Savings Strategies for Military Personnel

Servicemembers face financial issues that most people don't experience: They have to move frequently—sometimes on short notice—and they can be deployed to combat zones for months or years. But they also have access to valuable benefits and investing options not available to the general public. Exploiting the opportunities can help secure your family's financial future.

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Even though those who stay in the military for 20 years or more can qualify for a pension, it's still important to save on your own. In truth, few people actually stay in the military long enough to claim a pension, and, unlike civilian pensions, there’s no "partial vesting" to guarantee that workers who leave "early" get something. With the military, if you leave before 20 years, you get nothing. Even if you qualify, pension payments probably won’t be enough to cover your bills—you're usually entitled to 50% or less of your base salary if you retire at 20 years (and more if you stay beyond two decades). See militarypay.defense.gov for options based on when you joined the service.

Instead of worrying about what might happen, take charge of something you can control: your own savings. The younger you are when you start setting aside funds for your future, the easier it will be to build a healthy nest egg. And while you’re in the military, there are special investing opportunities and tax breaks to help you supercharge your savings. It's up to you to make the most of your options.

Thrift Savings Plan: Autopilot Savings

The government's Thrift Savings Plan is a great place to start. Men and women in the military can invest in this low-cost, tax-advantaged retirement-savings plan for federal employees, which is similar to a private company's 401(k) plan.

You can contribute up to $17,000 to the TSP in 2012, and even more if you receive tax-exempt pay while serving in a combat zone—up to a total of $50,000 in 2012. Because contributions from your regular pay escape taxes, they don’t lower your paycheck nearly as much as you might expect: Contributing $10,000 cuts your take-home pay by just $7,500 if you're in the 25% tax bracket (and even less if your contributions also escape state income tax).

And your contributions grow tax-deferred until you withdraw the money in retirement. That could provide a hefty nest egg if you start early; $10,000 contributed this year would grow to more than $100,000 over 30 years, if your investment grows at an average rate of 8% per year. The same amount invested each year for the next 30 years would grow to more than $1 million. (Although an 8% return might sound like pie in the sky, the fact is that the annual average return of the stock market since 1926—a period that includes not only the recent Great Recession but also the Great Depression of the 1930s—is nearly 10%.)

The TSP makes it easy to put paying yourself first on autopilot. Contributions are deducted from each paycheck, and steady investing can pay off big-time. Say you contribute $300 every paycheck, which lowers your take-home pay by just $225 in the 25% tax bracket. Do that twice a month and you'll save $7,200 for the year. If you start at age 25 and contribute for the next 30 years, you could end up with more than $900,000 by the time you’re 55, if your investments return 8% per year.

And even if you leave the military at age 40 after 15 years of contributions and never add another dime to your TSP account, you could still end up with about $700,000 by age 55 (again, assuming an average return of 8%).

When it comes to how you invest inside the TSP, you can choose among five index mutual funds that invest in large com-panies, small firms, international firms, bonds or government securities. Or you can choose a lifecycle fund (called the L fund), which builds a diversified portfolio of the other funds to match your time horizon; the fund starts out invested primarily in stock funds when you have more than a decade before you plan to tap the money, then gradually becomes more conservative as your retirement date draws near.

Expenses for all of the funds are extremely low—about 25 cents a year for every $1,000 invested—making the TSP one of the lowest-cost investing options available. For a $100,000 portfolio, for example, you'd pay just $25 a year in investment-management fees.

The TSP is a tax shelter, so you don’t owe tax on earnings until you withdraw the money, and you won't ever be taxed on contributions from tax-exempt combat-zone pay. (A portion of every withdrawal will be tax-free to protect the tax-free status of combat pay.)

You can keep money in the TSP after you leave the military, or you can roll it into an IRA or another employer's 401(k), where it will continue to grow tax-deferred. If you take the money and spend it, you'll face an immediate tax bill and, if you're younger than 55 in the year you leave the military and tap the account, you’ll generally pay a 10% penalty, too. For more information about the rules, visit tsp.gov. You'll also find a calculator there to help you project your future account balance and see the power of long-term compounding of earnings. The power of money making money is wonderful to behold.

Tax-Free Earnings From a Roth IRA

Unlike contributions to a traditional IRA, which can earn a tax deduction to lower today's tax bill, contributions to a Roth IRA offer no instant gratification. But the delayed gratification of doing without today's tax deduction is sweet: All withdrawals from a Roth in retirement will be tax-free, whereas withdrawals from a regular IRA are taxed in your top tax bracket. Another advantage of the Roth is that you can withdraw contributions at any time tax- and penalty-free if you get in a pinch.

