Where to put US Navy lump sum payment?

[lsimpson33]

I'm working with an 18-year-old US Navy mentee.

He's been contributing to the Navy Thrift Savings Plan (TSP) Roth (confirmed that it is the ROTH) and his YTD is $200 as of 3/31/2021. He does have the option of switching over to their Deferred Contribution Plan (401k-like) if that would ever make sense.

In May, he'll receive a sign-on bonus of around $27k.

They will not allow him to do a lump sum payment to fully fund the Roth with the TSP. While I know he could increase his % contribution limits and live off some of the extra cash, I don't think he's at that discipline level yet to not spend it. I'm also trying to minimize his taxes at this point.

He does want to retire early, but he's still very young, so I'm more worried about taxes than building up a non-retirement account.

Here's the plan. Thoughts? Better options?

1. Open a second Roth for 2021 and put $5,600 in that ($800 is going into the TSP and $100 buffer, so a total of $6,500 for the tax maximum).
2. Put the rest of the money in a CD or something else where he can't touch it until 2022, then max out his Roth again. Then put the rest in a CD, rinse and repeat for 2023.

Thanks in advance for any thoughts or advice.

 

[SnowballCamper]

I suspect the mentee is already in the BRS (Blended Retirement System) since it went into effect January 1, 2019. It provides for matching funds. It is better for the service member that doesn't complete the 20 year cliff vesting time because it is transportable like a 401k.

The TSP has both Roth and tax deductible options.

Your mentee is getting the run around, as is typical. See the DFAS website https://www.dfas.mil/MilitaryMembers/tspformilitary/tspac/ Third paragraph under "Starting TSP Contributions" has a link to a worksheet to determine the percentage. I suggest printing out that and the webpage when the mentee goes to finance. Good Luck!

 

[pdsmith505]

I'm working with an 18-year-old US Navy mentee.

He's been contributing to the Navy Thrift Savings Plan (TSP) Roth (confirmed that it is the ROTH) and his YTD is $200 as of 3/31/2021. He does have the option of switching over to their Deferred Contribution Plan (401k-like) if that would ever make sense.

In May, he'll receive a sign-on bonus of around $27k.

They will not allow him to do a lump sum payment to fully fund the Roth with the TSP. While I know he could increase his % contribution limits and live off some of the extra cash, I don't think he's at that discipline level yet to not spend it. I'm also trying to minimize his taxes at this point.

He does want to retire early, but he's still very young, so I'm more worried about taxes than building up a non-retirement account.

Here's the plan. Thoughts? Better options?

1. Open a second Roth for 2021 and put $5,600 in that ($800 is going into the TSP and $100 buffer, so a total of $6,500 for the tax maximum).
2. Put the rest of the money in a CD or something else where he can't touch it until 2022, then max out his Roth again. Then put the rest in a CD, rinse and repeat for 2023.

Thanks in advance for any thoughts or advice.

It sounds like you have a bad understanding of the TSP. Yearly contribution limit for TSP is currently $19,500 (it'll be $20k next year). The contribution limit doesn't change regardless of if you direct your contributions to the "Traditional" or "Roth" TSP options.

Your mentee is also part of the "Blended Retirement System". The government will match up to 5% of his base pay in contributions to his TSP account. Make sure he is at least contributing 5% base pay. Doing that, at E-3 pay scale (~$2100/month basic pay), he'd be putting ~$210/month or $2500/year into the TSP account, including the government match.

In theory, he could max out his first year contribution to the TSP by putting 72% of his base pay into the TSP and getting that 5% match from the government on top, then live off of his sign-on bonus instead of his salary. If you could steer him to be that disciplined, that would be awesome. But, you already ruled that out.

The good news is that the "Roth" TSP is not a Roth IRA, and your mentee is still eligible to create his own Roth IRA outside of the the TSP. That Roth IRA would follow the same rules you are familiar with, and is not affected by the TSP contributions.

So, now with the better understanding of what the Roth / Traditional TSP is, it's limits, and what it's not, maybe you have a better idea of how to direct him to set himself up for success.

If I were talking to him? I'd say do all of the below
1) Elect a minimum of 5% contribution to TSP to maximize the Government match. 10% is better, because of the magic of compounding interest. Use the Roth option.
1)a) For now, direct the contribution to the "Lifecycle 2065" fund. They will manage the portfolio for him, and he can always move it to the individual funds later when he has an idea of what he wants to do.
2) Use the sign-on bonus to fully fund a separate Roth IRA. Keep the rest in a liquid account "war reserve' so he can use it for emergency expenses.
3) Use the "war reserve" from (2) to fund next year's Roth IRA contribution, and so on.
3) Work to put $6.5k back into the "war reserve" in #2 every year so that it stays level, even with pulling Roth IRA funds out.

