The Pentagon supports proposed changes to the government's Thrift Savings Plan that would automatically sign up troops and offer an investment option that provides tax-free earnings at retirement, if draft legislation now being considered makes it into law.
The idea behind automatic sign-ups is simple: "The consensus within the financial community is that you should be investing for your retirement," said Army Maj. John Johnson, director of the Pentagon's Armed Forces Tax Council. "And a big reason why a lot of people don't is inertia. They just don't take that action."
The Federal Retirement Thrift Investment Board, which oversees the TSP program, shares that view. "Automatic enrollment [is] a good way to make inertia work in favor of participation," said Tom Trabucco, the board's legislative director.
Under the proposal, troops who are automatically enrolled could opt out of TSP if they desired.
If lawmakers approve, the proposal to add a Roth IRA option to the TSP would be a boon to many combat troops who do not pay taxes on earnings or bonuses received in the war zones.
Normally, contributions to Roth accounts are made in after-tax dollars, which reduces take-home pay but allows participants to withdraw the principal and interest tax-free at retirement.
In a normal IRA or 401(k) account, participants contribute pre-tax dollars — meaning their take-home pay is higher because a lower amount is taxed — but the money is taxed when withdrawn at retirement.
With a Roth IRA, troops who re-enlist in the war zone and get a tax-free bonus could contribute thousands of tax-free dollars into Roth IRA accounts and never have to pay tax on the earnings.
"That's the biggest reason we support the Roth," Johnson said. "The benefits will be greatest for deployed members in combat zones, and junior troops."
Roth IRAs and traditional IRAs have advantages to consider, Johnson said. Money contributed to a traditional IRA, for example, can be claimed as a tax deduction.
"You put $2,000 in [a Roth IRA], and 30 years later, that $2,000 might have grown to $20,000," he said. "And you pull it all out, totally tax-free. But if you go the other way, you get the $2,000 deduction up front, but when you pull out the $20,000, you pay taxes on the $20,000."
To figure out which choice makes sense, investors have to look ahead and try to determine whether they'll be in a lower tax bracket now, or later.
For anyone in a zero-percent tax bracket — such as troops in a combat zone — "it's a no-brainer," Johnson said. "They obviously should be doing Roth. And a lot of military people are in a zero tax bracket. I mean, most military members deployed pay no taxes. So it's a huge benefit."
But those in higher brackets may also benefit. In the course of providing financial advice, said Phil Dyer, deputy director for financial education for the Military Officers Association of America, "I routinely find military retirees who are in a higher tax bracket in retirement than they ever were during any of their active-duty years or even second-career years.
"If they've done a good job saving, they've got their military retired pay, they've got Social Security ... they've got a lot of money in 401(k) plans," he said.
At that point, withdrawn traditional TSP earnings, which are taxable, are "just going to increase the tax burden," he said. "And so that's where Roth, I think, offers another benefit."
But Dyer added a cautionary note: "We have no idea what taxes are going to look like 25, 30 years from now," he said.
Most war-zone troops in the TSP program can invest their tax-exempt pay in the TSP, up to annual limits — although under the current options offered, the interest would still be subject to taxation on withdrawals.
"If somebody's in the combat zone and contributing to TSP, there actually is a de facto Roth that's created because when that money comes in, if they're in a combat zone, they're tax-free up to the maximum enlisted pay rate," Dyer said. "If they're contributing to TSP, that money's going to be segregated ... into a parallel TSP account to maintain that tax-free status" on the contributions.
Again, interest earned on those tax-free contributions would be taxed upon withdrawal after retirement.
While a tax-free Roth would be most beneficial for TSP participants in a war zone, Dyer said, it would be a potential boon for nondeployed troops as well, even though they would be investing after-tax dollars.
"It goes into the account, grows tax-deferred ... and then when the money comes out, provided it's a qualified distribution on the back end, the money's going to come out free from federal and state income taxes.
"With 15-, 20-, 30-plus years of compounding, it's a huge advantage," Dyer said, adding that the management fees on the TSP "are, hands-down, the lowest out there."
"TSP is not sexy, not really exciting," Dyer said, "but from a fee standpoint, you can't beat it."
Senior Pentagon officials agree.
"If given that option, we are confident that the Department of Defense would implement default auto-enrollment into Roth TSP accounts," David S.C. Chu, undersecretary of defense for personnel and readiness, wrote in a May 20 letter to the TSP board.
But Chu said that while the Pentagon favors the idea of automatic enrollment, he thinks each agency head should be granted discretion on whether to implement it.
The maximum TSP contribution this year is $15,500, the same as for regular 401(k) plans. Participants age 50 and older who contribute that amount can deposit up to $5,000 more in "catch-up" contributions. While a Roth IRA option is far from reality, if it were enacted, the limits would probably be the same, Johnson said.
The current proposal makes no mention of government matching funds for TSP contributions by service members. The service secretaries have authority to designate troops in critical skills for matching funds, but none are currently authorized. Civilian government employees receive matching funds on the first 5 percent of basic pay contributed each pay period.