About the Author

Kate Horrell
Kate Horrell is a military financial coach, mom of four teens, and Navy spouse. She has a background in taxes and mortgage banking, and a trove of experience helping other military families with their money. Follow her on twitter @realKateHorrell.
  • Doug

    I am deployed, and as an officer, a portion of my pay is tax exempt and a portion is taxable (bonus, special pay, etc.). I would like to maximize my tax-DEFERRED contributions to TSP, and minimize my tax-EXEMPT contributions, thereby maximizing my current year tax benefits. Is there a way to select which pay will be contributed to TSP? Do they automatically contribute tax-exempt or tax-deferred pay first? Thanks!

  • Doug, I know it is late and I am tired, but why would you want to use tax-deferred pay instead of tax-exempt pay? I’m sure there is a sensible reason but I’m not seeing it right now.

    I’m doing a little research on your question and I’ll get back to you. The quick answer is that they assume it is tax-exempt. I’m not even sure there is a mechanism to make it tax-deferred.

    Please answer – I’m dying to know your logic and hopefully learn something new.

  • Doug

    Pretty simple logic, it reduces the taxes I pay this year. Again, some of my income is tax-exempt, and some is taxable. If I make my TSP contributions from taxable income (i.e. tax-deferred contributions), then I pay less taxes this year. I get no immediate benefit from tax-exempt contributions. I’d rather put these into a Roth on my own.

    There are other side benefits as well. Since TSP contributions reduce my reported income on my W2, it lowers my marginal tax bracket and allows me to do some Roth IRA rollovers in the 15% bracket. Also, it keeps me eligible for other tax benefits like the child tax credit.

    A final thing I’m a little confused about is the $49,000 annual TSP limit while deployed to a combat zone. Does the $16,500 tax-deferred limit still apply as well? In other words, could I make the entire $49,000 contribution from taxable income (and thereby save $7000+ on taxes) or am I still limited to no more than $16,500 tax-deferred contributions and the remaining $32,500 has to be tax-exempt. Looked everywhere, but can’t find clear guidance on this.

    • Mark

      Doug, By now I’m sure you found out, since it is October. Any word of advice to others? According to TSP Bulletin 10-12, it sounds like once you contribute to your TSP with any tax exempt pay, you become subject to the $49000 limit for the year period (tax exempt + tax deferred contributions)And yes, I bet you could have contributed a minimal amount of tax exempt money (which would open the door to the 49000 limit) and then proceed the rest of the year paying into your TSP with tax deferred pay up to the $49000 limit regardless of what kind of pay it is. Is this correct?

  • I can see your thought pattern, and it makes sense. I confess that I tend to think in terms of being tax-free the entire tax year since that has been our family’s most recent experience. If you are in and out of a combat zone, or deployed across two calendar years, the situation changes. Also, I don’t want to ask a lot of personal questions but it very much depends on your family composition and the amount and type of income outside the military (spouse, investments, etc.).

    There are a few problems that I see. First, you will have to check with your finance office to see if there is any way to make those contributions out of tax-deferred money while you are in a tax-exempt area. I’m not sure there is. If you are not in the tax-exempt area for the entire tax year, you could adjust your contributions such that you are contributing specific amounts during the months in which you are tax-exempt, and specific amounts during the months in which you are taxable, in order to meet your yearly goals for each category. It would require pretty careful attention to detail, particularly making sure that you got the changes in before the cut-off date in the previous month. There would, of course, always be the possibility that something would not work out properly so I think you need to leave some wiggle room in your calculations.

    In terms of lowering your tax bracket, contributing from your taxable income will accomplish that goal. Again, you have to do the math pretty carefully. Your eligibility for various credits varies based upon your Adjusted Gross Income and your actual tax owed, and the results get shifty as the numbers move. For example, by lowering your tax owed, you will decrease your eligibility for credits such as the child care credit, the energy improvement credit and any other non-refundable credit. If you bring your tax liability down to zero, non-refundable tax credits don’t matter.

    Once you get further down the tax form, (and I’m going to skip over self-employment tax because that is enough for an entire book), you get to the refundable credits, which include the Earned Income Credit and the additional child tax credit. The Earned Income Credit amounts are shaped like a bell curve and depending on your ability to hit the right part of the curve, you can earn a substantial credit. Too much or too little income, smaller credit. The additional child tax credit can be a substantial amount if you have multiple children.

    My overseas internet is acting crazy so I’m going to submit this comment and address the next issue in a separate comment.

  • Doug


    Appreciate the advice. Perhaps some details might make it easier to understand. In my particular situation, as a physician, the military gives me an annual special pay / incentive pay once a year as a lump sum. That bonus will be coming in next month (July) while I am in a combat zone, and will be over $50,000. So, I will get the max tax-exempt (equivalent to E9 pay, about $7500), and the rest will all be taxable. I’m trying to max out my TSP and tax shelter as much of the income as I can.

    So as of now I’ve requested max TSP contribution from bonus pays and 1% contribution from base pay for the month of July. My hunch is that they will first contribute the roughly $7500 tax exempt pay, and then the remaining contribution will be from taxable income. I’m not sure there is any way to affect this, but it will be interesting to see what they do.

    But that brings me back to the other question you mentioned you will address later. Is my taxable contribution still limited to $16,500? If I request a $49,000 contribution for the month, and they take $7500 of it tax exempt, will they then put in $41,500 as a tax-deferred contribution, or will they limit my additional contribution to $16,500 and cut me off at a total contribution of $24,000 for the month (7500 + 16,500 = 24000)? Like I said, I can’t really find this info anywhere. I may have to just try and see what happens.

