Retirement

While you are in the military you have access to several types of retirement plans. For military personnel they refer to it as the Blended Retirement System or BRS for short. For civilian employees of the Department of Defense (DoD) they refer to it as either the Federal Employees Retirement System (FERS) or Civil Service Retirement System (CSRS). 

In each of these retirement systems, military personnel and civilian employees have access to both defined contribution retirement plans and defined benefit retirement plans. Separate from these retirement plans, most military service members and civilian employees pay into Social Security as well. The combination of an employer sponsored defined contribution retirement plan, defined benefit retirement plan and social security retirement plan it known as the "three legged stool". The three legged stool analogy was initially developed as an easy way to articulate the shared responsibility of the federal government, employer and employee to all participate in preparing the employee for a successful retirement. It gets a little confusing because in the case of military members and civilian employees of the DoD their employer also happens to be the federal government. However, it is not much different than the system you often see at large  private companies.

In our experience, those veterans who transition from the military into another career working as a civil servant do so in-part because of the financial security that comes from the promise of having a pension they can count on. The quality of having two different pensions underwritten by the good faith and credit of the U.S. government is a reassuring prospect to many.

The various retirement systems are broken up into the following categories:

• Defined Contribution Retirement Plan
  • Thrift Savings Plan (TSP)
• Defined Benefit Plan
  • Military Pension, or
  • FERS, or
  • CSRS
• Social Security 
  • Social Security Retirement Income

Military and Federal Government workers have access to two primary forms of retirement through the DoD and one type through Social Security. Let's unpack how each work in tandem to provide you with a secure retirement.

TSP

The TSP, or more technically, the federal government's defined contribution retirement plan, is a type of retirement plan that encourages employees to contribute money for their earned income towards their retirement plan by providing tax breaks and employer matching contributions. The TSP is very similar to a 401(k) and is governed by many of the same laws and regulations.

One of the reasons contributing to the TSP, or any defined contribution retirement plan, is so valuable is that your employer will match  portion of your contributions. This is like getting a pay raise for doing nothing more than improving your own savings rate. What a great deal!  The TSP currently matches up to 4% of your salary. The first 3% is a dollar-for-dollar match, and the next 2% is fifty cents to the dollar. For example:

• You save 3% and they match 3%
• You save 4% and they match 3.5%
• You save 5% and they match 4%

Everything over 5% goes without a matching contribution from the TSP.  So, as you can see this is like a 4% pay raise every year for the rest of your career.

Our experience, and the data demonstrates, that many people who become millionaires do so in large part from the savings and investing growth they experience through their employer sponsored retirement plans like the TSP. The matching aspect of the TSP is a big part of this. For example, if you normally contribute 10% to the TSP and receive a match of 4% this is like getting an extra 40% of returns in that first year on the amount you contributed. Clearly this is a powerful tool for improving your wealth.

Defined Benefit Pension Plan

This is usually what people think about when someone says they have a pension. What it is a guarantee, based on a pre-determined calculation, that you will receive a set amount of income. These types of pensions (defined benefit) use to be much more popular decades ago but fell out of favor in-part because companies made bad projections about how long people would live and so they underfunded their pension plans. In some case these underfunded pensions resulted in defaults of those organizations. This has not ever been a big risk for pensions associated with working in the federal government because the federal government has the full taxation authority that they do and the Federal Reserve can always print more money. The implicit guarantee that your pension is backed by the full faith of the federal government is a tremendously valuable resource in retirement.

Military Pensions, FERS and CSRS pensions are all calculated in similar ways. Using formulas that account for your length of service, the average of your highest three years of earnings and some factor that will be different based on what pension plan you are participating in and other factors. 

A typical example of a military pension for an active duty BRS participant will look something like the following:

• 2.0% x Years of Service x Average of Highest 3 years of Base Pay = Annual Annuity
• 2.0% x 22 Years x $85,000 = $37,400

It is also important to note that most pension plans include a cost of living adjustment each year so that your annual annuity goes up with inflation. It is also important to understand if your military pension is taxable or not.

Some veterans who retire from the military will go on to serve another career as a federal employee or civil servant earning themselves a second defined benefit pension. In the span of two 20 year careers this might earn a person the equivalent of 80% of their income in pension income during retirement. We find that those people who have chosen this career strategy seldom regret the choice and enjoy a great deal of financial security in retirement.

Social Security Income

Finally, in addition to your pension payments and TSP withdrawals, you will also be eligible for Social Security Income when you hit retirement age. Like you defined benefit pension plan from work this too is a predetermined set of payments you will receive in retirement based on a calculation. The calculation for these payments is a complex topic I will save for another time, but suffice it to say that Social Security typically only pays out a few hundred dollars a month to recipients. 

The Social Security Income that you receive in retirement is income that is owed to you as a result of you having paid into the program through your income taxes. As with your employer's defined benefit retirement plans, Social Security retirement income is decided based on a calculation which references in-part the length of your work history and the income you earned during your career. Social Security does have a relatively low payout compared to your pre-retirement income for individuals who have higher incomes because of certain limitations Congress has placed on the program.

Building Blocks of Retirement

When you take these three types of retirement plans and put them together you can begin to see that they build on one another.

• Social Security only attempts to keep you out of abject poverty in retirement by offering a very small monthly payment. 
• Your defined benefit pension plan seeks to replace a portion of your earned income, but never enough to fully replace it.
  • Military pension for example maxes out around 50% of your base pay.
• TSP is your growth engine so you can save and invest in the economy. This is the part of your retirement plan system that has unlimited upside potential. If you are ever to have more purchasing power in retirement than before it then it must come from contributions and growth in your TSP account.

