TMW002 – Financial Independence and Early Retirement on a Military Salary. An Interview with Doug Nordman

Retirement. It means many different things to different people. To some it means working until you are 65, then hoping you have enough money put away to live the rest of your life in relative comfort. Others are able to retire at an earlier age. How do they do it? How can they afford to retire after working a 20- or 30-year career? It’s easy to say some people just make a lot of money, so they can retire early. But there is a lot more to it than just earning money.

Yes, you need to earn money. But you also need to save and invest that money wisely. You also need to account for things like inflation and escalating health care costs, supporting your family, and outliving your nest egg.

Financial Independence & Earlly Retirement on a Military Salary

Want to retire early? Listen to this podcast!

In today’s podcast, I want to introduce you to my friend, and early-retiree, Doug Nordman. Doug is a retired Naval officer. He was able to retire at age 41 and never work again. But don’t let that fool you – Doug remains just as busy today as he was when he was in the service. The difference is he is doing the things he loves, not what he has to do.

Doug structures his day around his passions – surfing, writing, and helping others. In fact, Doug’s book, The Military Guide to Financial Independence and Retirement, had a large influence on me, as you will hear in this podcast. Doug also runs a blog called The Military Guide, where he writes about a variety of topics related to military benefits, veterans topics, retirement, and personal finance.

About the Book: The Military Guide to Financial Independence and Retirement explains how one can retire on a military salary and related retirement benefits, without having to work again. But it also explains how those who don’t serve a full 20-year career in the military can save for early retirement and reach their goals at their own pace.

Chapter 5 in his book had a big influence on me, as it covers serving in the Guard or Reserves, something I had thought little about until a few years ago. If you have separated from the military and haven’t considered joining the Guard or Reserves, then it might be something worth exploring. The personal, professional, and financial benefits can have a lasting impact on your life.

What You Will Learn in This Podcast

In this podcast, we cover the following topics:

  • Doug’s story about how he and his wife were able to engineer their lives to meet their personal and financial goals, allowing Doug to retire for good at age 41.
  • An overview of Doug’s book, and some of the personal stories that went into it.
  • Why Doug donates all his book’s royalties to military charities, including the Wounded Warrior Project and the Fisher House Foundation.
  • The definition of Financial Independence, and how you can achieve it.
  • The difference of being Financially Responsible, and Financially Independent.
  • How to live a balanced life while pursuing your values and goals.
  • Where to find additional resources for reaching Financial Independence.
  • The under-appreciated value of serving in the National Guard or Reserves, and the true value of the retirement benefits from the Guard or Reserves (most people vastly underestimate the value of a Guard or Reserve retirement!).
  • Doug’s current project, with the current working title of, “The Military Guide to Making Good Insurance Decisions.” Doug wants to help people understand which types of insurance they need, which they can skip, and why.

 You Don’t Want to Miss This Episode

If retirement is on your mind, you need to listen to this episode. Whether you will have a military pension and the related benefits, or whether you are going it alone with your own investments, you will want to hear the information in this podcast. You will learn a lot about how to approach financial independence and retirement.

I highly recommend his book. The Military Guide to Financial Independence and Retirement is the best book I have read about military finance. And I don’t make this statement lightly. This book is also not just for current servicemembers. It can be an excellent resource for anyone who has served. I have read it cover to cover twice, and I have read certain sections multiple times. This book opened my eyes to many aspects of my own finances and has shaped my view of working and saving for retirement. As you will hear in the podcast, Doug recommends you see if your library has a copy you can borrow. He also recommends seeing if your unit can purchase copies for people on base. If those avenues don’t work, then you can find it on Amazon in paperback or Kindle format. It can also be found at several other online retailers. You can also read much of the content from the book in the archives on his site.

Where to Find Doug Online:

You can lave comments here on our site, or if you want to reach Doug, you can find him at the following locations:

Modernizing Military Retirement Pay – Hybrid Military Retirement Plan

The military retirement system is one of the most generous pension plans to be found almost anywhere. But the days of retiring at half pay after 20 years of service may be numbered. The DoD and Congress have been investigating opportunities to cut military retirement costs. It’s a delicate balance. The government needs to trim expenses across the board (thanks to the Sequestration), but the military needs to balance cuts with retention. Slice too deep, and too many service members will leave the service before they qualify for retirement benefits, leaving the military short on experience and leadership.

Modernizing military retirement benefits

Will retirement be as rewarding in the future?

