Members of the U.S. armed forces qualify for special tax breaks, which can offer unique financial planning opportunities, experts say.
Typically, earnings are higher after military service because there are two sources of income: your new career and your military retirement benefits, said certified financial planner Patrick Beagle, owner and president of WealthCrest Financial Services in Springfield, Va. The firm specializes in military and federal employees.
During service, it’s smart to make after-tax Roth contributions to a Thrift Savings Plan, or TSP, retirement accounts, he said. Roth deposits are after taxes, but the funds grow tax-free.
“You’re probably making a mistake” if you skip Roth TSP contributions while serving during your lower-income years, said Beagle, who is also a retired Marine aviator.
‘Tax-free’ combat zone income
Another planning opportunity happens while serving in a combat zone, said CFP Curtis Sheldon, who is also an enrolled agent at C.L. Sheldon and Company in Alexandria, Va. The firm specializes in working with active and retired military members.
“For the vast majority of people, when you deploy to a combat zone, you have tax-free income,” and even a single day of service counts for the full month, he said. Your earnings are exempt from taxes during that period, including basic pay, bonuses, student loan repayments and more, according to the IRS.
Typically, you should aim to receive more income during that period to maximize your tax-exempt income, experts say.
For example, you can defer your reenlistment bonus until you’re in a combat zone, and the earnings will be tax-free, Beagle said.
Weigh Roth conversions
While deployed in a combat zone, it’s also a “really, really good year” for higher-ranking individuals to do Roth conversions while temporarily in a lower tax bracket, Sheldon said. These service members may otherwise be higher earners and may have a larger pre-tax retirement account to covert.
Roth individual retirement account conversions transfer pretax or nondeductible IRA money to a Roth IRA, which begins future tax-free growth. The trade-off is investors owe upfront taxes on the converted balance.
Leverage the Savings Deposit Program
Another benefit is the Department of Defense’s Savings Deposit Program, or SDP, which offers 10% annual interest on savings of up to $10,000 while service members are deployed in a combat zone.
To compare, the average interest rate for traditional banks was 0.41%, as of Mar. 17, according to the Federal Deposit Insurance Corporation. Meanwhile, the top 1% average rate savings account rate was 4.26%, as of Mar. 31, according to Deposit Accounts.
You can close the account after leaving a combat zone and use the money as a “slush fund” for living expenses to defer more Roth contributions into your TSP, Beagle said.
“There are all these different wickets,” he said. “You can pick and choose among all the [military] benefits” to maximize future investment returns.
