Maximizing Military Retirement Pay: Strategic Investment Options

Investing your military retirement pay can be tricky, but it's not impossible. There are a few things to consider when investing your military retirement pay, such as your desired retirement age, cash needs, and investment types. It's also important to remember that you shouldn't rely solely on your pension, as you may decide to leave before completing a full 20 years of service. Additionally, your monthly pension amount may not be enough to fund your desired retirement lifestyle. It's recommended that you save at least 10% of your income and invest it in a Thrift Savings Plan or a Roth IRA. You can also consider investing in stocks, bonds, mutual funds, or exchange-traded funds (ETFs). Before investing, it's crucial to educate yourself about different investment options and determine your risk tolerance and investment goals.

Save 10% of your paycheck

Saving 10% of your paycheck is a great way to ensure you have a comfortable retirement. Here are some tips to help you save 10% of your military paycheck:

• Pay yourself first: Have 10% of your paycheck automatically transferred into a savings or investment account. This strategy is successful because it's easier to not spend money that you never had. You can use a Thrift Savings Plan (TSP) or a Roth IRA to save this money.
• Create a plan: Make sure you have a clear investment plan with desired retirement age, cash needs for retirement, required annual contribution, and types of investments needed. You can use an online retirement planner to help with this.
• Build an emergency fund: It is recommended to set aside 3-6 months of living expenses in case of unexpected costs, such as redeployment or transitioning to civilian life.
• Don't rely solely on your pension: While serving for 20 years will qualify you for a pension, there is a chance you may not serve the full 20 years. Additionally, the monthly pension amount may not be enough to fund your desired retirement lifestyle. Therefore, it is important to build a cushion by saving 10%.
• Understand your current financial situation: Take an honest look at your finances by creating a net worth statement. List your assets and liabilities, then subtract your liabilities from your assets to determine your net worth. Update this statement annually to track your progress.
• Know your income and expenses: Keep track of your monthly income and expenses to understand your financial situation. This will help you identify areas where you can cut back on spending and increase your savings.
• Find ways to save: Look for small everyday expenses that you can cut back on, such as buying a cup of coffee every day. Instead, consider making your own coffee at home and saving that money. Over time, even small amounts saved can add up to significant savings.
• Pay off high-interest debt: If you have any high-interest debt, such as credit card debt, focus on paying it off before investing. The interest charges on credit cards can be very high, and it is unlikely that any investment will be able to keep up with those charges.

Choose a savings account or Roth IRA

When it comes to investing military retirement pay, there are two main options for tax-advantaged retirement savings: the Thrift Savings Plan (TSP) and Individual Retirement Arrangements (IRA). Both TSP and IRAs have the option to choose a traditional tax treatment or Roth tax treatment.

Traditional Tax Treatment

Contributions are made pre-tax, meaning they are taken out of your pay before your taxes were calculated (for TSP) or you can take a deduction on your income tax return (for IRAs). This lowers your taxable income for the year, which means that you pay fewer income taxes in the year you make the contribution. You pay the income taxes on the contributions and income earned when you take distributions in retirement.

Roth Tax Treatment

If you select a Roth IRA, you don't deduct your contribution in the year that you make them. Instead, Roth IRA contributions and earnings are income tax-free when they are taken out of the account in retirement. This is a good option for those who anticipate being in a higher tax bracket in retirement.

Savings Account or Roth IRA?

If you are eligible for both traditional and Roth IRAs, how do you choose between the two options? Here are some questions to consider:

• How long do you expect to keep earning money? If you'll be working beyond age 70, you will have to begin withdrawing from a traditional IRA and paying tax on those withdrawals, while still paying income tax on your compensation.
• What tax bracket do you expect to be in when you start withdrawing money? If you expect to be in a lower tax bracket than you are now, then a traditional IRA enables you to save money upfront by deducting your contributions and put off paying some taxes until later.
• Do you plan to use up your IRA assets during your lifetime, or leave them to your heirs? A Roth IRA can be used for estate planning, to build up assets for those who will inherit. While a traditional IRA can be inherited, your heirs and beneficiaries would probably gain more from a Roth IRA. Without mandatory withdrawals, your account can keep accumulating income, tax-free, until your death, when it will pass to the person you've designated.

Other Considerations

• Investment options: TSPs are somewhat limited in terms of where you can put your money. A TSP offers five stock and bond index funds as well as life-cycle funds, whereas many IRAs provide a much larger array of investment choices, including real estate and commodities.
• Tax-advantaged contributions: The IRA contribution limit doesn't count against your TSP ceiling, so younger investors might prefer to put their money into a Roth TSP and a Roth IRA.
• Withdrawal flexibility: With a Roth IRA, you can withdraw contributions anytime with no tax or penalty. The Roth TSP doesn't offer this flexibility, so you would have to rely on loans to avoid early withdrawal penalties.