The latest study, called Concepts for Modernizing Military Retirement (pdf), aims to meet that balance by offering a hybrid pension plan that combines a 401(k) style defined contribution benefit with a traditional pension. The basics work like this: all troops who serve at least 6 years will receive a contribution on their Thrift Savings Plan, a cash retention bonus will be paid at 12 years of service, and a larger lump-sum payment will be made after retiring after 20 or more years of service.

These new TSP contributions and cash payments come at a price, however. Military retirees would either receive a reduced retirement benefit multiplier, or a reduced pension while they are still working age (until around age 62).

Let’s take a look at what this may mean for future military retirees.

Hybrid Military Retirement Plan

There are three main components of the new potential retirement plan*. Here are the basics of each:

Matching Contributions in the Thrift Savings Plan: All service members would have a Thrift Savings Plan account opened on their behalf. Starting at year 2, the DoD would automatically contribute 5% of the service member’s base pay to the account, with no requirement for military members to make any contributions to receive the full 5%. Service members would be able to make their own contributions to the account if they wish. However, full ownership of the DoD contributions would not pass to the servicemember until they reach 6 years of service. A vesting period like this is a common retention tool in the civilian world.

Mid-career retention pay: The next benefit would be a lump-sum mid-career retention pay made to the servicemember around year 12. The proposal is around 2 months pay for enlisted members, and 6 months pay for officers. However, these payments would be controlled by each branch of service, so these numbers may be variable if the retention pay is used as a reenlistment incentive for undermanned or critical career fields.

Transition Pay at Retirement: There would also be a “transition pay” given upon military retirement at 20 years of service. This could be anywhere from one year of basic pay, up to three years of basic pay, depending on which option is chosen (see below for the immediate vesting, or the delayed vesting option).

Two Proposals:

There are two options currently under proposal regarding how much military retirees would receive for their military pension, and when they would receive it.

Proposal  1 – Immediate Vesting: This proposal would be similar to the current retirement system in which retirees would begin receiving full retirement checks and standard Cost of Living Adjustments for life.

Proposal  2 – Partial Payments While Still Working Age: The second proposal would enact a dual-tiered pension plan with reduced monthly payments to working age retirees, with payments beginning immediately upon separate from the military. The reduced pension would probably be around 25% of base pay. The retiree would then begin receiving full retirement pension at a more traditional retirement age of around age 62.

New Retirement Multiplier

The current military retirement multiplier is 2.5% pf pay for each year served. If you serve the minimum 20 years to qualify for military retirement benefits, you will have earned 50% of your base pay (actually, the average of your highest three years of pay for most military members still serving). Serving 30 years would earn a retiree 75% of their pay, and so on. This proposal would change the retirement multiplier, depending on which of the above options is chosen, the immediate vesting option, or the delayed vesting option.

Multiplier for Immediate Vesting: The immediate vesting option would place the multiplier at 1.75% of base pay. This would equate to a 35% benefit at 20 years of service. Serving for 30 years would net a retiree 52.5% of their pay.

Multiplier for Delayed Vesting: If the option for delayed vesting is chosen, the multiplier would likely remain at 2.5%, or possibly be reduced to 2.0%. The 2.5% multiplier would have no impact on the retiree, with the exception of the retiree receiving reduced pension payments until they reach retirement age. A 2% multiplier would pay 40% at 20 years, and 60% at 30 years (after reaching traditional retirement age).

How Much Will This Cost Retirees?

The DoD numbers show this will cost most retirees around 10% of their lifetime benefits compared to current retirement plans, depending on various factors, such as the rank and time in service of the retiree, age at retirement, market conditions for the TSP contributions, and which of the two options are chosen, the immediate or delayed vesting.

Who Wins & Who Loses Under This Proposal?

There are always pros and cons to every change. Lets take a deeper look at how this impacts military members.

Non-Retirees Benefit the Most. There are some people on the other side of the table (lawmakers and policy makers) who often quote that the military retirement system isn’t fair because fewer than 20% of service members remain on active duty long enough to qualify for a 20 year retirement. Many of the servicemembers who leave before serving 20 years walk away with nothing. This plan would change that. Anyone who serves at least 6 years would walk away with vested contributions in their Thrift Savings Plan account. The mid-career cash bonus at 12 years would also benefit many servicemembers, especially if they have the option of contributing the amount to their TSP. These Thrift Savings Plan contributions belong to the servicemember when they leave the military. This has the potential to be worth tens of thousands of dollars in the future, depending on how much the member received from the DoD, market conditions, and more importantly, whether the troops left the money in their TSP until retirement age.

