By Barbara O’Neill, Ph.D., CFP®, Rutgers Cooperative Extension
More than 80% of service members never reach the 20-year mark to qualify for retired pay. That is why it is important for them to “hedge their bets” by contributing as much as they possibly can to the Thrift Savings Plan (TSP). Otherwise, they run the risk of serving in the military for a number of years and having absolutely no retirement savings to show for their service when they leave.
Service members can contribute a portion of their pay to the TSP while they are on active duty and can fund an individual retirement account (IRA)—a traditional IRA and/or Roth IRA—as well. A retirement planning calculator available at the Ballpark Estimate website can help service members determine how much they need to save for retirement.
Financial experts agree that people who start saving money for retirement at a young age will see the largest growth in their savings. Service members can start contributing to the TSP when they begin their career. The TSP is savings they can take with them in the likely event they don’t receive a pension. The TSP.gov site demonstrates the value of starting TSP contributions as soon as possible.
TSP fund options are among some of the lowest-cost investments available anywhere. TSP fund expenses average 0.025% or 2.5 basis points (a basis point is 1/100th of 1% or 0.01%). Stated another way, TSP expenses are about 25 cents for every $1,000 invested. If someone had a $100,000 TSP portfolio, he or she would pay only $25 a year in investment management expenses. The TSP also offers many helpful financial planning tools and calculators.
A Roth Thrift Saving Plan (TSP) account is a good option for many service members. With a Roth TSP, participants invest after-tax dollars (i.e., money that has already been taxed) that cannot be taxed again upon withdrawal in retirement. While plan participants don’t receive an immediate tax write-off for the amount of their contribution, they receive tax-free earnings after age 59½ if their account has been open at least five years. Also, unlike Roth IRAs, there are no maximum income limits for Roth TSP participation.
Roth TSP accounts are especially attractive for young service members because they have four to five decades of tax-free investment growth ahead of them. In addition, they are likely to be in a lower tax bracket (e.g., 15% marginal tax bracket) currently than they will be later in life (e.g., 28% tax bracket), so a current tax will have less impact than a future one. For a list of federal marginal tax brackets, click here.
How do you convince service members to save for retirement? Show them the money! Provide a compelling illustration of how small amounts of money grow over time. Research indicates that people often save more when they fully understand how savings can grow with compound interest. Here’s an example from , a publication for military families. If someone saves $300 every paycheck, this lowers their take-home pay by $225 in the 25% tax bracket ($300 minus the $75 tax benefit). Do that twice a month and you’ll save $7,200 a year ($300 x 24 paydays). Assuming an 8% average investment return over 30 years from age 25 to 55, a service member would save more than $900,000.
This post was published on the OneOp blog on February 9, 2015.