Should military members contribute to Thrift Savings Plan or a Roth IRA? What's the difference between to the two? One fundamental difference between the two options is that your pay tax on your money first, they you put it in a Roth IRA. However, when you are able to pull it out all the returns are tax free. In contrast, the Thrift Savings Plan (TSP) is very much like a civilian 401(k) plan. Your money goes in before you get taxed and you pay tax when you take it out--at your current income level.
I am enlisted in the United States Air Force and I believe that for enlisted members you should contribute to the Roth IRA before you invest in the TSP. Once you max out your Roth IRA, then you should contribute to the TSP. Here's why I believe this:
1. Most if not all enlisted people are in a very low income bracket (15%). That means you pay 15% on your money before you put it in your Roth IRA. However, everything you make in the account is tax free when you pull it out. If you become the next Warren Buffet and make 50% a year over 30 years, everything will be tax free. In addition, most of us will actually make more money once we get out of the military and will probably be in a higher tax bracket. Therefore, contributing to a Roth while in the military makes more sense for most people.
2. The Roth IRA 5000 limit will soon adjust with inflation and you can max out the Roth IRA and keep up with inflation in the future. In addition, you can contribute 5000 for yourself and your spouse. Therefore, most families can contribute up to 10K a year.
3. Roth IRA has way more flexibility for investment choices than TSP. With TSP you're locked into a choice between 6 index funds. With a Roth IRA you can invest in anything your want. You can buy individual stocks, exchange traded funds and many other investment vehicles. In fact, you could buy the same type of funds that are available in TSP in your Roth IRA, but you have the option to move you're money if things get crazy. A big drawback of TSP is that most of it's funds are tied to the overall market performance. Therefore, Macro Economic issues hugely impact TSP funds.
4. Another way, even though I don't recommend it, the Roth IRA is more flexible is after 5 years of investing you can take out the principal with no penalties. You can't do this with TSP. For example, let's say you put 5K a year in a Roth IRA for 5 years and after 5 years you're account had a value of 30K. That's 25K of principal and 5K of gains. You can take out the 25K with no fees or penalties. In addition, you can take the gains if you're buying a house. However, once again this is a bad idea! Compounding interest takes a long time and you will feel the impact. Don't do this unless you have no choice! I just like the fact that I have this option is the need arises.
There's 4 reasons why I believe the Roth IRA is better than TSP for enlisted military members. TSP is a good 401(k) because it has low fees and uses index funds. However, the flexibility, options, and tax breaks of a Roth IRA can't be ignored.
Currently, the government doesn't match TSP contributions for Active Duty military. If they change this the situation above will be different and I'll write another article about it. Below is a break down of the two programs.
TSP Roth IRA
| Contribution Limit | $15,500 per year | $5,000 per year |
| Minimum Age to Begin Withdraw | 59 ½ years-old | No Minimum Age |
| Age for Mandatory Withdraws | 70 ½ years-old | Never |
| Taxed When? | When Withdrawn | Before Invested |
| Getting Out of the Military? | Contributions must stop | Contributions can continue |
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