Retirees See the Biggest Change. These two plans are different enough to warrant an individual response. Under the immediate vesting option, retirees would see a much reduced multiplier, substantially reducing their retirement pay. This would virtually guarantee every military retiree would have to work again after they reach military retirement. Currently, many retirees are able to plan in advance and may be able to retiree for good on a military pension. The added TSP contributions would make up for some of the pension shortfall, but this moves the responsibility to the servicemember, and would require them to leave their funds in the TSP until they are able to withdraw it (currently age 59½).

The delayed vesting option would cap military pensions at 25% until the retiree reaches a traditional retirement age (age 62), at which point they would receive their full pension. The delayed vesting option has either the same multiplier, or a slightly reduced multiplier. The primary difference is a larger cash payout for the career transition bonus paid out when the servicemember retires. How the servicemember uses the transition pay would have a large impact on how the numbers work out in the long run.

Does the government win? Either of these plans would save the government money in the long run, but they wouldn’t bring immediate cash savings. The Pentagon would grandfather in all current servicemembers to their current retirement plan, and the DoD would have to begin making large lump sum payments in the mean time to all servicemembers who meet the benchmarks for cash payments. The real savings by the Pentagon wouldn’t be seen for a few decades at least. After that, the savings would grow.

Will The DoD Move Toward a Hybrid Retirement Plan?

About two years ago, the Defense Business Board proposed some radical changes to the retirement system that would move almost the entire military retirement system to a 401(k)-like retirement plan. The plan would eventually shift 100% the responsibility for retirement from the government to the troops. The proposal was wildly unpopular, and the DoD feared the military would have a hard time meeting retention goals. This new proposal is somewhere in the middle.

One thing is clear: changes are coming to the military retirement system. It’s not really a question of if. It’s a question of when, and to what degree the changes will take place. We have already seen the previous proposal to shift all of the retirement to a 401(k) type plan. And this year we have seen Congress pass a law to reduce Cost of Living Adjustments for working age retirees. That law was repealed almost in its entirety shortly after it was passed. The law was changed to grandfather in all servicemembers who were in the military prior to 2014. Those who entered the service in 2014 or later will still have a reduced military pension.

The writing is on the wall. Changes will happen. It’s just a matter of the government finding a happy medium that will work for the lawmakers and lobbyists, and that won’t hurt retention too much.

The good news is the DoD has stated current servicemembers would be grandfathered into their current retirement plan. Hopefully this will be the case, and any changes that happen in the future will happen when servicemembers join the military under the assumption of the new rules.

* To be clear, the Pentagon is not calling this a proposal or recommendation at this time, simply an option the military could choose in the future.

 Source: MilitaryTimes.com

Image credit: General Frank Grass.

Concurrent Receipt Rules – Concurrent Retirement Disability Pay (CRDP)

Concurrent Retirement and Disability Pay (CRDP), also known as Concurrent Receipt, allows military retirees to receive both a full military retirement pension and full VA Disability compensation benefits, provided they meet eligibility requirements (listed below).

concurrent receipt military retirement pay

Are you eligible for Concurrent Receipt?

The CRDP program, which began on January 1, 2004, replaces the VA disability offset, which was previously required by law (and still is for some retirees). There is a 10 year phase in period in which military retirement pay was increased 10% each year until the recipient began receiving full military retirement pay (there was no phase-in period for retirees with a VA disability rating of 100%). The phase-in period lasted until January 2014.

Concurrent Receipt Replaces the VA Disability Offset

The VA disability offset requires military members to waive part of their military retirement pay in order to receive VA disability compensation benefits. Retirees are required to waive retirement pay up to the amount of VA Disability compensation they received (for retirees who have a VA disability rating of 40% or lower). The exception is retirees who have a VA disability rating of 50% or higher, in which case they are eligible for Concurrent Receipt, in which they can receive full military retirement pay and full VA disability pay. Retirees can elect not to waive military retirement pay and forgo receiving VA disability pay. However, waiving military retirement pay makes sense because the VA disability benefit is a non-taxable benefit, and military pensions are taxable income. Receiving VA disability pay will help retirees receive a larger net income.