    Your other suggestion, of waiting until I leave the combat zone and then contributing to TSP, is a good one I’ve considered. However, the couple months this year that I will have earnings outside of a combat zone will not equal the lump sum bonus payment next month.

  • Vince


    How does Doug’s IRA rollover into an IRA play a factor into his 2010 taxes and being eligble for the tax breaks? One other question is earning to little a bad thing for tax breaks? thanks.


  • Vince, Doug’s situation has gotten far beyond my immediately knowledge. I could figure it out, but it would take me a long time and there is no guarantee that I would be right. Doug is in an unusual situation and needs to either dedicate a significant amount of time to working up a good plan himself, or hire a knowledgeable tax preparer to help him organize things to the best advantage.

    And yes, earning too little can make you ineligible for many tax breaks. My family got caught in that trap last year, when my husband was deployed for the entire tax year. We were unable to take the credit for replacing our windows (would have waited ’til 2010 had I figured that out before hand.) There are other credits that require a certain level of income. The earned income credit is a complicated one that is awarded in varying amounts that go up and then go down based upon income, but there is a way to choose or not choose to include combat income. (I don’t know it that well, so I can’t comment entirely, but I should learn.)

    Thanks for your comment.

  • Steve

    VA disability payments are Tax exempt, can I place these VA payments in my TSP account?

  • dennis Mongeon

    Please comment on the email below. I am now a CA resident and will withdraw funds from TSP next year.

    > Date: Tue, 9 Sep 2008 08:38:28 -0400

    > From: *************************

    > Subject: RE: Individual – Income Tax (Resident)

    > CC:


    > To: Dennis R Mongeon


    > The law defers state income tax on amounts contributed to retirement plans authorized by IRC Section 401(k) only. It does not defer income tax on plans that have similar features or requirements to 401(k) plan, but are not themselves 401(k) plans.


    > Consequently, New Jersey law does not allow employees to defer the tax on contributions made under a salary reduction agreement to an IRC Section 403(b), 457, or other federal qualified deferred compensation plan. An employee must, therefore, include the amount of any federally deferred contributions to such plans in gross income.


    > Pensions are reportable as income to a New Jersey resident. How much of it is taxable for the year depends on whether you have a contributory or noncontributory pension and whether you qualify to use the three-year rule method or if you must use the general method.


    > It is very important to keep any statements that show your contributions to your

    > pension, annuity, or IRA. You will need this information when you start to withdraw money from the plan. You may have to pay more tax if you do not know the amount of your contributions

    > on which New Jersey income tax has already been paid.




  • Dennis, I’m a little confused. What is your question?

    Individual states do have the option of taxing various sorts of pension income. Also, you will pay federal income tax on distributions from your TSP account (except for the part that is tax exempt.)

    If you are asking about keeping track of your contributions, then yes, that is important. Your annual W-2 as well as LESes show the amount of contributions which are tax deferred and which amounts are tax exempt.

    You may find this helpful: https://www.tsp.gov/PDF/formspubs/octax06-780.pdf

    I’d be glad to answer more if I know the question :)

  • Rich

    I am in a combat zone, and am trying to maximize the amount I am contributing to my TAX-EXEMPT TSP, but I keep getting confused. I have done the math FAIRLY well ( that I can figure) and succeeded n contributing almost – BUT NOT OVER – the $7714 combat exclusion amount. HOwever, each paycheck I have both tax-deferred and tax-exempt contributions. As far as I can tell, they should ALL be tax -exempt – as long as my contribution for the month is below $7714… is that correct ? I can’t get any good answers out of my finance office, who freely admit they don’t understand TSP. Any ideas ?

  • Jason

    I am in a similar situation to some of those above – an O-4 deployed in a combat zone, will be receiving an annual bonus soon, and am trying to determine the best way to tax shelter this bonus by allocating it to TSP. As I understand it, this money would be tax-deferred if contributed to my Traditional TSP. At the time of withdrawal though, would I be taxed on the contributions or only the gains? (again, given that the contributions were made while in a combat zone). And alternatively, I am wondering what the tax implications would be if I instead allocated the bonus money to my new Roth TSP?

    • KateKashman

      I’ve found it, sort of! Here’s an article that I wrote about why you should contribute to a Roth IRA while you are in a tax-exempt combat zone. The exact same thoughts apply to the Roth TSP. You can contribute to both your Roth IRA and your Roth TSP. Contributions to your Roth TSP must be made during the time that you are in tax-exempt status, but contributions to the Roth IRA may be made any time during the taxable year.

      Whoohooo! I wonder if they need my husband anywhere interesting?

  • Allison

    Combat Zone Bonus Pay

    Under the Heroes Act any bonus payments paid by a state or local government to active or former military personnel for service in a combat zone payments made before, on, or after June 17, 2008. will be excluded from the recipient’s gross income. Bonus payments are distinguished from military differential payments and are not included in income reported on Forms W-2. The bonus payments are defined in Section 112 of the Heroes Act as payments made “by a State or political subdivision to any member or former member of the uniformed services of the United States or any dependent of such member only by reason of such member’s service in a combat zone.”

  • sandee

    Is my pay on CZTE leave supposed to be able to be contributed to the TSP as tax exempt funds?

    This leave was earned in a combat zone and the pay I receive while oneave is tax free, but finance is telling me I have to be in a combat zone to make tax exempt contributions.