Priority of savings as one nears military retirement

[av8er]

All,

Wanted to tap into the collective wisdom of the group to get some thoughts/advice on how I should prioritize my savings for the last several years of my military career (likely will retire w/in the next 4 years).

I have two competing goals: 1) Continue to maximize ROTH TSP/IRAs while on AD to minimize tax burden in retirement and 2) purchase a house once I retire from the military, preferably in full w/ cash on hand.

I'd like to keep piling money into the ROTH accounts and, once I retire, do ROTH conversions on the traditional account balances to pull those funds over into the ROTH category (current split in my retirement accounts is ~60% ROTH and ~40% Traditional). Because my pension will automatically put me into a higher tax bracket, having our retirement accounts all in the ROTH category will give us more options down the road since I expect tax rates to increase over time.

In addition to our retirement savings, we also save aggressively for the purchase of our retirement home. We're a bit over halfway to our savings goal but likely won't be able to buy entirely w/cash unless we stop contributing to our retirement accounts for the last few years of AD.

I have two options that I'm considering:

1) Keep piling money into ROTH accounts while on AD and take out a low interest rate mortgage that I can pay off through ROTH conversions of my Traditional TSP account balance over a timeframe that makes sense. This would allow me to maximize contributions into my ROTH accounts during my working years while drawing down the Traditional accounts through ROTH conversions in retirement. The ROTH conversion amounts, though, would go towards paying the mortgage for several years until it was paid off so it would not add to my ROTH account balances. I have sufficient existing ROTH IRA contributions to execute a ROTH conversion ladder in year one of retirement.

2) Stop funding my ROTH accounts for the last 3-4 years of my military career to ensure I can purchase our retirement home w/cash. This will preclude me from needing a mortgage, but will also mean that I'll miss out on several years of ROTH contributions. In retirement, I would execute ROTH conversions to transfer my Traditional accounts into the ROTH category. And, because I would not need to draw out those funds for a mortgage, they would grow our overall ROTH balance over time.

Thoughts on the proper prioritization of savings? Any advice is greatly appreciated!

 

[Koolau]

Now regretting that, in retirement I have TOO much in 401(k) (dirty, miserable rotten RMDs!) and not enough in Roths. I always suggest folks emphasize funding Roths WHENEVER possible (almost) no matter what. (So far, at least) they can't take them away from you or ever tax you on them. If that means a mortgage for the house, I'd do that. I'm sure many here will disagree with me. Roths are just my particular 'kink' with not too much in the way of 'evidence' or 'precedent' so YMMV

 

[RetireBy90]

It is my understanding that Roth contributions can be withdrawn before 59.5 without penalty, so I would continue to pump into the Roth until you are ready to buy the house. You can then draw what you need for the house. If you change your mind you will still have the funds in the Roth awaiting your needs.

Also, I would consider a small 15 year mortgage, depending on your age. Rates are so low and the FED says they will be low for some time. I just got a 15 year mortgage at 2.375%. I can get close to 4% in dividends so I’ll leave the money invested DW and I are both retired Army, so the 2 checks pay mortgage and a bit more. Just something to consider.

 

[Finance Dave]

It is my understanding that Roth contributions can be withdrawn before 59.5 without penalty, so I would continue to pump into the Roth until you are ready to buy the house. You can then draw what you need for the house. If you change your mind you will still have the funds in the Roth awaiting your needs.

Also, I would consider a small 15 year mortgage, depending on your age. Rates are so low and the FED says they will be low for some time. I just got a 15 year mortgage at 2.375%. I can get close to 4% in dividends so I’ll leave the money invested DW and I are both retired Army, so the 2 checks pay mortgage and a bit more. Just something to consider.

I'd read up on that first option before playing it...I'm no expert but I THINK that if you take the Roth contributions you must take a proportional amount of the profits as well...thus triggering a tax event....maybe others on here can verify if this is the case.

 

[Offgrid Organic Farmer]

I retired in 2001, as an E6 after having served 20 years on Active Duty in the US Navy. At that time I had a Triplex about half paid off, though full of tenants.

We returned stateside and moved into one apartment of that Triplex. The rent income was more than enough to cover the mortgage, insurance and taxes. We did well to just sit there.

But after four years of being retired, we decided that we wanted to more to a rural homestead. We refinanced the mortgage and used the money to buy land and to build our homestead.

We have been here 15 years, so far. Living rural is a lot less expensive than city life was. But we do have the advantage of owning our home with no mortgage.

 

[Nords]

I have two competing goals: 1) Continue to maximize ROTH TSP/IRAs while on AD to minimize tax burden in retirement and 2) purchase a house once I retire from the military, preferably in full w/ cash on hand.

1. As others have mentioned, you can withdraw Roth IRA contributions at any time.

After you leave the military you can also roll your Roth TSP over to a Roth IRA and withdraw *those* contributions at any time.

If you have contributions to a traditional TSP from combat zone tax-exempt pay then you can also do a partial Roth IRA conversion and withdraw the CZTE pay.

Those three options might bridge the gap between your taxable accounts and age 59.5.
Whether you contribute to your Roth TSP/IRAs or a taxable account, a passively-managed index fund with low expense ratios will be very tax-efficient and you won't miss out on much if it goes into a taxable account.