Concurrent Receipt Eligibility

Military retirees qualify for concurrent receipt under the following conditions:

  • You are a regular military retiree with a VA disability rating of 50 percent or greater.
  • You are a retiree of the Guard or Reserves with 20 or more Good Years, have a 50% VA disability rating, and have met retirement age (60 in most cases, but some Reservists are eligible for early retirement).
  • You are retired under Temporary Early Retirement Act (TERA) and have a VA disability rating of 50 percent or greater.
  • You are medically retired under Chapter 61 with 20 years or more and a 50% or greater VA disability rating.
  • You are a disability retiree who earned entitlement to retired pay under any provision of law other than solely by disability, and you have a VA disability rating of 50 percent or greater. You might become eligible for CRDP at the time you would have become eligible for retired pay.

The Disability rating of 50% or greater is the primary qualifier for retirees. If you have a disability rating that is lower than 50%, then you will not qualify for the Concurrent Receipt benefit. However, there are other programs which you may qualify for, including the Combat-Related Special Compensation (CRSC) program, which also replaces the VA disability offset program. The primary requirement for the CRSC program is having a 10% or higher combat related disability. Examples of qualifying disabilities for the CRSC program include training that simulates war, hazardous duty, armed conflict, and instrumentality of war (weapons, combat vehicles, Agent Orange, etc.).

Individual Unemployability & Concurrent Receipt

You are eligible for full concurrent receipt of both your VA disability compensation and your retired pay if you are a military retiree who meets all of the above eligibility requirements in addition to both of the following:

  •     You are rated by the VA as unemployable, generally referred to as Individual Unemployability (IU)
  •     You are in receipt of VA disability compensation as a result of IU

This is effective October 1, 2008 and is retroactive to January 1, 2005.

Applying for Concurrent Receipt

In most cases, you do not need to apply for Concurrent Receipt. It should be automatically applied to your paychecks. However, there may be times when your situation changes and the system doesn’t automatically take this into account. In most cases, you will be eligible for retroactive back pay. Determining back pay will require an audit from DFAS and the VA. DFAS states they will pay any retroactive benefits within 30-60 days of receipt of you’re your first CRDP monthly payment. If their audit determines you should be eligible for a retroactive payment for the VA then they will forward the results  of their audit to the VA, which is responsible for making the VA disability benefits payment.

Retroactive pay limitations: Your retroactive pay can only go back to January 1, 2004, which is the first day concurrent receipt was available. However, DFAS will only go back to the day you first received a 50% disability rating. If your 50% disability rating was made retroactive, then your eligibility will extend to that date, provided it isn’t before January 1, 2004.

Example: The VA has begun extensive reviews of disability benefits ratings for military personnel from the Vietnam Era. Many veterans have begun receiving retroactive disability benefits for Agent Orange exposure and related illnesses, and PTSD. If you are a military retiree who received retroactive disability compensation, then you may be eligible for retroactive back pay for the Concurrent Receipt program.

Other examples of retroactive pay would be someone who retired and began receiving VA disability compensation some months later, after their disability compensation package was approved. In many cases, this can take some months.

Value of Concurrent Receipt Pay

Under the VA disability offset program, you must waive a portion of your retirement pay if you wish to receive VA disability compensation. This is usually a smart move, because VA disability compensation is considered non-taxable income, whereas military retirement pay is taxable income. You are required to make this decision if you are a retiree with a VA disability compensation rating of 40% or less.

Those who qualify for concurrent receipt are eligible to receive both benefits in full. The value of this is enormous.

Simplified example: Let’s make a simple example of a retired  E-7 with 20 years service. The base pay for an E-7, according to the 2014 pay scale, would be $4,372. At 50%, the retirement pay would be $2,186. The following chart shows how valuable this benefit is (assuming the retiree elects to waive a portion of his or her retirement pay in order to receive the VA disability pay, which is tax exempt):

  • 0% disability: Base pay = $2,186
  • 10% Disability: $2,055 Base Pay, $131 VA Disability Pay; $2,186 Total
  • 20% Disability: $1,927 Base Pay, $259 VA Disability Pay; $2,186 Total
  • 30% Disability: $1,785 Base Pay, $401 VA Disability Pay; $2,186 Total
  • 40% Disability: $1,610 Base Pay, $576 VA Disability Pay; $2,186 Total
  • 50% Disability: $2,186 + $822 = $3,008
  • 60% Disability: $2,186 + $1,041 = $3,227
  • 70% Disability: $2,186 + $1,302 = $3,488
  • 80% Disability: $2,186 + $1,526 = $3,712
  • 90% Disability: $2,186 + $1,714 = $3,900
  • 100% Disability: $2,186 + $2,858 = $5,044

Notes about these assumptions:

  • All military retirement benefits are considered taxable income (some states may not tax retirement benefits or other income, but the federal government does).
  • All VA Disability Compensation Benefits are non-taxable income at all levels
  • The disability benefits are for a retiree with no dependents. The Concurrent Retirement and Disability Pay benefit is worth much more when the retiree has dependents.

