Saving for Retirement When You're in the Military

Make the most of special savings plans and new rules.

(Image credit: Daniel Bendjy)

It’s easy to focus only on day-to-day issues when you’re in the military and miss out on valuable benefits that can improve your financial situation over the long run.

But servicemembers have access to special savings opportunities that aren’t available to most people, so it’s important to take advantage of these programs while you can.

Many servicemembers overlook the importance of saving because they hope to retire from the military after 20 years and receive pension income for life. However, fewer than 18% of servicemembers stay long enough to qualify for military retirement pay. The rest get nothing.

Subscribe to Kiplinger’s Personal Finance

Be a smarter, better informed investor.

Save up to 74%

Sign up for Kiplinger’s Free E-Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

Sign up

Unlike civilian jobs, there is no partial vesting under the current system if you leave before 20 years. Even if you do end up getting the pension, your retirement income could be as little as 50% of your base pay (more if you stay longer than 20 years), leaving you to fill in the gaps yourself. And major changes are coming soon to the military retirement system, which will provide new opportunities for servicemembers who don’t stay for 20 years. But the new system could also reduce your lifetime income and make it even more important to save on your own. Because of these changes, many servicemembers will need to make key decisions about their financial futures in 2018.

No matter which retirement system you choose, it’s essential to save on your own, too. The younger you are when you start setting aside money for your future, the easier it will be to build a healthy nest egg. While you are in the military, you can take advantage of special investing programs and tax breaks to help you supercharge your savings—even if you can only afford to set aside a little money now. It’s up to you to make the most of your options.

Begin With the Thrift Savings Plan

The government’s Thrift Savings Plan is a great place to start saving. Members of the military can invest in this tax-advantaged retirement savings plan for federal employees, which is similar to a private company’s 401(k) plan but with extremely low fees. You can invest up to $18,000 in the TSP in 2017, and even more if you’re receiving tax-free income while deployed—boosting the limit to $54,000 this year.

The TSP provides valuable tax advantages, no matter how much you can afford to invest, and a new rule gives you the option to take the tax breaks now or build up tax-free income for the future.

If you choose to make traditional contributions, the money you set aside reduces your taxable income now and grows tax-deferred until retirement. For example, contributing $10,000 cuts your take-home pay by just $7,500 if you’re in the 25% federal tax bracket (even less if your contributions also escape state income tax).

Alternatively, you now have the option to make Roth TSP contributions, which don’t provide a tax break now but do let you withdraw the money tax-free in retirement. This is similar to a Roth IRA but without any income limits to block contributions. (Note that contributions from tax-free pay in a combat zone will never be taxed.)

With either version of the TSP, your contributions can grow significantly over the years if you start early. Say you contribute $300 each paycheck to a traditional TSP. Your take-home pay will only shrink by $225 if you are in the 25% tax bracket. And 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! 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. These examples assume your investments return 8% per year, which has been a typical average for long-term investments.

As mentioned above, if you forego the tax break on your contributions now and instead contribute to the Roth version of the TSP, your withdrawals will be totally tax-free in retirement. If your taxable income is lower now than it will be in the future, you’ll come out ahead with the Roth.

“For most people relying primarily on military income, the Roth is generally the way to go,” says Patrick Beagle, a certified financial planner in Springfield, Va., who is also a former helicopter pilot who retired from the Marines and specializes in helping military families with their finances. “They are generally in the lowest bracket they will ever be in, because of all of the non-tax compensation.”

Take Advantage of Low-Cost Investing

You have several low-cost investing options in the TSP. You can choose from five index mutual funds investing in large companies, 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 invests primarily in stock funds at the start, when you have more than a decade before you plan to tap the money. And it gradually becomes more conservative as your retirement date draws near. Choosing the L fund is an easy way to invest.

Expenses for all of the funds are extremely low—about 38 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 $38 a year in investment management fees.

You can keep the 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. Just be aware that if you take the money from a traditional TSP and spend it, you could face an immediate tax bill. What’s more, you’ll generally face a 10% penalty if you withdraw the money from the account before age 59 ½ (unless you leave your job after age 55).

See for more information and a calculator to help you project your future account balance and see the power of long-term compounding of earnings.

An extra incentive to save: If you’re having a tough time putting aside money for retirement, consider that your contributions can also earn you an extra tax break. The Retirement Savings Contribution Credit is worth 10% to 50% of the first $2,000 you contribute for the year to the TSP, an IRA or another retirement savings plan. The lower your income, the higher your credit.

It’s worth $1,000 per person at the lowest income levels. But it drops to $200 if you are near the cutoff—$31,000 for single filers; $46,500 for filing head of household; or $62,000 if married filing jointly. These limits are based on adjusted gross income, which doesn’t include your tax-free housing allowance or any tax-free pay received while in a combat zone.

Tax-Free Earnings From a Roth IRA

A Roth IRA can be a great way for anyone to supplement their retirement savings—you generally don’t get a tax break for Roth contributions, but you can withdraw your earnings tax-free in retirement (and can withdraw contributions at any time without taxes or penalties). And deployed servicemembers get an extra perk: If you’re receiving tax-free pay in a combat zone, your money goes into the Roth tax-free, and your contributions as well as your earnings come out tax-free in retirement.

You can contribute up to $5,500 to a Roth IRA in 2016 and 2017 (or $6,500 if you’re 50 or older) as long as your modified adjusted gross income is less than $117,000 for single filers ($118,000 in 2017), or $184,000 if married filing jointly ($186,000 in 2017). (The opportunity to make contributions gradually phases out as income rises above those levels.)

You can open a Roth IRA with a brokerage firm, mutual fund 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 the Investor Protection Trust’s series of investor education booklets for more information about creating a portfolio.)

Note that you can invest the maximum in both a Roth IRA and the Thrift Savings Plan in the same year. And you have until April 15 of the following year to make an IRA contribution (or a few days later if the 15th falls on a weekend). For example, April 18, 2017, is the deadline for 2016 contributions.

Finally, if you have a spouse who doesn’t earn income, you can contribute to an IRA on his or her behalf. And children who earn income from a job also can contribute to a Roth IRA, which can be a great way to get them started saving for the future.

Guaranteed Return on Savings

It sounds almost too good to be true—10% interest guaranteed. But in this case it’s no scam: The military’s Savings Deposit Program lets servicemembers invest up to $10,000 in the program each time they are deployed. You receive 10% annual interest, compounded quarterly, and can keep the money in the account while you’re deployed and up to three months after you return.

For more information, see the SDP page at the Defense Finance and Accounting website.

What You Need to Know About the New Retirement System

You may need to make a major decision about your financial future in 2018 because the military is introducing a new retirement system.

While the new system reduces the guaranteed income available after 20 years, it provides matching contributions to your Thrift Savings Plan, which you can keep after just two years of service. Your options depend on the year you entered the military.

Before 2006. If you joined the military before January 1, 2006, you’re covered under the original system. You need to stay for at least 20 years to qualify for the military pension, which can be worth 50% (more if you stay longer) of your basic pay. See the section below for more information about how retirement pay is calculated.

From 2006 to 2017. If you joined from January 1, 2006, to December 31, 2017, then you’ll need to make a big choice. You can stay with the old system, or you can sign up for the new “blended retirement system” that reduces your pension but also provides matching Thrift Savings Plan contributions. (The timing for members of the Reserves is based on the number of retirement points.)

After 2018. If you join on January 1, 2018, or later, you’ll automatically be enrolled in the blended retirement system.

Kimberly Lankford
Contributing Editor, Kiplinger's Personal Finance

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.