Getting Started Series Part 3: Tax Advantaged Retirement Accounts

Getting Started Series Part 3: Retirement Accounts

This is a series intended to answer the question “I’m covering my bills, now what?” It’s for people who have a steady source of income and have a vague notion that they should be doing something more with their money, but don’t really know how to begin. This will go through what to do with that money post-bills, from setting up an emergency fund, to debt management, retirement, and investment. Although most of this information is applicable to civilians, we’ll also be providing resources and information specifically geared toward military servicemembers and their families.

In Part 1 we discussed the need for the emergency fund. In Part 2 we discussed the various types of debt and highlighted the importance of eliminating debt. Once you have mastered those concepts, you will slowly but surely begin to accumulate more savings. The next step, and therefore our next topic, is contributing towards retirement. More specifically, we will discuss the various tax advantaged retirement accounts. There is a lot of information to cover here, but I am going to try to be as succinct as possible while still being as clear as I can. While there are other accounts and options available, for the purpose of this beginners’ series I’m going to stick to the most common.


There are two types of tax treatment options: traditional or Roth. The difference between these two options is how the money is taxed.

Traditional (Pre-tax): This money is “tax-sheltered”, meaning that it’s withdrawn from your paycheck before taxes. Typical traditional accounts are a traditional IRA, a 401k, a 403b, or a traditional TSP. You pay taxes on this money once you withdraw it in retirement.

The benefits of a traditional retirement savings plan:

  • A traditional plan could keep you in a lower tax bracket.
  • Your paycheck reduction is less than the money you are investing. Let’s say for example that your paycheck is $2000 and that 25% is withheld for taxes. This means that you take home after taxes $1500. If you choose to contribute $200 per paying period to a traditional plan, your taxable income drops to $1800, so after taxes you take home $1350. Even though you are contributing $200 to your retirement account, your paycheck only dropped by $150.
  • Because it’s not taxed, you are putting more money into the account as compared to a Roth, so with compound interest the traditional account grows more over time.

Roth (Post-tax): Typical Roth accounts are a Roth IRA, a Roth 401k or 403b, or a Roth TSP. This money is taxed now, so you don’t pay taxes on it in retirement.

The benefits of a Roth account:

  • You pay the taxes on this money in your current tax bracket, versus whatever tax bracket you end up in once you make withdrawals. For people who expect to earn much more income later, such as medical students, Roth is a good choice.
  • Since you already paid taxes on it, you don’t have to worry about your withdrawals affecting your taxes with your other sources of retirement income, such as pensions, a second job, or other traditional retirement accounts.
  • There’s always the chance that lawmakers will increase taxes. People who are skeptical of big government tend to like the idea of paying today’s known tax rate versus the uncertainty of the tax brackets thirty years or so into the future.


“Traditional” or “Roth” is a descriptor that simply tells how the account is being taxed. It is not the name of the actual account. So now let’s take a look at the most common retirement savings plan accounts: IRAs and employer provided (e.g. 401ks, 403bs, TSP)

IRA: An IRA is an Individual Retirement Arrangement. You do not go through your employer to open this. Instead, you go through a financial intuition such as USAA or Vanguard. In order to open an IRA, you must have “taxable compensation” (i.e. a job from which you pay taxes, although some other sources such as alimony count as well). If you are married and file jointly, only one person has to have taxable wages.

An IRA is great because a myriad of people can participate. There are many scenarios in which certain groups will benefit from an IRA because they have an income but do not have a retirement option through work: i.e. if you are self-employed, unemployed but collecting alimony, working part-time, etc.

One of the greatest features of the IRA is the power of choice. You get to choose a Roth or a traditional option. We invest heavily in Roth accounts (another planned post which we will share soon detailing our reasons), but for many people a traditional is a better choice. With the IRA, you are free to choose whichever you want.  Also, with an IRA, you are not trapped by whatever provider your employer selected, but instead you are able to shop around and choose a brokerage firm with low expense ratios (we’ll discuss expense ratios in Part 8 of this series).

