After leaving the service, you might want to move money to an Individual Retirement Arrangement -- commonly known as an IRA -- to consolidate your retirement savings or get more flexibility for your investments. If you intend to move your military retirement account, usually a Thrift Savings Plan, to an IRA, you can proceed as planned. However, if you want to contribute to an IRA, and your only income for the year is your military retirement, you’re out of luck.
If you don't have taxable compensation during the year, you don't get the benefits of contributing to an IRA. "Compensation" only includes income earned from a salary, wages or self-employment income. Since you don't perform services for pensions, it isn't considered earned income. Therefore, military retirement pay can't be used to qualify to make IRA contributions. However, any other earned income, even from a part-time job, can be used for IRA contributions.
Transferring money from a Thrift Savings Plan, or TSP, to a traditional IRA is as easy as switching your savings account from one bank to another. Both accounts are tax-deferred. As long as you don't mess up the transfer or rollover, you won’t owe any income taxes until you take distributions from the IRA in a later year. In addition, the money keeps growing without being taxed until you do take distributions.
Conversion to a Roth IRA
If you think you’ll be in a higher tax bracket at retirement than you are in the current year, consider converting your TSP to a Roth IRA. Both accounts are tax-sheltered, so the money still grows tax-free. But Roth IRAs are funded with after tax contributions, which means your qualified distributions come out completely tax-free. When you convert, you have to pay taxes on the converted amount that year. Despite that, you'll save money in the long run if you’re in a higher tax bracket at retirement. For example, assume you’re in the 10 percent tax bracket in the year of the conversion. If you convert, yes, you’ll have to pay 10 percent on the conversion. However, if you’re in the 25 percent tax bracket when you take distributions, you’ll avoid a future 25 percent tax rate.
Fund Moving Options
When the time comes to move the money, you can use either a transfer or an indirect rollover. Using a transfer is simpler because the money goes straight from one account to the other. You don't have to handle the money physically or worry about any tax withholding. Better yet, you don't have to report it on your taxes. With an indirect rollover, the process is more complicated. You'll get a check for 80 percent of the distribution and you have 60 days to deposit 100 percent of it into your IRA. Then, you have to tell the IRS about the rollover on your taxes, and only then will you get the lost 20 percent as part of your tax refund.
Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."