A common question is whether a military member should contribute to the Thrift Savings Plan or a ROTH IRA. According to Walter Updegrave, CNNMoney’s personal finance expert, the best strategy is to fully fund the ROTH before putting money into the TSP. For single people, the max is $5,000 for 2008, and $10,000 for couples. After that, military members can contribute $15,500 into their TSP accounts. If you’ve still got money left over, you can put money into tax managed accounts such as index funds.
Why is this a good strategy? Remember, ROTH IRA contributions are made after the taxes have been paid. Once invested, ROTH proceeds aren’t taxed again! It’s likely that if you invest wisely, you will pay taxes on your income while its small, and retire wealthy.
TSP contributions are made before the taxes are paid. They grow tax deferred, meaning that you pay taxes on all the proceeds when they are withdrawn. Over time, this money will also grow to a substantial sum but it will be taxed as ordinary income when it is withdrawn.
The last pot of money is your taxable investment account. A lot of small investors discovered that their mutual funds were not tax managed very well at the end of 2007. While the investments had performed poorly over the year, they discovered that there were large capital gains taken at the end of the year, and those triggered tax consequences.
Tax managed accounts prevent the stock turnover that triggers these taxable events, and reduce the tax burden over time.