However, the IRA does have limitations. You may only contribute $5,500 a year until age 50, and then $6,500 a year until age 70 ½. (The IRS calls this “catch-up contributions”.) If you take the traditional option, you will have a Required Minimum Distributions (RMDS) starting at age 70 ½. This is the amount of money that the government requires you withdraw from the account. The Roth option does not have RMDs. However, there is an income cap for the Roth option. You cannot contribute to a Roth IRA if your joint income is over $183,000 – $193,000 for 2015  (see more details here about contribution limits from the IRS). If you exceed that income and want to continue contributing to a Roth, you can do the backdoor option which the White Coast Investor explains very clearly here. Another item of note with the IRA is you have to choose traditional or Roth. You can’t have one of each. You can, however, have an IRA and a 401k.


Employer provided: These are accounts offered through your employer. The most common types are a 401k and a 403b, but if you are in the military you will have the Thrift Savings Plan (TSP). A 401k is the standard employer provided retirement savings plan and the one you have most likely heard of. A 403b is basically a 401k, but for the non-profit sector. Since I work at a school, my employer provides a 403b rather than a 401k. The TSP is the savings retirement plan offered to federal employees including the military. We will discuss the TSP in depth in Part 4 of this series.

These employer accounts have a much higher contribution limit than the IRA. In fact, for 2015, you can contribute $18,000 annually into a 401k (or 403b or TSP) up to age 50, after which point you can contribute an additional $6,000 a year as a catch-up contribution. That means, as compared to an IRA, you can have even more money set aside for retirement and receiving special tax treatment.

Another great feature of the employer provided accounts is that the employer will commonly match your contribution up to a certain amount. This is usually provided as a percentage, and while it’s not standardized across the board, it’s common to see something like “100% match up to 3%”. This means that the company will contribute the same money as you up to 3% of your income. So if you contribute 3% of your income, the company will match that and contribute 3% of your income as well. By taking advantage of the employer match you’re actually doubling your contribution since you now have 6% of your income invested annually into your 401k. This is why you commonly hear people advising to max out your company’s match. What they are really saying is to take as much advantage as possible of whatever your company has offered to match since it is essentially free money. Note: Employer matches are not typically provided to people who will receive a pension. Also, the military does not match TSP contributions.  

In the past, these employer options were only available with the traditional tax treatment option. However, in recent years, many employers have begun to offer Roth 401ks, 403bs, and the TSP comes in a Roth option as well (unfortunately, my 403b does not). However, unlike a Roth IRA, the Roth 401k (or 403b or TSP) has Required Minimum Distributions at age 70 ½ that you must withdraw.

Another drawback of the employer plans is that you are stuck going with whatever third party company your employer contracted. You don’t have the ability to shop around and look for the best expense ratio. In my example, my 403b has an expense ratio that is six times as expensive as my IRA. But once you are no longer employed for the company you can move your account to another financial institution of your choosing.


What about withdrawing that money? You are eligible to withdraw money from any of your tax advantaged retirement accounts at 59 ½. If you withdraw early from a traditional account, the money is taxed and you pay a 10% penalty. But there are some exceptions, which I am directly quoting from the IRS. For a traditional IRA, the exceptions are:

  • You have unreimbursed medical expenses that are more than 10% (or 7.5% if you or your spouse was born before January 2, 1950) of your adjusted gross income.
  • The distributions are not more than the cost of your medical insurance due to a period of unemployment.
  • You are totally and permanently disabled.
  • You are the beneficiary of a deceased IRA owner.
  • You are receiving distributions in the form of an annuity.
  • The distributions are not more than your qualified higher education expenses.
  • You use the distributions to buy, build, or rebuild a first home.
  • The distribution is due to an IRS levy of the qualified plan

Read more about the exceptions per the IRS here.

For a Roth IRA, early withdrawals also incur a 10% penalty, but they are not taxed, since you already paid taxes on the money. The exceptions to this penalty, as quoted from the IRS, are:

  • You have reached age 59½.
  • You are totally and permanently disabled.
  • You are the beneficiary of a deceased IRA owner.
  • You use the distribution to buy, build, or rebuild a first home.
  • The distributions are part of a series of substantially equal payments.
  • You have unreimbursed medical expenses that are more than 10% (or 7.5% if you or your spouse was born before January 2, 1950) of your adjusted gross income (defined earlier) for the year.
  • You are paying medical insurance premiums during a period of unemployment.
  • The distributions are not more than your qualified higher education expenses.
  • The distribution is due to an IRS levy of the qualified plan.
  • The distribution is a qualified reservist distribution

Read more here from the IRS.