Takeaway: having a VA disability rating is valuable for your retirement. A disability rating of 40% or less will off set taxable income with non-taxable income, which will result in a large tax savings. A VA disability rating of 50% or larger is worth considerably more over the long run. You can run a similar scenario with your own situation to get an idea of what concurrent receipt would be worth for your specific situation, based on your retirement pay, years of service, and VA disability rating.

The Future of Concurrent Retirement and Disability Pay

There has been talk of extending the Concurrent Retirement and Disability Pay benefit to all military retirees with a VA Disability compensation rating of 10% or higher. Unfortunately, the recent budget problems have shelved those talks, and it doesn’t look like that will happen any time soon. In fact, there has been discussion of doing away with the benefit.

As we have seen in recent months, military retirement pay and other military and veterans benefits are under fire. Congress even went so far as to reduce military retirement benefits for some retirees, then later backtrack and restore those same benefits. Concurrent Receipt has been targeted as an area for cutting fixed expenses for retirees. Concurrent Receipt is a relatively new law, having first been approved in mid-2003, and implemented beginning in January, 2004. It wouldn’t be a surprise to see this law come under more pressure in the near future. That said, Concurrent Receipt made it through the most recent round of benefits cuts. So let’s hope Congress leaves this benefit alone.

Where to go for additional information: If you have any questions regarding your CRDP payment from DFAS, call 800-321-1080. For questions concerning disability ratings or disability compensation, please contact the VA at 800-827-1000.

Photo credit: orangejack.

2013 Retirement Plan Contribution Limits

Anyone who is saving for retirement needs to pay attention to the retirement plan contribution limits. There are two reasons this is important – you want to contribute as much as you can to reach your goals, but you also don’t want to contribute too much, because that can trigger possible penalties. The IRS reviews retirement plan contribution limits each year, and this year they made a few changes and increased the maximum contribution levels of several retirement plans for 2013. The big changes came to employee sponsored deferral programs such as the Thrift Savings Plan and the 401(k) plan – and similar plans such as the 403b, 457, 401a Plans. Let’s take a look at some of the details you need to know.

Types of Retirement Plans

Retirement Plan Contribution Limits

There are many plans to choose from.

There are many different retirement accounts available to workers, and they can be broken down into three major types: employer-sponsored, individual, and self-employed/small business. Let’s take a look at some of the different types of plans and their contribution limits. One note before we start – this is a simplified version of the types of retirement plans out available to most people. This does not include traditional pension plans such as those provided by the military retirement system, the government, or companies in the private sector.

Employer-sponsored retirement plans. If you are in the military or work in the civil service, you are most likely eligible for the Thrift Savings Plan, or TSP. For the most part, the Thrift Savings Plan functions just like a 401k plan, which is a more common retirement plan in the civilian sector. Similar retirement plans include the 403b (common in non-profit sectors), 457, and 401a plans. These numbers might seem confusing at first, but don’t put much into their names – they simply refer to a chapter of the tax code.

Individual retirement plans including the popular Roth and Traditional IRAs. These plans are one of the best ways to save for retirement, whether you have access to an employer sponsored retirement plan or not. In fact, you can invest in both of these types of plans without having to worry about exceeding your retirement plan contribution limits. This is because these plans are not in the same classification.

Self-employed retirement plans or small business retirement plans. There are a variety of retirement plans that are only open to small businesses and those who are self-employed. One of the most popular is the Solo-401k, which has the same limits as the 401k plan you would find in the commercial sector, with one major addition: small business owners can defer a portion of their business income as a tax-free contribution. Other examples include SEP IRAs, SIMPLE IRAs, and Keough Plans. The IRS has a good rundown here.

