Uses For Tax-Exempt Pay

**Desperado** · 11-25-2006, 04:23 PM

Another thread in this forum has a detailed discussion of tax-exempt war-zone pay and its uses. Of course, one can contribute up to $29K per year of it into the TSP. The alternatives include funding a Roth, buying taxable investments (such as Vanguard's Total Stock Market Fund, Tax-managed small fund, Tax-managed international fund etc), paying down the mortgage, and of course spending it. The benefit of putting it into the TSP is tax-deferred growth, but without any tax deduction (like an IRA) or tax-free withdrawals (like a Roth). This seems to me to be the equivalent of using a very low cost variable annuity. Generally, low-cost variable annuities are appropriate for high-tax bracket individuals and those who need more tax-protected space for tax-inefficient assets such as REITs and Bonds. Since the TSP doesn't have a REIT fund (yet), I suppose it would only be appropriate if I were going to use the TSP space for bonds. Although I don't need more fixed income in my asset allocation at this time, I suspect my entire TSP fund will be invested in the G fund in 10-15 years, while my non-TSP assets will be invested more in equities. A variable annuity, of course, often isn't a good idea for holding tax-efficient equity funds because it converts gains from long-term capital gains into regular income. It takes decades of tax-deferred growth to make up for this.

I plan on 4 months of deployment at the end of 2007. I will have no difficulty maxing out both my own and a spousal Roth and my tax-deferred 15K TSP contribution before I am deployed and should receive about $30K during those 4 months that I do not need to spend (mostly a medical special pay.)

I am trying to decide whether to use the money to:
1) Contribute to the TSP so I have more money in there eventually that can be used for fixed income.
2) Pay down my mortgage (6.125%, 25% marginal tax bracket)
3) Hold the money in a money market account until Jan 1st, then immediately fully fund our 2008 Roths and go 100% TSP for the first 3-4 months of 2008 while living off the stashed money.

Any recommendations would be appreciated.

**domingo3** · 12-07-2006, 04:59 PM

A couple of questions for you.

First, how much longer do you anticipate being in the military for? The reason I ask is that if you dump that tax free money into the TSP, you can roll it over to a ROTH IRA when you separate from the military. The gains that you made in the interim will not be tax-free, but the contributions themselves will be.

Second, do you anticipate that you will still be in the 25% tax bracket, even with 4 months of tax free pay?

Also, how large is your mortgage, and what other deductions do you have? What I'm getting at is if your total deductions, including mortgage interest, is close to your standard deduction, the tax benefit is marginal. Generally, though, it's best to stay fully invested and pay off your mortgage on schedule.

Dulmping the money into TSP and Roths at the beginning of the year would have a small benefit if you're in conservative interest earning investments. If you're dumping into equities, you lose the security of dollar cost averaging throughout the year. You never know what will happen to the market next June.

**Desperado** · 12-12-2006, 02:37 AM

Originally Posted by domingo3

First, how much longer do you anticipate being in the military for? The reason I ask is that if you dump that tax free money into the TSP, you can roll it over to a ROTH IRA when you separate from the military. The gains that you made in the interim will not be tax-free, but the contributions themselves will be.

I'll only be in the military to make 5 years worth of TSP contributions (4 years of actual service.) But that last year I'll be in a higher tax bracket than I probably will be in retirement. So it probably wouldn't be a great time for a Roth conversion. The other problem is you cannot just convert the tax-exempt money, you have to convert all of it. If I convert all my TSP, then I lose access to some very low cost investments and the G Fund free lunch, which I plan to use for a very, very long time. In fact, I eventually anticipate that my entire TSP will be in the G fund in 15-20 years as my bond allocation.

Originally Posted by domingo3

Second, do you anticipate that you will still be in the 25% tax bracket, even with 4 months of tax free pay?

It could be close. I may be able to sneak into the 15% bracket, but it would be very close.

Originally Posted by domingo3

Also, how large is your mortgage, and what other deductions do you have? What I'm getting at is if your total deductions, including mortgage interest, is close to your standard deduction, the tax benefit is marginal. Generally, though, it's best to stay fully invested and pay off your mortgage on schedule.

I anticipate my mortgage deductions to be about 6K, next year, and that should all be above the standard deduction cut-off. (Lots of charitable contributions.)

Originally Posted by domingo3

Dulmping the money into TSP and Roths at the beginning of the year would have a small benefit if you're in conservative interest earning investments. If you're dumping into equities, you lose the security of dollar cost averaging throughout the year. You never know what will happen to the market next June.

I don't dump into equities. I dump into everything. I rebalance with each new contribution. I'm confident I can maintain my asset allocation in the face of a bear market.

**Desperado** · 12-12-2006, 02:42 AM

asdfsad

**pyriel** · 12-14-2006, 12:31 AM

E mployee
S elf employed
B usiness
I nvestor

E and S are taxed the most
B and I are those that taxed the least.

Me, I want to be in the B and I and currently funneling most of my asset within that direction. However, I am also an E which is why I maxed out my TSP. However, I feel that if i am to funnel my TSP contribution into a business, I could get more tax deduction and get better return. We'll see...

My wife and I currently have Married with 10 exemptions but due to my business we still get a return for from our last year's tax;-)... If you are keeping your $$ in the G fund then that is your perogative and more power to you... I do like your comment about giving charitable contributions. You get a high five for that.;-)

P

**domingo3** · 01-04-2007, 08:25 PM

Based on your situation, you're probably best off paying down your mortgage.

My hesitation with going all in at the beginning of the year is not a matter of assett allocation, it is a matter of market timing.

If you were investing more aggressively within TSP, I'd recommend funding TSP over paying off your mortgage.

I don't believe you'd be giving up anything that special by being outside the TSP, and you would gain a great deal of flexibility. Also, I wouldn't want that much money tied up in the G fund, because I see it as losing out on potential returns, but you know more about your situation than I do.