There are some different rules for the SIMPLE IRA and 457s (which we did not cover today as they’re not one of the most common retirement accounts). In general, your employer provided accounts will follow the same rules and exceptions as the IRAs listed above.


How much money should you contribute towards a retirement plan?

Everybody seems to have a different opinion about how much you should save for retirement. Most companies offer retirement workshops through their HR department and there are many calculators available online to help you crunch the numbers.

But here is our thought- as much as you comfortably can. The tax benefits of these accounts are indispensable and make a huge difference. Even though my traditional 403b has an expense ratio that is higher than I’d like, the tax benefits make it worthwhile. As I explained in the benefits of the traditional tax treatment at the beginning of this post, I am able to contribute more money because that money comes out pre-tax, rather than paying my income taxes and then investing. My traditional 403b also helps to keep us in a lower tax bracket. Davin’s Roth TSP locks that money into the current tax bracket; we pay those taxes now rather than later when he is earning more money. These are benefits that we wouldn’t be able to access by investing in an individual non-retirement investment account.

Additionally, it is better to oversave than to undersave for retirement. The future is an unpredictable thing, and it’s hard to say how much inflation may occur after your retirement. You also don’t know what your health will be like. Personally, I would rather have enough money saved to take care of myself in old age than to worry about making ends meet or covering my medical bills. It’s also very difficult to reenter the work force in your 80s if you realized that you ran out of money. For those reasons and for peace of mind, we are actively aiming to oversave for retirement.


In what order should you prioritize these retirement accounts? Not everybody has every option, but this is the order in which I recommended prioritizing your retirement accounts:

  1. Any employer provided account that offers a match. Maximize that match and get all the free money you can get!
  2. TSP- you just can’t beat those low expense ratios! Again, we will cover TSPs further in Part 4.
  3. An IRA. You can decide for yourself if a Roth or a traditional is a better choice in your situation. But an IRA gives you the power to shop around at different financial institutions and choose the lowest expense ratios and fees.
  4. Maximize the employer provided account past the match. This would be the last option because typically these accounts have high expense ratios and you’re stuck with whoever your employer contracted. However, like we discussed above, the tax advantages still make it worth maxing this account before turning to taxable accounts.


Those are the basics of the tax-advantaged retirement savings accounts.  We will dig deeper into many of these sub-topics mentioned today. Next week, we will discuss the TSP in depth for our military servicemembers and families in Part 4 of the Getting Started Series. In Part 5 we will explore the different mutual funds and index funds you could invest in, including with those retirement accounts we talked about today.  So be sure to check back with Finances & Fatigues!


Similar posts
  • Financial Independence & the Ser... Sounds like a modern day fairytale! What does financial independence mean if you’re looking at a military career? Well first, let’s take a look at the meaning of financial independence. If you read personal finance blogs, you will see many people reference the goal of financial independence, often shortened to FI. In a nutshell, the [...]
  • My money philosophy, compressed to an... I recently read this post about personal finance bloggers giving their best money advice on an index card. So I wrote my own! I present to you my philosophy on money on a single index card:   This is probably against the rules, but here’s a little elaboration… Make it easy– Automate your accounts. Use index funds so [...]
  • Why we invest in Roth accounts Read more about retirement accounts and the TSP.   One reason why we started this blog was because we felt like our situation, namely as a military family, was vastly different from that of other financial bloggers and writers. And because of that difference, a lot of “tried and true” advice or “rules” don’t apply to [...]
  • This is why people hate investing (an...   We entered summer with a plan. We were going to move many of our accounts over to Vanguard, including both of our Roth IRAs, an old traditional IRA that Davin had rolled over from an old 401k, an individual brokerage account that I had, and I was going to roll over my 403b from [...]
  • Getting Started Series Part 8: What a... This is a series intended to answer the question “I’m covering my bills, now what?” It’s for people who have a steady source of income and have a vague notion that they should be doing something more with their money, but don’t really know how to begin. This will go through what to do with [...]

No Comments Yet

Questions? Comments? Witty remarks?