Here's a link to a handy calculator that you can sit down with him and go over.
https://militarypay.defense.gov/Calculators/Blended-Retirement-System-Standalone-Calculator/

As a young military guy, his living expenses are going to be relatively low compared to the average person... so long as he doesn't do anything stupid. He gets allowances for housing and subsistence (which will mean his berthing and messing on the ship/installation at first). He gets a uniform allowance which, while it doesn't necessarily cover all of his uniform expenses, cuts down on costs for work clothing. And, on top of that, he is getting a salary.

Here's some things that I see a lot of young military guys do that are definitely "don't do this" items:
1) Don't buy a fancy car right off the bat. Especially not on a 20% interest loan. No one cares if your Cougarthunderfalconbird looks cool driving up and down the street on base.
2) Don't get married just to get an extra $200 in BAH and out of living in the barracks/ship.

 

[Nords]

I'm working with an 18-year-old US Navy mentee.

He's been contributing to the Navy Thrift Savings Plan (TSP) Roth (confirmed that it is the ROTH) and his YTD is $200 as of 3/31/2021. He does have the option of switching over to their Deferred Contribution Plan (401k-like) if that would ever make sense.

In May, he'll receive a sign-on bonus of around $27k.

They will not allow him to do a lump sum payment to fully fund the Roth with the TSP. While I know he could increase his % contribution limits and live off some of the extra cash, I don't think he's at that discipline level yet to not spend it. I'm also trying to minimize his taxes at this point.

LSimpson33, I don’t know the details of your mentee’s rate or bonus program, but let me clarify the TSP & IRA vocabulary.

I’m confused by your comment “He does have the option of switching over to their Deferred Contribution Plan (401k-like) if that would ever make sense.” The TSP is the deferred contribution plan, and it comes with both Roth TSP and traditional TSP options.

Here’s his options for retirement accounts:
1. He’s eligible to contribute to his Roth TSP account and to a Roth IRA.
2. He’s also eligible to contribute to his traditional TSP account and a traditional IRA.

Military compensation is very lightly taxed. He may be in the lowest income-tax bracket of his life right now, and at his lower income he may also be eligible for the Earned Income Tax Credit. He might actually pay zero income taxes for a few years, which means that his Roth TSP and his Roth IRA are where he should be contributing now.

His 2021 contribution limit to his Roth TSP is $19,500. That’s both the elective deferral limit of 401(k) law as well as the TSP’s hard-stop limit to the Roth TSP. (The traditional TSP can have higher contribution limits when he’s earning his income in a combat zone.) However he’s in the Blended Retirement System, and that means he’s eligible for Dept of Defense agency/matching contributions to his TSP. The agency contributions should be happening now (1% of base pay to the traditional TSP) and the matching contributions (another 4% of base pay to the traditional TSP) start when he has two years of service. In addition, the DoD BRS agency & matching contributions do not count toward that $19,500 elective deferral limit.

The Navy’s pay software limits its Roth TSP contributions to roughly 60%-65% of base pay and 100% of special pays (like sea pay and bonuses). He absolutely can contribute most of his bonus to his Roth TSP, but only up to the $19,500 limit.

As a side issue, once he hits that $19,500 limit in the Roth TSP then he’ll be locked out of all further TSP contributions for the rest of the calendar year. This is not an issue for the first two years of service, but when his DoD BRS matching contributions start then he’ll want to contribute at least 5% of his base pay to the Roth TSP. (That earns him the full match, which by law the DoD will put in his traditional TSP account.) However he has to limit his monthly Roth TSP contributions (from base pay and special pays) to make sure that he contributes at least 5% to the Roth TSP every month of the year. If he front-loads his Roth TSP contributions before December then he’ll be locked out of further TSP contributions and he’ll miss out on his match for the months when he’s locked out.

All of these rules and limits are laid out in the BRS policy document at this link:

https://militarypay.defense.gov/Portals/3/Combined BRS Policy Document (Updated Oct 2020).pdf
For now, the part he cares about is in paragraph 7.

When he has more control over his time during working hours then I’d strongly encourage him to visit his military base’s family financial support office. It’s staffed with Accredited Financial Counselors who’ll explain the system for free and help him set up a budget. I highly recommend visiting with a counselor for an hour and especially the course “Million Dollar Sailor.” The TSP also has a number of videos on their TSP.gov site and on their Facebook feed.

I’m also happy to answer more questions here or by e-mailing NordsNords at Gmail.