage You Need (Kaplan, 2006), Kiplinger's Ask Kim for Money Smart Solutions (Kaplan, 2007) and The Kiplinger/BBB Personal Finance Guide for Military Families. She is frequently featured as a financial expert on television and radio, including NBC's Today Show, CNN, CNBC and National Public Radio.