Staff Sergeant Dana Reyes was four months into a deployment when she looked at her leave and earnings statement and did a double take. No federal income tax withheld. Her base pay, special pay, and hostile fire pay were all sitting there untaxed, and her bank balance was growing faster than it ever had. She had a thought many deployed service members have: I should put as much of this into the TSP as I can.

She was right. The harder question was which kind of money to put in, and what happens to it later.

What the exclusion does

Pay earned while serving in a designated combat zone is excluded from federal income tax. For enlisted members and warrant officers, that exclusion covers all of it. For commissioned officers, it is capped each month at the highest enlisted pay rate plus any imminent danger or hostile fire pay. Anything above the cap is taxed as usual.

So the money arrives already clean. That changes the usual traditional versus Roth math, because the main reason to choose traditional, a tax break now, has nothing to work on. Your pay is not taxed now, so there is nothing to defer.

How the TSP treats it

You can direct contributions from combat zone pay into your TSP, and the plan tracks them as tax-exempt contributions. If you choose traditional, those dollars go in and are recorded separately from your regular taxable contributions. Your statement shows a tax-exempt balance, and you will see it again at withdrawal.

Here is the part that trips people up. Only the contributions themselves are tax-exempt. The earnings on them sit in your traditional balance and are taxable when you take them out. Agency matching contributions, including Blended Retirement System matching, also go into the traditional balance and are taxable on withdrawal.

Withdrawals from a traditional balance are generally paid out proportionally between taxable and tax-exempt money. You cannot simply pull the tax-exempt dollars out first and leave the taxable growth behind.

Why Roth usually wins here

When you contribute from tax-exempt pay to the Roth side, you are putting in money that has never been taxed and will never be taxed on the way in. If the Roth withdrawal is qualified (generally after age 59½ and five years since your first Roth contribution), the earnings come out tax-free too.

Compare the two with a simple example. Say Dana puts $1,500 a month from combat zone pay into the TSP for seven months, $10,500 total. Assume a 7 percent average annual return over 25 years, which is an illustration, not a forecast. That $10,500 grows to roughly $57,000.

  • Traditional (tax-exempt contributions): About $10,500 of that is tax-exempt basis. The other $46,500 or so is earnings, taxable on withdrawal. At a 12 percent bracket, that is around $5,600 in tax. At 22 percent, closer to $10,200.
  • Roth: Zero tax on the full $57,000, assuming a qualified withdrawal.

Same deployment pay, same contribution, and the Roth choice is worth thousands of dollars. The higher your future bracket, the bigger the gap. For a career member who may later earn a pension plus a second career salary, that gap can be meaningful.

Traditional is not wrong, and there are narrow cases for it. An officer whose pay exceeds the monthly cap has a taxable slice, and traditional contributions can shelter that slice. But for the excluded portion, the Roth side is usually the better home. Your own situation might differ, so run the numbers or talk to a tax professional, especially if you expect unusual income later.

The contribution limit nobody mentions

This is where deployed members can really move the needle. Normally, the elective deferral limit applies to what you contribute to the TSP. For 2025, that is $23,500 for most participants, with extra catch-up room for those 50 and older.

Contributions from tax-exempt pay are treated differently. They are not subject to the elective deferral limit. They count instead toward the broader annual additions limit under Internal Revenue Code Section 415(c), which was $70,000 for 2025. Your contributions cannot exceed your total compensation for the year, and the limit also counts employer matching.

In practice, a member with a big combat zone paycheck can contribute far more than the usual cap. Someone who puts away $30,000 or more in a year from tax-exempt pay is not doing anything unusual or improper. These limits change annually, so check tsp.gov for the current numbers before you set your election.

Don't forget the IRA

The TSP is not your only option. Under federal law, nontaxable combat pay can be treated as compensation for IRA contribution purposes. That means you can fund a traditional or Roth IRA even if most of your income for the year was excluded.

This matters for two reasons. First, it lets you use IRA room in addition to the TSP. Second, it opens the door to a spousal IRA, so a non-working spouse at home can also get a contribution funded by your deployment pay.

The Roth IRA has income limits based on modified adjusted gross income, and combat pay you exclude does not count toward AGI. That often makes Roth IRA eligibility easier for deployed members. The IRA contribution limit is much lower than the TSP limit ($7,000 for most people in 2025, higher at 50 and over), so check irs.gov for current figures.

Practical steps before and during deployment

A few things worth doing, in rough order:

  1. Confirm the zone is designated. Not every deployment qualifies. Your finance office and IRS Publication 3 list designated areas and qualifying service.
  2. Set a Roth election for the TSP. Use myPay or your service's pay system. Do this early, because changes can take a pay cycle or two to take effect.
  3. Decide how much to send. Think about your emergency fund and family needs first. TSP money is harder to reach than a savings account.
  4. Capture your match. Under BRS, you get matching up to 5 percent of basic pay. Make sure you are contributing enough to get it, then decide how far beyond that to go.
  5. Keep your records. If you contribute to an IRA or want to confirm your tax-exempt balance later, you will want your LES and deployment orders handy.

One more caveat

Roth contributions made from tax-exempt pay will not lower this year's tax bill, because there is no tax to lower. Some members find that unsatisfying. They want the deduction. But a deduction on income that was never taxed would be a bit like getting a coupon for something already free.

Dana ended up choosing Roth for most of her deployment contributions, kept a smaller cash cushion for the return home, and opened a Roth IRA for herself. Her husband got one too. The whole decision took maybe an hour of reading and one form. The payoff will land decades from now, in the form of withdrawals she will not have to calculate a tax bill on.