I'm trying to puzzle out whether a deployed servicemember should contribute extra Combat Zone Tax Exclusion (CZTE) income to a taxable brokerage account or to Traditional TSP up to the annual additions limit.

After running the numbers, I think it's close enough to not really matter which way you go.

I ran 2 scenarios to see which one wins. Please let me know if you see any errors in the math or assumptions, I used Claude.ai to help with this.

Assumptions:

• Combat zone deployment Jan 1 to 31 Dec of a year.
• You contribute $7,000 to Roth IRA and $23,000 to Roth TSP during the year.
• 5% annual growth rate + 1.4% dividend yield.
• Vanguard ETF VOO or S&P 500 average dividends in the taxable, C Fund in the TSP.
• 35 year investment time to grow, age 25 to 60.
• Initial investment of $10,000.

Scenario 1: $10,000 into Taxable Brokerage Account

Scenario 1: Taxable Brokerage Account with Annual Dividend Tax

• Initial investment: $10,000
• Annual growth rate: 6.4% (5% + 1.4% dividend yield)
• Time horizon: 35 years
• Dividend tax rate: 15% (paid annually)
• Long-term capital gains tax rate: 15% (paid at the end)

Let's break this down year by year:

Year 1:

• Starting value: $10,000
• Growth: $10,000 * 0.05 = $500
• Dividends: $10,000 * 0.014 = $140
• Dividend tax: $140 * 0.15 = $21
• End of year value: $10,000 + $500 + $140 – $21 = $10,619

Year 2:

• Starting value: $10,619
• Growth: $10,619 * 0.05 = $530.95
• Dividends: $10,619 * 0.014 = $148.67
• Dividend tax: $148.67 * 0.15 = $22.30
• End of year value: $10,619 + $530.95 + $148.67 – $22.30 = $11,276.32
• This process continues for 35 years. Using a spreadsheet to calculate this precisely:

After 35 years:

• End value before tax: $81,832.67
• Total growth: $71,832.67
• Taxable capital gains: $71,832.67
• Capital gains tax: $71,832.67 * 0.15 = $10,774.90
• Final after-tax value: $81,832.67 – $10,774.90 = $71,057.77

Scenario 2: $10,000 into Traditional TSP

• Initial investment: $10,000 (CZTE pay, tax-free), counts against annual additions limit
• Annual growth rate: 6.4%
• Time horizon: 35 years
• Withdrawal tax rate: 22% (only on earnings, not initial contribution)

After 35 years:

• End value: $87,691.39
• Initial contribution (tax-free): $10,000
• Taxable amount (earnings): $87,691.39- $10,000 = $77,691.39
• Tax on withdrawal: $77,691.39 * 0.22 = $17,092.10
• Final after-tax value: $87,691.39 – $17,092.10= $70,599.29

Comparison of final after-tax values (less than 1% apart):

1. Taxable Brokerage Account: $71,057.77
2. Traditional TSP: $70,599.29

Close enough

Seeing how close these results are, I think I would lean towards the taxable brokerage account. US income taxes have changed before. Long term capital gains have typically been below US income tax. But that may change in the future and that's okay.

At the end of the day, you're making assumptions and betting on the unknowable future.

The flexibility of a taxable brokerage account and ability to access the funds penalty free before age 59.5 might be beneficial.

At the end of the day, if you're the kind of person who saves $40,000 of tax free pay in a single year, you're going to be alright.

Given how close these results are, other factors might become more important in making a decision, such as:

• Flexibility in withdrawals
• Potential for tax-loss harvesting in the taxable account
• Ease of management
• Potential changes in tax rates
• Required Minimum Distributions (RMDs) for the TSP