2. I have way too many readers who've stressed themselves out over buying a home after the military, and IVMF's studies show that nearly half of all vets move again within two years of leaving active duty (for happy reasons).

If you insist on buying a home right after you leave active duty (for all the right reasons) then make sure you're ready to deal with the pitfalls:
https://the-military-guide.com/dont-buy-home-leave-active-duty/

You have more options than paying cash. You could borrow a 30-year fixed-rate mortgage (perhaps a VA loan that waives the funding fee) and make the payments from your pension. Your pension deposits (and any VA disability compensation) rise every year with inflation while your P&I payments stay flat. Do the math on that and decide whether it's worth the price of sleeping more comfortably at night.

 

[av8er]

Appreciate the comments/thoughts. Currently leaning towards option #1: continue to fully fund ROTH TSP/IRA until MIL retirement as a first priority, continue to save aggressively in taxable accounts for our retirement home as a second priority, and use a low interest mortgage to cover any gap. Intend to use a Roth conversion ladder from the Traditional side of TSP to cover the mortgage/pay it off in a reasonable (and most tax advantageous) timeframe and, once paid off, continue to use the conversions as a vehicle to move the remaining Traditional funds into the Roth category. Ultimately, would like to have all Traditional funds moved into the Roth category before RMDs are required.

Mathematically the option above makes the most sense, particularly in today's low mortgage interest rate environment--it provides the most flexibility while allowing me to continue to maximize earnings in my Roth accounts. And, if I decided I didn't like having the mortgage at any point, I could simply withdraw enough Roth contributions to pay it off...but, I also really like the idea of having a paid for house at the beginning of retirement which is why I've toyed with prioritizing house savings over Roth contributions for the last few years before retirement. For now, I think I'm going to stick with the most mathematically-advantageous option!

And Nords, tracking all WRT the potential pitfalls of purchasing a house immediately after military retirement...but, after decades of living in post housing and rentals, my better half is ready to finally settle down/put down some roots! We'll still have kids at home for several years after I retire...our housing needs (and even location desires) may well change once they've left home.

 

[Twize]

Time and compounding is your friend. I would continue to max out the Roth then save for house secondary like you said. However I would go for a 15 year mortgage and pay it off as fast as possible. Having no mortgage is so awesome! I love the freedom that comes with not having that hanging over my head.

 

[jollystomper]

I also agree with the first option. I was never eligible for a Roth IRA while working so missed the ability to save into it, so go for it.

At the current VERY low mortgage rates I also agree with getting a 15 year mortgage with the goal of paying it off early at some point.

 

[corn18]

I'd read up on that first option before playing it...I'm no expert but I THINK that if you take the Roth contributions you must take a proportional amount of the profits as well...thus triggering a tax event....maybe others on here can verify if this is the case.

Nope. Here are the ordering rules for Roth IRA's. There is no proportional rule. You can pull out 100% of contributions before you ever get taxed.

For example:

$200k Roth account: $150k contributions, $50k earning. You can pull out $150k and not owe any tax or penalties.

Be careful not to confuse contributions with conversions.

ORDER OF DISTRIBUTIONS
Regular contributions
Taxable portion of first conversion
Nontaxable portion of first conversion
Each subsequent conversion, in order, with the taxable portion coming out first for each conversion
Earnings (any increase in value occurring inside the Roth IRA)

TAXES AND PENALTIES

UNDER AGE 59.5*
FIVE YEAR CONVERSION HOLDING PERIOD NOT MET*
Contributions: Tax-No; Penalty-No*
Conversions: Tax-No; Penalty-Yes (Taxable Portion)*
Conversions: Tax-No ;Penalty-No (Nontaxable Portion)*
Earnings: Tax-Yes; Penalty-Yes*

UNDER AGE 59.5*
FIVE YEAR CONVERSION HOLDING PERIOD MET*
Contributions: Tax-No; Penalty-No*
Conversions: Tax-No; Penalty-No (Taxable Portion)*
Conversions: Tax-No; Penalty-No (Nontaxable Portion)*
Earnings: Tax-Yes; Penalty-Yes*

OVER AGE 59.5*
LESS THAN FIVE YEARS SINCE OPENING FIRST ROTH IRA*
Contributions: Tax-No ;Penalty-No*
Conversions: Tax-No; Penalty-No (Taxable Portion)*
Conversions: Tax-No; Penalty-No (Nontaxable Portion)*
Earnings: Tax-Yes; Penalty-No*

OVER AGE 59.5*
FIVE YEARS OR MORE SINCE OPENING FIRST ROTH IRA*
All Distributions Are Qualified*
No Taxes*
No Penalties*

 

[teej1985]

ORDER OF DISTRIBUTIONS Regular contributions Taxable portion of first conversion Nontaxable portion of first conversion Each subsequent conversion, in order, with the taxable portion coming out first for each conversion Earnings (any increase in value occurring inside the Roth IRA)

What is a nontaxable portion of a conversion? Would that be if you had converted a nondeductible IRA?

 

[corn18]

What is a nontaxable portion of a conversion? Would that be if you had converted a nondeductible IRA?

Correct. Or after tax contributions to your 401k that you converted to a Roth IRA (not a 401k Roth).