Take it or leave it? p1 - Military Career Development Strategies & Tips - Military Times EDGE

The question of whether to save for retirement in the federal Thrift Savings Plan is not a difficult one, says John Gannon, president of the Financial Industry Regulatory Authority Investor Education Foundation: TSP is one of the most cost-effective, well-designed employer savings plans in existence, and he thinks too few service members take advantage of it.

But what, if anything, should you do with your savings when you leave the military? Should you convert your TSP account to another type of plan? That’s a more complicated question.

The Thrift savings plan

The Thrift Savings Plan allows all active-duty, National Guard and reserve members to contribute part of their basic pay before taxes to a choice of investment funds, although unlike federal civilians, service members do not receive matching contributions from the government.

There are two advantages to “before tax” contributions, according to the TSP Web site, www.tsp.gov:

• Your TSP contributions are taken out of your pay before taxes are withheld, so you pay less tax now.

• Taxes on contributions and attributable earnings are deferred until you withdraw your money.

Unless you have a very small account — under $1,000 — you don’t have to roll over your TSP account when you leave the military, said Gannon. You can continue to manage it just as before; the only thing you can’t do is contribute more to it.

Roth savings plans

But what if you think you will be in a higher tax bracket when you retire than you are now? In that case, you might want to take your pain up front — that is, pay tax on your contribution now, and withdraw it and the interest tax-free decades down the road.

This is called a Roth option, and it has gotten a lot of attention lately: This year, for the first time, anyone can convert their individual retirement account to a Roth IRA, regardless of income, and people who make the conversion in 2010 can spread their tax liability over two years.

Service members, especially junior service members and those getting tax-free combat pay, are among those most likely to benefit from a Roth retirement savings plan. In fact, the Defense Department is putting off automatic enrollment for service members in TSP until a Roth option is up and running probably in early 2012. The rest of the federal government will begin enrolling new hires in the program automatically in August.

In the meantime, many service members and veterans might be tempted to make the switch.

“For many people, there would be a tax benefit of converting,” Gannon said. But the tax benefit is not the only factor; converting to a Roth option savings plan is “a complex decision, and I think it’s been oversimplified,” he said.

Some things to consider:

Taxes: You will have to pay taxes on the money in order to convert to a Roth plan. “That money’s going to have to come from somewhere,” Gannon said. “In the ideal situation, it’s not coming from the TSP. It’s usually not in your benefit to tap into your TSP to pay those taxes.”

Imminence of retirement: “The longer you have to work, the more sense doing a Roth conversion is,” Gannon said. “The closer you are to [retiring], the less sense it makes. It still might make sense, but it’s less likely.”

Costs: You’re not likely to find a lower-cost savings plan than TSP, said Mike Miles, a Certified Financial Planner licensee and principal adviser for Variplan LLC, an independent fiduciary in Ashburn, Va. “Even the most inexpensive outside arrangements tend to be multiples more than the TSP” cost, which as of April 1, was about 1/20th of 1 percent. Employer 401(k) plans have notoriously high costs: in some cases 2 percent to 3 percent.

This is more important than some people realize, Miles said. “People really underestimate the impact of cost on their return. Cost is one of the most important factors in determining performance, and people tend to treat it as a secondary factor.”

Other factors: Converting to a Roth plan could be a bad idea if you need to apply for college financial aid or Social Security disability benefits because it increases your taxable income for that year, Gannon said. These situations will not affect many people, he noted, but should be considered.

So should you convert your TSP account to an outside plan — perhaps a Roth plan — when you leave the service?

“When in doubt, no,” Miles said.

It is possible that certain service members and veterans could benefit from converting their TSP account, but he doesn’t recommend doing so without analyzing these and other factors with a competent, objective adviser.

“The default answer should be to leave the money in TSP and manage it there.”