Congratulations, You Just Graduated From a Service Academy! Now, Start Planning for Retirement
by John Cooney on Jun 22, 2017
Congratulations, you just spent the past four years in one of the most challenging college environments that exist. You were pushed to your physical, emotional, and intellectual limits and earned the right to be commissioned as an officer in the United States Military. So now, while you are enjoying a little leave, on your way to your basic officer course, or already at your first assignment leading troops, you need to make sure you are planning for retirement. Wait, what, retirement, but you just graduated? Remember, you will never again get the chance to start planning for retirement this early. I have outlined three steps below that you can take before you ever show up for your first formation that can put you on the right path to achieving financial security in your retirement.
Step 1: Establish a Thrift Savings Plan (TSP) Account
The TSP is a Federal Government-sponsored retirement account that allows service members to defer a percentage of their salary into a select group of funds. These deferrals can be before tax (traditional) or after tax (Roth). If you choose traditional contributions, the income tax on the contributions and the earnings will be tax deferred, that is, you will not pay taxes on them until you withdraw the money. If you make Roth contributions, you will pay income taxes on the contribution amount now, but those contributions and the earnings on those contributions will be tax free when you withdraw them, as long as you do not withdraw before you are 59 ½ and it has been at least 5 years since you made the first Roth contribution. Starting and investing in the TSP is incredibly simple; Army, Navy, and Air Force personnel can do so at www.MyPay.dfas.mil , USMC folks can do so at Marine OnLine, and the USCG uses Direct Access. At these sites, you will choose the percentage of your basic pay, special pay, incentive pay, and bonuses that you want to defer into your TSP account and whether the deferrals will be traditional or Roth. The TSP is composed of five individual accounts that range from Government securities to an international stock index fund. In additional to the five individual funds, the TSP also offers Lifecycle funds, which are funds targeted to a specific retirement year that are made up of a combination of the five individual funds in a manner designed to reduce risk the closer you move to retirement. For example, the Lifestyle Income fund, which is designed for personnel who are currently withdrawing money from their account or plan to begin doing so in the next year or two, has 80% of the assets invested in the low risk “G” and “F” funds and only 20% invested in the three stock funds. In contrast, the Lifestyle 2050 fund, designed for personnel who would begin withdrawing from the account in 30+ years is made up of 85% stock funds, and 15% “G” and “F” funds. As the years go by, the L2050 fund will continue to adjust the allocation percentages so that in the year 2050, it will mirror the allocation percentages in the L Income Fund. The idea is that as you get closer to retirement, the account reduces the overall risk. If you do not designate a fund for your contributions, they will default to the “G” Fund, but fear not, you can always access your account at TSP.gov, and change the allocation percentage to any one or a mix of the TSP funds.
Some of the other benefits of the TSP are the relatively low account fees and portability. The TSP has one of the lowest, if not the lowest account fee charges amongst any retirement plan. In 2016, the average net expense for TSP accounts was $0.38 cents per $1,000. That means for every $1,000 in your TSP account, the government charged 38 cents to cover costs of administering the program. Fees suck, but when compared to most mutual funds and 401K accounts, 38 cents out of $1000 is an incredibly good deal. Second is portability. The TSP account is yours, it is your money that you put in, and you own that money and the earnings on the money. If you choose to leave the service, you still keep the account. You can leave it alone, enjoy the low fees, and let it continue to grow until retirement, or you can roll it over to another eligible employer plan, like a 401K or to an IRA. Don’t wait, the best time to start saving for retirement is yesterday, so do the next best thing and start today!
Have questions on which TSP fund is right for you?
Step 2: Open an IRA
Step 2 in securing your financial future in retirement is opening an IRA account. An IRA stands for Individual Retirement Account and is a tax advantaged way to save for retirement. Just like with your TSP contributions, IRAs come in two forms; traditional and Roth. With the traditional IRA contributions, the money you contribute is considered pre-tax, that is it will not count as income for tax purposes in the year you contribute. The money you contribute and the earnings on those contributions continue to grow in a tax-deferred status until you withdraw them. The basic idea being that you will be contributing the money in your income earning years and typically will be in a higher tax bracket than you will be in retirement when you withdraw the money. For Roth contributions the taxes are not deferred, instead, you pay taxes on the money you earn in the year of the contribution and then the money and the earnings on those contributions will grow tax free so when you withdraw the money, no taxes are owed. Roth IRAs can also be a little more flexible in that they require no minimum distributions. If you have money in a traditional IRA, the government mandates that starting at age 70 ½ you begin taking a minimum withdrawal that is based on life expectancy and your account balance. This is to ensure the government gets their taxes. With Roth IRAs, since there is no taxable event at distribution, the government has less of an interest in making sure there is a withdrawal, so there are no minimum distributions required. This can allow you to continue to grow the Roth IRA account until you need to access it.