Understanding the three building blocks of retirement—Social Security, your defined benefit pension, and your TSP—is just the beginning. To secure a financially stable and fulfilling retirement, you need a strategic approach to managing these assets.

How Much Should You Save in the TSP?

While the government provides an employer match, your personal contributions play a crucial role in your ability to retire on your own terms. Financial experts often recommend saving at least 10-15% of your income in a defined contribution plan like the TSP. I am an advocate of saving between 25-50% in total for those who want achieve a significant level of wealth or financial independence. How much you should save to achieve your goals depends on many factors like your age, how much you already have saved, when you plan on retiring and what your lifestyle in retirement might look like, among other considerations. Military service members and veterans have unique considerations they ought to consider beyond just their savings rate:

• Deployment and Tax-Free Contributions: If you contribute to your TSP while deployed in a combat zone, those contributions are tax-exempt, meaning they can grow completely tax-free if allocated to the Roth TSP. You can read more in our blog post about how you can Super Charge Your Savings During Deployment.
• Roth vs. Traditional TSP: Deciding between Roth and Traditional contributions depends on your expected tax bracket in retirement. If you anticipate higher taxes later, Roth TSP contributions can be advantageous. Keep in mind, that a 0% tax bracket while deployed makes for a great opportunity to save in your Roth TSP account.
• Catch-Up Contributions: If you’re age 50 or older, you can take advantage of catch-up contributions, allowing you to contribute beyond the standard limit to accelerate your retirement savings. The earlier you start saving the less total money you will likely need to save. Catch-up contributions are nice but going into your 50's knowing you are ready is nicer.

Investment Options in the TSP

The TSP offers several investment choices that range from conservative to aggressive. Selecting the right mix of funds can greatly impact your long-term retirement income:

• G Fund (Government Securities Fund): Offers stability with virtually no risk, but generally lower returns than what you would expect in other funds. However, during recessions this fund really shines.
• F Fund (Fixed Income Index Fund): A bond fund that can provide moderate growth with some risk. This fund invests in investment grade corporate bonds. 
• C Fund (Common Stock Index Fund): Tracks the S&P 500, providing exposure to large U.S. companies.
• S Fund (Small Cap Stock Index Fund): Focuses on small and medium sized U.S. companies, which are generally thought to offer higher growth potential but with greater volatility.
• I Fund (International Stock Index Fund): Invests in international markets, adding global diversification. Read our blog post about The TSP's New I-Fund Benchmark.
• Lifecycle Funds (L Funds): Designed for those who prefer an automatically managed, diversified portfolio based on their expected retirement date. This is a great "set it and forget it" option. Do be sure to take a look at their asset allocation strategy though as the TSP is generally more conservative than other financial institutions in how they allocate across asset classes in their lifecycle funds.

For a deeper look, read our blog post What You Need To Know About the TSP.

A strong investment strategy will take into account your risk tolerance, time horizon, and overall financial goals. 

For those eligible for a military pension, strategic planning is essential to ensure you maximize its benefits. There are different approaches to how your military pension should be considered when investing in the TSP or other accounts. The two main schools of thought are to treat your military pension as a large inflation indexed government bond, and the second approach is to offset the cash you require in retirement by the amount of your after-tax pension payments when crafting your financial plan. While I am sure many financial advisors are tempted to take the easy road and conclude that the proper treatment of the pension is as a large inflation protected bond they would be wrong because you can never sell your pension for cash. This means you can never reallocate your assets within your portfolio. You also can not cash out any more or less than what the government has determined you are owed. The intellectually honest approach is to count the cash flows from the pension as cash flows which can be used to offset your expenses and nothing more.

Some other considerations for your pension:

• Survivor Benefit Plan (SBP): If you are married or have dependents, the SBP can provide a guaranteed income stream for your beneficiaries in the event of your passing. However, SBP premiums reduce your monthly pension payments, so careful evaluation is needed to understand the costs and benefits of the SBP. There are many arguments to be made for and against the value of the SBP and so you should think through your approach to this decision carefully as it may have a tremendous impact on you and your family's financial well-being. For example, we have heard from veterans how they have outlived their spouse only to find that the premiums they paid into the SBP were gone forever. One consideration we encourage retiring military members to think about is looking to insurance policies or annuity contracts that trigger upon the death of either spouse as an alternative to the SBP. In some cases this is an attractive alternative but certainly not always.
• VA Disability Compensation and Your Pension: If you qualify for VA disability benefits, some of your pension may be offset, depending on the percentage of your disability rating. However, if your disability rating is high enough you may qualify for Concurrent Retirement and Disability Payments (CRDP). Furthermore, some retired military members, if they qualify, may be eligible for a tax-free pension and VA disability concurrently. Understanding how these benefits interact is crucial for planning your finances. A full retirement pension and VA Disability that are both tax-free often go a very long way towards achieving financial independence.

At Stars & Stripes Financial Advisors, we understand the complexities of retirement planning for military service members, veterans, and their families. Your retirement strategy should be tailored to your unique needs, accounting for your military and veteran benefits, investments, and long-term goals.

If you’re ready to take the next step, we’re here to guide you. Schedule a free consultation today, and let’s build the retirement you’ve earned.