Bottom Line Up Front (BLUF): Finding the right mix of investment accounts can be confusing at first. Start with Goals in Mind, but Prioritize Retirement. Do these steps: 1. Start with Roth TSP (only if enrolled in BRS). 2. Max out Roth IRA. 3. Increase Roth TSP to reach 15% total invested. 4. Choose your next step based on your goals.
When you are first starting out, it can be confusing to learn about all of the different types of investing accounts. I mean… what is a brokerage account, and what is it for? Or, what is the difference between a Roth IRA and IRA… or an IRA vs. the Thrift Savings Plan? And, the #1 question: Which types of accounts should I use?
In this article, I hope to give a prioritized list of which investment accounts to use first (based on how they benefit most military investors).
Note: The decision of which types of investment accounts to use should be based on more that just reading one blog post. However, hopefully this article will give you a little more knowledge and a place to start your own research.
Start with Goals In Mind (but Prioritize Your Retirement)
With financial planning, always start with the goal in mind. However, almost everyone needs to invest more for retirement than they think they do. Beyond retirement, you should also consider whether you might need money to…
- Buy a new house
- Pay for (some/all) of your kids’ college
- Support your parents (because they didn’t invest for retirement)
Though you should consider these goals, make sure that you start by investing in your own retirement first. Why? It’s like putting on your air mask on a plane first. If you don’t help yourself, you can’t help others. Also, if you don’t, you may find yourself becoming a burden on your kids in the future.
By putting your investment dollars into the right types of investing accounts, you can give yourself a little flexibility while still getting the benefits of using tax-advantaged retirement accounts like TSP and IRAs.
Investment Account Types (in order):
Because you want to invest in your retirement first (but want the flexibility to handle future unknown costs/needs), these are the types of investment accounts I’d recommend investing in:
Step 1. Roth Thrift Savings Plan (if you are enrolled in BRS retirement) - Get Your Match
NOTE: If you are not enrolled in the BRS plan (i.e. old timers who joined on or before 31 Dec 2017, and didn’t opt in), you should skip to step 2.
If you are enrolled in the Blended Retirement System (BRS) retirement plan, invest in Thrift Savings Plan (TSP) first! Military members who joined after 31 Dec 2017, or who otherwise opted into the BRS, get matching contributions to their TSP when they invest up to 5%. This means that if you invest at least 5% of your base pay, the government will invest an additional 4% into your TSP account to “match” your contribution. In short, this is a completely guaranteed, free 80% return on your money, so do this first! (This also goes for veterans/retirees who have access to a 401K plan with company matching.)
For most military members - and especially enlisted members - you should invest in a Roth TSP vs. traditional TSP. Why? Because a lot of military pay (like our sustenance and housing allowances) is tax free, most military members pay a low tax rate.
Roth TSP investments grow tax free. For example, if you invest $100,000 for 30 years (at a 7% return), it would be worth $761,226 thanks to compound interest. In your Roth TSP, that extra $660,000 of growth is tax free. In a traditional TSP, you’d have to pay taxes on that $660,000… which at 22% tax would be cost $145,000 in taxes! (You do get a tax deduction when you invest in traditional TSP, but if you have a long time horizon, the Roth TSP’s tax-free gains are better in the long run.
Recommendation: Invest 5% of your base pay (if you are enrolled in BRS) to get your TSP matching contribution (i.e. free money). Then, move on to Step 2
For step-by-step instructions on how to start your TSP contributions, please see my two posts entitled “How to Start Investing in the Thrift Savings Plan (TSP) Part One: Setup MyPay” and “How to Start Investing in the Thrift Savings Plan (TSP) Part Two: Change Your TSP Allocations to get started.
Step 2. Roth IRA - Max it out ($6,000/year)!
Next, it is time to start maxing out your Roth Investment Retirement Account, or Roth IRA.
What is a Roth IRA? It is an investment account where you invest after-tax dollars, but all of your investments grow tax free. Like the example above for Roth TSP, investing in a Roth IRA allows you to get the benefit of compound interest and avoid huge tax bills later in retirement. It also has some amazing additional benefits. For starters, you also do not have to pay taxes on any investment dividends or earnings… ever. You are also not required to take Required Mandatory Distributions (RMDs) when you hit retirement age… which allows your money to grow longer. Finally, you can remove your contributions (i.e. the money you invested, but not the earnings) at any point without a penalty.
What does this do for you? You benefit from a tax-advantaged retirement account, where you don’t have to pay any taxes on your investments’ growth. You can leave your money in longer if you want (for even more growth). Also, if you really have to, you can always remove your contributions at any time. For me, maximizing your investment in a Roth IRA is a no brainer.
The only downside? You can only invest $6,000/year in an IRA or Roth IRA (or $7,000/year if you are over 50 years old). For most people, investing only $6,000/year is not enough to retire comfortably. So, your plan should be to max this out, and then invest more in other accounts as well.
Side note: you can also invest another $6,000/year in an additional spousal Roth IRA for your spouse, even if they don’t have their own income.
To start a Roth IRA, you need to pick an investment company… preferrably a low-cost investment firm that allows for free trades and no annual fees. Some of the most notable companies include:
- Charles Schwab (who I use)
- Vanguard
- Fidelity
- …and dozens of other brokerages.
Once you pick an investment company, open a new account and request to open a Roth IRA. Sign a bunch of paperwork online and then start transferring money into your new Roth IRA every month. Then, you need to buy investments. For info on what types of investments that I buy, read more on my post entitled “Military Investing - Step 6: Diversify”.