Which type of IRA should you open? Well a lot of that decision is going to depend on your personal preference and what you think your income taxes will be in the future. While typically you will be in a lower tax bracket in retirement than when you are working, we are also in a historically low time for income tax brackets. So while your bracket may be lower in the future, the percentage may not necessarily be lower. Since I do not have a crystal ball and cannot predict future tax brackets, I like to make sure I have a diverse set of retirement accounts to choose from when making withdrawals. The diversity I am referring to here is in regards to income tax treatment. If you are making traditional contributions to your TSP account, you may want to open a corresponding Roth IRA to allow yourself some options when withdrawing money from these accounts in retirement. You may be over 60 and still working part-time, but want to take money out of a retirement account to supplement your income. If you have a Roth IRA, you could withdraw from that account and not owe any income taxes on the withdrawal. Then the next year you stop working and your income level drops to a lower tax bracket, you can then take advantage of the lower tax bracket and withdraw from the traditional account, and allow the Roth IRA to continue to grow tax-free. Bottom line, it is all about giving yourself options, and the earlier you start saving in an IRA whether it is traditional or Roth, the better your options will be.
Step 3: Opt-In to the Blended Retirement System (BRS)
Hopefully, by now you know that the Department of Defense is changing the Military Retirement System from the legacy “High 3” system to the Blended Retirement System. If you are being commissioned in 2017, you will be eligible to decide to stay in the legacy system or to opt-in to the BRS. Under the legacy system, if you serve 20 years, you earn a lifetime, inflation protected pension that is based on the number of years you serve, the average of your three highest paying years, and an inflation multiplier of 2.5%. Under the BRS, you will still get a pension if you serve 20 years, and it will still be based on the number of years you serve and the average of your three highest paying years, but the pension multiplier has been reduced to 2.0%. Let’s look at an example of each. You are a Major who retired after twenty years and earned an average of $11,000 per month for the last three years of service. Under the legacy system, your pension would be calculated:
2.5% X 20 X 11,000 = $5,500/month
Under the BRS, your pension would be calculated:
2.0% X 20 X 11,000 = $4,400/month
As you can see, under the BRS you are effectively receiving 20% less in your pension. This is where the blended part of the BRS comes in; in exchange for the lower pension amount, DOD will start contributing to and matching contributions to your TSP account. The idea being, that through encouraging service members to invest in the TSP and take advantage of government matching contributions, they can accumulate enough money in their TSP accounts to make up for the reduction in pension, while at the same time saving the government millions of dollars per year. So, if the BRS reduces your pension, why would I be suggesting you opt-in? Well, for two reasons, time and uncertainty. As an officer just entering into the service, you have the luxury of time until you retire and can take advantage of compounding returns to really grow your TSP account, so that even if you do make it to your twenty year mark and qualify for the pension, through smart saving and investment choices you will still have enough retirement income to meet your needs. The second reason is uncertainty. The biggest advantage of the BRS is that it gives those who serve honorably but do not stay in for twenty years the ability to leave the service with a government aided start to retirement that they can take with them to use for retirement. You may have every intention of serving twenty years and do not see an advantage in giving up twenty percent of your pension, but life can be unpredictable. Opting-in, when you have your whole career ahead of you to build your TSP balance, gives you more flexibility if you do not qualify for the pension, and is why I would recommend anyone starting their career now to opt-in.
So I cheated a little on this one, you can’t do this just yet since the opt-in window does not open until January 1st, 2018. So, what you should do now is take as much time as possible between now and December 31st to educate yourself on your options, and be ready to make a decision as early as you can, especially if that decision is to opt-in. A great starting point is to use the comparison calculator at http://militarypay.defense.gov/Calculators/BRS/ to see what the financial outcomes are to various career scenarios you can take.
One last important note, while the BRS will initiate government contributions to your TSP, nothing is preventing you from contributing on your own to the TSP now. Whether you opt-in or not, you should be building towards your retirement now by contributing to the TSP (See Step 1!!).
Do you have questions on the comparison calculator?
Again, congratulations on your graduation and commission. You are about to embark on an exciting journey leading America’s sons and daughters. As you begin your service to a grateful nation, take a little time to set your future self up for financial success by making smart retirement choices today.
John Cooney is the founder and owner of Green and Gold Financial Planning, a fee-only financial planning firm that specializes in working with veterans, service members and their families. He remembers how excited he was driving home from West Point after graduation in 1998 but wishes he had read an article like this to help get his retirement planning started. Contact him today @ john@greenandgoldfinancial.com to talk about how you can start securing your financial freedom now.
