The following is a guest post from my colleague, Spencer. Spencer writes at the Military Money Manual on achieving financial independence while serving in the US military. He is investing for financial freedom by age 40 and serving as an officer in the US Air Force.
For the first time in decades, the Department of Defense is revamping the military retirement system. Starting January 1, 2018, all new enlistees will automatically enroll in the new system, which features matching TSP contributions up to 5%, continuation pay bonuses for 12 years of service, and an immediate pension after 20 years of service. (For more details see my detailed summary of the new military retirement system.)
For anyone who joined the military on or after January 1, 2006, you will be faced with a choice: opt in to the new system or stay with the old system. If you make no choice, the current plan is to default you to the old system.
I choose to opt into the new retirement system. I will be a captain (O-3) with 8 years of service in May 2018. After running the numbers, I’ve decided that having at least some retirement benefits if I get out before 20 years is worth the chance of a 20% decreased pension payment, if I make it to 20 years.
You Need to Opt In, Too
Anyone with less than 10 years of service in 2018 should also opt into the new system. Even if you think you’re going to make the military a 20 year career, you don’t know what the future will hold.
The statistics show that you won’t make 20 years. Only 17-20% of the military serves long enough to receive any kind of retirement benefit. The number is higher for Air Force officers like myself and lower for enlisted Marines. Whether it’s the up or out promotion system or leaving due to family, personal, or professional reasons, there are many reasons why most personnel do not make it to 20 years.
In the current system, you or I could serve for 16 years, not promote to major or lieutenant colonel, get passed over for continuation, and get forced out. The Air Force cut 19,833 personnel in Fiscal Year 2014. Of those, over 6,000 officers and enlisted were involuntarily cut through reduction-in-force boards, or RIFs. These airman received no pension and no health insurance. Sixteen years of service and nothing to show for it other than what you saved and invested. Under the new system you would at least have your TSP account with all the matching that had gone into it, plus the continuation pay bonus paid at the 12 year mark.
New Military Retirement = Flexibility
The new system provides increased flexibility and freedom for the service member. Rather than gutting it out for 20 years just to receive any sort of benefit, you can take your TSP matching with you when you leave.
The beloved “check of the month club” military pension is still there in the new system! While the benefit is reduced to 2% from 2.5% x years of service (40% of base pay at 20 years rather than 50% under the old system), the pension is still inflation protected, begins paying immediately upon retirement, and includes access to TriCare health coverage. For a 20 year O-5 retiring in 2016, the difference between 40% and 50% is $39,898 vs. $49,872. $10,000 a year is not a small difference and over a 40 or 50 year retirement that gap will continue to grow.
However, $40,000/year is a significant amount of money. Many early retirees live on far less (see Mr. Money Mustache). If you make minimal contributions to your TSP (5%) over your years of service and received the DoD TSP match, you should be in a good financial position, depending on your expenses and lifestyle.
Real World Old vs. New Military Retirement Scenario
Here’s 3 examples of my personal situation. I ran the numbers for a 0% return, 5% return, and 7% return in the TSP. To get returns like this, you’ll need to move your money out of the G Fund and into a more diversified asset allocation, with at least 60% or more of your assets in the C, S, or I fund. At least move your money into the latest Lifecycle Fund while you figure out what kind of asset allocation you need.
In 2018 I will be an 8 year Air Force captain (O-3). In these examples I assumed I serve 20 years and contribute 5% of my pay into the TSP. All figures are in real 2016 dollars, we’ll ignore inflation for this exercise. Under the old system, my annual retirement income would be $49,872 at 50%. Under the new system, my annual retired income would be $39,898 at 40%. I give the value of the TSP at age 60 assuming I’ve made no contribution until 2018. Age 59.5 is when you can begin accessing your TSP penalty free but I used age 60 to make the math easier.
0% Rate of Return
Old System: At age 60, I will have $55,532 in my TSP (just my contributions). If I live to 82, the total value of my retirement would be $2,050,412 (TSP account + annual retirement income x 40 years).
New System: Age 60, with 5% DoD match, and investing the continuation pay bonus (2.5x monthly base pay, paid in year 12), I will have $127,926 in my TSP. If I live to 82, the total value of my retirement would be $1,723,830.
In this scenario the old system wins by $300,000. However, I could very well die before 82 or leave the service before 20 years and then any pension is a moot point. I could also live well beyond 82 if Ray Kurzweil is correct. Living beyond 82 favors the old system.
5% Rate of Return
Old System: age 60, TSP: $186,678, living to 82 total value: $2,181,558
New System: age 60, TSP: $433,309, total value: $2,029,213
The new system is only short by about $150,000 in this scenario. Again, what’s $150,000 spread out over a lifetime? I think the increased flexibility the new system gives you today is worth giving up a potential $150,000 at some point in the distant future.
7% Rate of Return
Think a 7% rate of return is unrealistic? With dividends the S&P 500 has delivered an inflation adjusted average return of 8.5% since 1871. It’s tough to predict the future, but we can look to the past for patterns and trends.
Old System: age 60, TSP: $300,980, total value: $2,295,860
New System: age 60, TSP: $699,879, total value: $2,295,783
Here the old and new system are within a few hundred dollars of each other. Again, it’s almost a toss-up on this point. While you do get the increased guaranteed pension, what did you have to sacrifice to get it? The old system only pays anything if you serve until the 20 year mark.
If you were just staying in the service to get a 20 year pension, you may have had a miserable time. Even though the old system mathematically (barely) wins out over the new system at a 7% return, the main argument in favor of the new system is the enhanced quality of life and flexibility.
The TSP matching can boost your TSP account by $15,000 in 4 years as a 8-12 year O-3. That’s $15,000 working for you in the market that you would not have under the old retirement system.
Benefits of the TSP
The TSP is the best employer sponsored retirement account available today. The expense ratios are 1/10th of what you would pay at Vanguard and there are no transaction or trading fees. The 5 investment funds offered are broadly diversified and cover the entire US stock market (C and S Fund), government bonds (G Fund), corporate bonds (F Fund), and most of the world (I Fund).
If you don’t know how to pick an asset allocation, just start by moving your money into the latest Lifecycle Fund (L2050 as of 2016). The Lifecycle Fund start with more stocks and less bonds and slowly becomes more bond heavy as you approach retirement. Once your money is invested in a Lifecycle Fund, start educating yourself on asset allocations to maximize your returns. As for myself, I am invested in 90% stocks, 10% bonds and plan to stay with that portfolio for the next few years. There is a lot of free research and information out there regarding asset allocation, I recommend you start with the Bogleheads wiki.
Will You Opt In?
The new military retirement plan offers the intelligent military investor more flexibility with their career choices and investments, while sacrificing some of the vaunted military pension available at 20 years of service. Even if you are certain that you will stay in for 20 years, you may not be given that choice. Thousands of volunteers are involuntarily separated every year.
You never know what the future might hold, whether it’s a better paying job on the outside or if you have to take care of an ill family member. Life holds many surprises and given that 80%+ of service members don’t make it to 20 years, chances are you won’t. Rather than gamble that you will make it 20 years, take the safer option and join me in opting into the new military retirement system.
I think Spencer has done a great job of explaining his thought process. Do you have questions or thoughts?