(A version of this article by Kimberly Lankford originally appeared in the September 2022 issue of Military Officer, a magazine available to all MOAA Premium and Life members. Learn more about the magazine here; learn more about joining MOAA here.)

You may be getting ready for an idyllic retirement after building up your savings for years, especially if you are eligible for lifetime income from military retirement pay.

But many pre-retirees don’t realize the tax torpedo that’s lurking ahead. When you leave the military, you may have a much larger tax burden than you did while you were in the service — you no longer receive a tax-free housing allowance, and you suddenly have to pay taxes to the state where you live. Your retirement savings may be worth less than expected if you have large balances in tax-deferred retirement accounts that are taxable when withdrawn. And the federal government — and some state governments — will also carve out a slice of your military retirement pay.

“I think most active-duty military don’t truly realize how huge of a tax break they have and how much of their pay is shielded from income taxes,” said Lila Quintiliani, AFC®, ChFC®, program director, financial and benefits education for MOAA. “The shock hits them after they retire.”

But if you plan in advance, there are several strategies you can deploy to help minimize the retirement tax hit well before you stop working.

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“Too often military retirees don’t worry about taxes until they retire. In reality, they should be thinking about them from Day One,” said Lt. Col. Patrick Beagle, USMC (Ret), CFP®, owner of WealthCrest Financial Services in Springfield, Va.

You have a lot of opportunities to reduce your future tax bill while you’re still on active duty. Your tax rate is low because you’re receiving tax-advantaged benefits, such as your tax-free housing allowance, and you may be getting state income tax breaks, too. This is the best time to build tax-free savings for the future.

Roth TSP contributions. Servicemembers have an opportunity to save for retirement in the low-cost Thrift Savings Plan, and they have the choice of two types of contributions: Traditional pre-tax contributions reduce your taxable income now but your withdrawals will be taxable, while Roth contributions don’t give you a current tax break but can be withdrawn tax-free in retirement.

You can save up to $20,500 in the TSP in 2022 (or $27,000 if age 50 or older) through Roth and/or traditional contributions.

“Start the TSP as soon as you can, and for most, the Roth TSP is the best option,” said Beagle. “Since a portion of your pay is tax free [BAH/BAS], your tax bracket will likely be low, especially in comparison to when you retire.”

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He recommends starting by saving at least 10% of your pay in the TSP, and increasing your contributions whenever you can. “With a promotion, save half of what you gained in salary,” he said.

Extra TSP contributions when deployed. You can boost your contributions significantly when receiving tax-free income in deployment — up to the contribution limit of $61,000 in 2022. This money gets an extra tax break — it goes in tax-free (even into the Roth) and comes out tax-free, too.

“If you’re in a combat zone, there is absolutely no reason to skip the Roth, because you’re going to be taking tax-free income and you’re going to be contributing it to an account you never pay taxes on,” said Col. Curt Sheldon, USAF (Ret), a CFP® professional and enrolled agent in Alexandria, Va., and Life Member of MOAA.

You can contribute up to $20,500 of your tax-free pay to the Roth TSP, which will be tax-free when withdrawn, along with any of its earnings. The remainder can be tax-exempt contributions to a traditional TSP — those contributions will not be taxed when the money is withdrawn, said Sheldon. Any earnings on the tax-exempt contributions in the traditional TSP are taxable upon withdrawal.

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Roth IRA and spousal IRA. You can build additional tax-free savings in a Roth IRA. You can contribute up to $6,000 (plus $1,000 if 50 or older). If you work but your spouse doesn’t, you can also contribute to a spousal Roth IRA on his or her behalf.

To contribute the full amount in 2022, your modified adjusted gross income must be below $129,000 if single or $204,000 if married filing jointly, and the contribution amount phases out entirely for single filers earning more than $144,000, or $214,000 for married couples filing jointly. These AGI figures do not include your tax-free housing allowance.

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You can withdraw the Roth IRA money tax-free after age 59½ once you have held a Roth IRA for at least five years, and you can access your contributions without taxes or penalties at any time.

Establish residency in a low-tax state. When you’re on active duty, you have the flexibility to maintain your legal residency (domicile) in the state where you lived when you joined the military, or you can establish residency in another state while you are stationed there. You and your spouse can maintain that state of residency as long as you’re on active duty, even after you move. Keep these rules in mind if you’re stationed in a state with low or no income taxes, such as Texas and Florida.

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“Consider changing your residency if you find yourself stationed in a state that does not tax military pay during active duty,” said Beagle. “For example, many of my peers changed to Florida residency when they were in flight school, thus saving 20 years of state tax.”

Find out from the state department of taxation the steps you need to take to establish residency while stationed in that state. You usually must register to vote, register your car, get your driver’s license in that state, and plan to return to the state after you leave the service.

Get ready. Most people have a big tax surprise after they leave the military. They’re no longer receiving a tax-free housing allowance, and they’re taxed in the state where they actually live — not their domicile while they were on active duty. They may also be receiving income from a civilian job in addition to military retirement pay. Your taxable income is likely to be highest during this time.

“This is when the tax bite starts to be felt,” said Quintiliani.

Start preparing for these extra taxes in advance. “As you near separation, build a transition fund of larger cash reserves,” said Beagle. “Most people way underestimate not only the tax picture, but other expenses in their first year after they retire or leave the military. The more ready cash you have, the less stress you will have.”

Kimberly Lankford is a financial expert based in Virginia and the spouse of a retired Army colonel.