Don't rely on a pension

While pensions are a great source of retirement income, it is not advisable to rely solely on them for a comfortable retirement. Here are some reasons why:

• Changes to pension plans: Pension plans can change, and not always for the better. For example, some companies are switching from defined-benefit plans to defined-contribution plans, which shift the risk of pension fund performance from the employer to the employee.
• Uncertainty and risk: With defined-contribution plans, employees are often left to select their own investments, even without knowledge in the area. This uncertainty and risk can impact your retirement savings negatively.
• Insufficient income: The average Social Security recipient in the US receives around $18,000 annually, which may not be enough to live comfortably. Therefore, it is essential to have other sources of retirement income.
• Limited access: Not all workers have access to employer-sponsored pension plans or 401(k)s. As a result, individuals may need to get creative with their retirement savings through IRAs, regular investment accounts, or side hustles.
• Healthcare costs: Many retirees underestimate the cost of healthcare in retirement. It is important to anticipate these expenses and plan accordingly.
• Inflation: Inflation can significantly impact the value of your pension income over time. For example, the removal of the State Pension triple lock in the UK will result in pensioners' income shrinking in real terms.
• Longevity: People are living longer, and the State Pension age is increasing. This means that individuals may need to work longer and save more to maintain their standard of living in retirement.
• Unforeseen circumstances: Life can be unpredictable, and relying solely on a pension may not provide the financial security needed to deal with emergencies or unexpected expenses.
• Personal control: Ultimately, your retirement savings are in your hands. By diversifying your income sources and taking control of your financial future, you can better prepare for the uncertainties of retirement.

In conclusion, while a pension is an important component of retirement planning, it should not be your only source of income. By saving and investing wisely, exploring alternative retirement accounts, and staying informed about changes to pension plans, you can ensure a more secure and comfortable retirement.

Understand your investment style

Understanding your investment style is crucial to making the most of your military retirement pay. Here are some key considerations to help you define your investment approach:

Risk Tolerance

The first step in understanding your investment style is assessing your risk tolerance. This refers to how comfortable you are with taking on investment risk. Generally, investments with higher potential returns come with higher risk. As a military member, you may be used to a certain level of risk and uncertainty, but it's important to determine how much risk you're willing to take with your investments. Are you comfortable with more aggressive, high-risk investments, or do you prefer a more conservative approach? Your risk tolerance will guide the types of investments you choose.

Time Horizon

Another critical factor in defining your investment style is your time horizon, or how long you plan to invest for. This is closely linked to your retirement goals and timeline. If you're still years away from retirement, you may be able to take on more risk, as you have time to ride out market fluctuations. On the other hand, if you're closer to retirement, you may want to focus on more conservative investments to protect your principal. Consider your desired retirement age and how many years you have until you plan to access your investments.

Investment Knowledge and Involvement

Understanding your level of investment knowledge and how involved you want to be in managing your investments is essential. Some military members prefer a hands-on approach, actively researching and selecting their investments. Others may prefer to work with a financial advisor or utilize automated investment services. Assess your interest in learning about different investment options and your ability to make informed investment decisions. If you're unsure or don't have the time to devote to investment research, consider seeking professional advice or using investment tools that align with your goals.

Investment Options

Familiarize yourself with the various investment options available to military members, such as the Thrift Savings Plan (TSP), Individual Retirement Accounts (IRAs), and the Savings Deposit Program (SDP). Each of these options has its own characteristics, including contribution limits, tax implications, and investment choices. Understanding these options will help you tailor your investment style to your specific needs and goals.

Diversification

Diversification, or spreading your investments across different asset classes and industries, is a key consideration in defining your investment style. Diversification can help manage risk and improve long-term returns. Consider how you want to allocate your investments across stocks, bonds, mutual funds, exchange-traded funds (ETFs), and other investment options. Diversification doesn't guarantee profits or protect against losses, but it can help smooth out the ups and downs of the market.

Regular Review and Adjustment

Lastly, remember that your investment style may evolve over time as your circumstances change. Regularly review and adjust your investment strategy to ensure it remains aligned with your goals, risk tolerance, and market conditions. Life events, economic shifts, and changes in your income or expenses may prompt you to reevaluate your investment approach. Stay flexible and be prepared to make adjustments as needed.

Consider a Thrift Savings Plan

The Thrift Savings Plan (TSP) is a federal government-sponsored retirement savings and investment plan. It is a defined contribution plan, meaning your retirement income will depend on how much you contribute during your working years and the earnings on those contributions. The TSP is similar to the 401(k) plans offered by many private corporations to their employees.

The TSP gives you a simple retirement strategy that makes saving money easier. It saves a percentage of your pay – you decide how much – through payroll deductions. Any contributions you make are yours to keep, whether you leave the military or stay until retirement.

There are two types of TSP: the traditional TSP and the Roth TSP. The traditional TSP involves making pre-tax contributions, meaning you don't pay taxes on them or on any earnings until you withdraw them, usually after age 59 1/2. This gives you a tax break today by lowering your current taxable income. With the Roth TSP, you make contributions after paying taxes on the money, so you won't owe any further taxes when you withdraw the funds, and the earnings are tax-free if you meet the IRS requirements.

You can choose to contribute to either or both types of TSP. When choosing, consider your current and future tax rate, your career path, and the government match. The government's matching contributions can only be made into a traditional TSP. If you have a Roth TSP, you will still have both types of accounts.

The TSP offers five individual TSP funds with different levels of risk and projected returns. The G and F funds have a lower level of risk with smaller projected returns, while the C, S, and I funds have higher levels of risk with greater projected returns. There are also Lifecycle or L funds, which are a diversified collection of the five individual funds designed to coincide with your expected retirement year.

The TSP is a great way to save for retirement, offering flexibility, tax advantages, and the potential for compound interest to grow your savings over time.

Frequently asked questions