You can contribute up to $5,000 to a Roth IRA in 2012 (or $6,000 if you're 50 or older) as long as your adjusted gross income is less than $110,000 in 2012 if single or $173,000 if married filing jointly. (The opportunity to make contributions gradually phases out as income rises above those levels.)

You need to have earned income in order to qualify for a Roth IRA (that's basically income from working rather than from investments or gifts), and even though combat-zone pay is tax-free, it counts for this purpose. In fact, the Roth can be a particularly good deal if you have tax-exempt combat-zone pay. Your money goes in tax-free, and your contributions as well as earnings come out tax-free, a sweet tax benefit. If you earn income but your spouse doesn't, you can also contribute $5,000 to an IRA in his or her name.

You can open a Roth IRA with a brokerage firm, mutual fund or insurance company, credit union or bank. When selecting an IRA administrator, look for low fees and a range of investment choices. If you have 20 or 30 years until retirement, it’s usually best to invest the money in a diversified portfolio of mutual funds (see 5 Steps to Start Investing and Kiplinger's Investment Portfolio Finder for more information on getting started in investing and creating a portfolio).

You can invest the maximum in both a Roth IRA and the Thrift Savings Plan in the same year. If you can't afford to invest in both plans, consider a Roth IRA first if you expect your income—and your tax bracket—to increase by the time you plan to withdraw the money, especially if you had tax-free income in a combat zone. Military personnel are often in a lower tax bracket than they will be after they leave the service, so it makes sense to pay tax on Roth contributions now and enjoy tax-free income later. (Note that the Thrift Savings Plan will introduce a Roth version late in 2012, which will have the same tax benefits of a Roth IRA but without the income limits on contributions.)

You can contribute to a Roth IRA with a single payment or sign up to have money automatically shifted from your bank account or paycheck. Investing $416.66 per month will get you to the $5,000 annual limit. You have until April 15 of the following year to make an IRA contribution—April 15, 2013, is the deadline for 2012 contributions, for example—but the sooner the money is tucked into the account, the sooner tax-free earnings begin to grow.

Making the Most of Your Opportunities

Alex Bowling is a first lieutenant in the infantry stationed at Fort Hood, Tex. Just 24 years old, he’s already a savvy and experienced saver. Bowling has been maxing out his Roth IRA for several years, and cashed in on the double benefit of contributing tax-free combat pay earned during his seven-month deployment to Northern Iraq as an infantry platoon leader last year. "In my opinion, the Roth is the best retirement-account option for a young investor," he says, "especially considering the years of untaxed growth and my low tax bracket, which was even lower during deployment," he says.

He also diverts part of his salary each month into the Thrift Savings Plan, where the money grows tax-deferred. And he invests in mutual funds in taxable accounts, too. That's money he can access before retirement.

Bowling invests long-term money in index funds, which keeps costs low and simplifies his investing decisions. "I do not believe that I have the time or wherewithal to beat the market or search out the few money managers that can," he says.

He also saves time—and takes the emotion out of investing — by having money transferred directly from his paycheck to his Roth and TSP accounts every month. "It allows me to create growth and proper allocation without having to think about it. This ensures everything continues to happen regardless of time in the field or deployment," he says. "No one has time to come off patrol and manage investments."

He embraced another great savings opportunity when he was deployed last year: He invested in the military's special Savings Deposit Program, which guarantees a 10% return per year on up to $10,000 while you are deployed (and for up to three months after you return). You can't contribute to the SDP until you are deployed. But Bowling saved money before he left so he could contribute the maximum to the SDP as soon as he arrived in Iraq. Your take-home pay increases while you’re receiving tax-free income during deployment, which can help you afford to stash extra money in the SDP. Bowling plans to use the SDP earnings to help max out his 2012 Roth IRA contributions.

As a platoon leader, Bowling is very familiar with the financial issues facing today’s soldiers and the importance of setting financial priorities. It's important to pay off high-interest credit-card debt and build an emergency fund in addition to saving for the future. Bowling keeps two months' worth of pay in an accessible fund to cover personal expenses, and a separate account for emergencies. The last thing he wants to do is go into debt or tap retirement savings to cover unexpected bills.