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After announcing that I would be deployed in 2017 for 6 months, my orders changed. I was not able to execute my 6 month deployment, $50,000 savings challenge. I did not deploy to a combat zone. Instead, I PCS'd to an exciting OCONUS assignment in Abu Dhabi, United Arab Emirates.
My assignment to the UAE came with tax free, Combat Zone Tax Exclusion (CZTE) income for two years, from May 2017 to May 2019 based on my duty location. I plan on saving aggressively with a 50% savings rate, but I do not expect to save $54,000 in six months. I still need to feed the family! We also want to travel and experience the culture as much as possible in this exotic region while we are here.
The CZTE income for the next two years is a fantastic opportunity to sprint towards financial independence. The first priority is contributing 50% of my monthly income to my Roth accounts to lock in the tax free flavor of the money forever.
When you contribute tax free money to a Roth account, the money goes in untaxed, grows untaxed, and comes out untaxed. This is the ultimate tax strategy billionaires wish they could use.
So, I will max out my and my wife's Roth IRA as well as my Roth TSP in 2017-2019.
In 2018, all of my income will be federal income tax exempt. While I'm maxing out my Roth accounts, I can simultaneously convert money in my Traditional IRA to my Roth IRA and potentially reap some tax benefits.
I used the MoneyChimp tax calculator to plan my tax strategy for 2018. See below:
Convert Traditional IRA to Roth IRA While in a Combat Zone
Converting my Traditional IRA funds to my Roth IRA account up to the married filing jointly standard deduction plus the personal exemptions, which is $20,800 for 2017.
For 2017 the IRS has set the married filing jointly standard deduction at $12,700 and the personal exemption at $4,050 (times two for my wife and I).
That means that you can have up to $20,800 of income (or Roth conversions) and not pay any taxes. Play around with the calculator to understand the concept.
Converting Traditional IRA money to Roth counts as taxable income in the year the money is converted. Traditional IRA money converted to Roth accounts must be taxed in the year converted, since Traditional contributions were not taxed in the year they were originally contributed. Uncle Sam always has to get his cut.
Here is a picture of a Viking statue in Norway to breakup the boring IRA conversion discussion:
However, if your taxable income is extremely low in a specific year (such as a year long deployment), Uncle Sam won't take much or any. Any income up to $20,800 for a married filing jointly couple in 2017 is exempt from federal income tax due to the standard deduction and the personal exemptions.
My plan is to convert $20,800 of my and my wife's Vanguard Traditional IRA contributions to our Vanguard Roth IRA account. This reduces our future tax burden and also give us the option to withdraw $20,800 from our Roth IRA tax free after five years, thanks to the IRS conversion rules. Root of Good goes into the details of climbing the Roth IRA Conversion Ladder.
Since we are converting in a year when we have no other regularly taxed income, converting our Traditional funds into Roth means we never pay taxes on this converted money. It's like contributing tax free CZTE income into a Roth IRA. It goes in untaxed, grows untaxed, and distributes untaxed.
Vanguard Roth IRA Conversion
Vanguard makes the conversion process easy. After logging in, find the search bar at the top of Vanguard's site. Search for “Roth IRA conversion.” Click the article entitled “How to convert a Roth IRA online.” From there, just follow Vanguard's easy to use conversion tool. The website will walk you through where the money it coming from and where it's going.
It should only take a few days to convert and transfer your Traditional IRA funds to your Vanguard Roth IRA. When you file taxes in the following year, you will need to receive tax documents from Vanguard to properly report your conversion and pay any taxes on the conversion. If you have done it right, your tax burden should be low or zero.
Other Ways to Maximize the Financial Benefits of Military Deployment
While you are deployed there are many things you can do to boost your savings, reduce your expenses, increase your investments, and sprint towards financial independence.
- Maximize you and your spouse's Roth IRA contributions (I recommend Vanguard for your Roth IRA) up to $11,000. Deployed CZTE pay goes into a Roth account untaxed, grows untaxed, and comes back to you untaxed. The ultimate tax avoidance strategy.
- Read my book, The Military Money Manual: A Practical Guide to Financial Freedom to learn how to achieve financial independence in the military.
- Contribute $10,000 to the SDP for a guaranteed 10% return (I use some of my emergency fund to top up the SDP).
- Maximize your Roth TSP contributions up to $18,000, then switch to contributing to Traditional TSP up to $54k annually. Same Roth style account benefits as the IRA.
- Convert your Traditional IRA funds to Roth IRA and pay little or no tax on the money.
- Here are 8 ways to save money while deployed.
- And finally why deployment can be the most financially beneficial time in your career.
- You may want to re-characterize a Roth IRA or Traditional IRA contribution if you get a surprise deployment you didn't plan for. Vanguard has instructions on how and why you would want to do that.
Have you tried converting your Traditional IRA to a Roth IRA while deployed and reaped the tax free benefits? I would like to hear if you have made any mistakes or would do anything differently; share your experience!