Recommendation: Invest the maximum ($6,000/year if you are under 50 years old) into a Roth IRA, and then move on to Step 3.
NOTE: The IRS requires that you make less than $129,000/year (or $204,000/year if married/widowed) to invest in a Roth IRA. However, you can get around this by using a backdoor Roth strategy. You start by opening a traditional IRA and Roth IRA (with the same company). Then, you transfer the money into your IRA each month, and then transfer that money to your Roth IRA (and invest it there). Please see this post from Charles Schwab for more details.
Step 3. Roth Thrift Savings Plan (Roth TSP) or Roth 401K - Increase until you are investing (at least) 15% of your total income
Next, I recommend investing in the Roth Thrift Savings Plan (Roth TSP).
Why invest in Roth TSP after a Roth IRA? Because, the Roth TSP does not share all of the benefits of the Roth IRA. While the Roth TSP’s investments still grow tax free, you can’t remove your contributions early. You also must take out Required Mandatory Distrubitions (RMDs) when you reach 72 years old, unlike in a Roth IRA. You can also only invest in it while still in the military or civil service.
However, you can invest way more into Roth TSP than a Roth IRA. You can invest up to $20,500/year into TSP. Between this and a Roth IRA, you can invest $26,500/year. However, for many people, this is more than they can afford. So, I recommend increasing your monthly investments until you are investing (at least) 15% of your total income for retirement. If you do more, great!
Recommendation: Invest enough between your Roth IRA and Roth TSP to invest (at least) 15% of your total income. Then, move on to Step 4.
For step-by-step instructions on how to start your TSP contributions, please see my two posts entitled “How to Start Investing in the Thrift Savings Plan (TSP) Part One: Setup MyPay” and “How to Start Investing in the Thrift Savings Plan (TSP) Part Two: Change Your TSP Allocations to get started.
3A. Roth 401K
For those who cannot invest in TSP - like retirees and veterans - you’ll want to invest in your employer’s 401K program instead (if available). If you have access to a Roth 401K plan, it would give you the same benefits as the Roth TSP. If not, ensure that you are investing in your company’s 401K program if possible. Regardless, I recommend continue to increase your contributions until you are investing at least 15% of your income.
Step 4. Choose Your Own Adventure - Depending on your goals, pick your next step:
Remember when we talked about goals? This is where it matters. Once you are investing enough for retirement (at least 15% of your income), your next step is to pick what you value more. Here are some of your next options:
4A. Want a Better Retirement? Keep Investing in Roth TSP
If your priority is to invest more for retirement, then you can continue investing in TSP (up to the maximum $20,500/year). This will help you build a much bigger nest egg. However, you won’t be able to access this additional money until retirement age (at least, without paying a big penalty).
4B. Want More Flexibility? Open a Brokerage Account
If your priority is to have flexibility to spend your money, but also to invest to keep up with inflation, then opening a brokerage account might be for you.
What is a brokerage account? It is just a regular investment account, like an IRA but without the tax benefits or the restrictions. With a brokerage account, you can pull your money out at any time. However, any investments in this account are subject to capital gains taxes each year… especially for those purchased and sold within the same year. Capital gains taxes will cut your overall investment profits, but you can use this type of account to save to buy a house any other expenses you might have.
Opening a brokerage account works like opening a Roth IRA. You create an account with an investment company, and then request to open a brokerage account. You sign lots of paperwork online, and then you transfer money into your account. Then, you buy investments. For info on what types of investments that I buy, read more on my post entitled “Military Investing - Step 6: Diversify”.
4C. Want To Save For Your Kids? Open a 529 or ESA (for college), or a UTMA or UGMA (not for college)
Do you want to make sure your kids are able to pay for college without crippling debt? Transferring your GI Bill only pays for college for one kid. Instead of hoping your kids earn their own scholarships - or that they don’t go - you could help invest for their future by saving for their education. Education Savings Accounts (ESA) and 529s are tax-advantaged accounts that let you save for your child’s education. However, spending this money is restricted to education expenses only, or else it comes with penalties.
Or, do you want to open a custodial account where you can invest on their behalf? That is an option with UTMA or UGMA accounts, which are investment accounts that must be transferred to your child when they come of age. Money invested in these accounts can be later spent on anything… like starting a business or paying non-education expenses. They are also somewhat tax advantaged, at least up to a certain amount of earnings per year.
If you are interested in any of these options, I detail what I know in my post entitled, “How to Save for College – ESA vs. 529 Plans
4D. Want to Invest in Real Estate?
If you are interested in investing in real estate… I’m probably not the best person to ask. However, I do detail some of the additional risks for military members in my post entitled, “Should I buy a house while in the military?”.
There are many people who’ve become fabulously wealthy investing in real estate. However, being in the military creates some added risks that you should be aware of. If you are still undeterred, there are many who other real estate investors - like Grant Cardone and Robert Kiyosaki - who provide the knowledge needed to follow this path. However, avoid real estate “training courses” until you do your own research… many of these are just scams designed to take your money.
4E. Looking for alternate investments?
The options above are not every type of investment that exists, just those that I am able to recommend. You could also “invest” in cryptocurrency and NFTs. Or, you could buy life insurance that bundles cash value investments (e.g. whole life, universal indexed life, etc.)… albeit with high fees. However, do your own research before investing, as it is very easy to lose your money. Also, I only recommend investing in these after you are fully funding your retirement needs.
Conclusion
I hope this article is useful for those who are trying to decide what type of investment accounts to use first, second, etc. I recommend fully funding your retirement first - in Roth IRA and Roth TSP - before branching out into other types of investment accounts.