2013 Retirement Plan Contribution Limits

The new limits are good for the 2013 tax year. Future retirement plan contribution limits will be pegged to inflation levels and raised in $500 increments. Here are the contribution limits for the various types of retirement plans:

Employer sponsored retirement plans: 401k, 403b, 457, 401a, and Thrift Savings Plan:

Individual Retirement Arrangements (IRAs):

Self-Employed and Small Business Plans:

  • SIMPLE IRA Plan – $12,000 in salary contributions and either a 2% fixed contribution or a 3% matching contribution.
  • Simplified Employee Pension (SEP) – Up to 25% of your net earnings from self-employment, up to $51,000.
  • Solo 401k – Salary deferrals up to $17,500 (under age 50); $23,000 (over age 50); Contribute up to an additional 25% of your net earnings from self-employment, up to $51,000.

It is recommended to get tax assistance if you have a self-employed retirement plan to ensure you choose the best retirement plan for your situation.

Don’t Exceed Retirement Plan Contribution Limits!

It’s also important to note that some of these plans share contribution limits. For example, the Solo 401k plan shares a contribution limit with the employer-sponsored plans listed above. For example, if your are under age 50, you would only be able to contribute $17,500 in 2013. Let’s say you are a military member who contributes to the Thrift Savings Plan and you also have a small business on the side and have a Solo 401k. The most you can contribute from your salary across both accounts is $17,500. The shared limit only applies to the employee deferral contribution (from your payroll), and the max limit of $51,000. You could contribute additional money to each account if you have bonuses or profit sharing. If you have questions, always consult a tax professional.

Traditional and Roth IRAs also share a contribution limit with each other. The limit for 2013 is $5,500 across both accounts if you are under age 50. You can contribute all to one account , or split it between them. It doesn’t matter as long as you don’t exceed the limit.

Contribute as much as you can now

It’s best to contribute as much as you can contribute to your retirement accounts because that gives your money more time to grow via compound interest. If the current markets make you nervous, then consider placing your money in a high interest money market account or a CD until you feel more comfortable investing the money in equities. Most retirement accounts have a cash fund or cash equivalent, which leaves you no excuse not to start investing now!

Proposed Changes to Military Retirement Benefits

The military retirement system is one of the most loved – and valuable – benefits available to military members. It is unique in many ways, and one of the few retirement plans in the US which starts paying beneficiaries immediately upon retirement without a standard waiting period or age limit.

Unfortunately, it is also a target by cost-conscious members of the government who are looking for ways to decrease the military budget and cut costs over the next few decades. Because of the high cost of the military retirement system, the Defense Business Board which was tasked with studying the military retirement system and making recommendations on how the government can save money on the military retirement system in the coming decades.

The basic conclusion by the Defense Business Board, found in this pdf entitled, Modernizing the Military Retirement System, was that the current military retirement system is “unfair, unaffordable, and inflexible.”

What follows is the slideshow prepared by the Defense Business Board, containing their recommendations and how they would affect the military. Afterward, we give our take on the proposed changes:

Proposed Changes to Military Retirement Benefits

US Military Logos

The current military retirement system – why it’s good for members and why it might change. In the current system, active duty servicemembers who retire after 20 years can expect to begin receiving their pension almost immediately and the payments will not only continue through the remainder of their lives, but will also increase based on Cost of Living Adjustments (COLA). A military retirement is worth millions over the course of a lifetime. While military retirement benefits may not be enough to live on for everyone, the system is a fairly generous program, and one that is hard earned by its recipients.

The problem with the military retirement system, according to the government, is that it is becoming increasingly more expensive and potentially unsustainable in the long run, especially when factoring in the full health care coverage given to military retirees and their family members. TRICARE has its critics, but overall, it is a very affordable insurance program which is basically unmatched in the civilian sector.

All of this leads us to cost: the government has been seeking out ways to reduce the overall cost of the military retirement system, which, if left unchanged, will spiral out of control in the coming decades. Here are some of the main notes from the study, which support the need for change:

  • The military retirement system has not materially changed for over 100 years
  • The current military retirement system was designed for an era when life spans were shorter
  • Pay was not competitive with civilian pay
  • Second careers were rare since military skills did not transition easily to the private sector

These additional reasons were given to support a new military retirement system:

  • DoD pays retirees 40 years of retirement benefits for 20 years of service
  • Military skills are transferable to the private sector
  • Second careers are now common for those retiring in their 40s

What follows are a couple of recent recommendations which have been making headway.

Defense Business Board Recommendations:

Please keep in mind these are only proposed changes by the Defense Business Board, and have not yet been put before Congress or the President and have not been voted on for becoming part of law.

  • Convert military retirement to a civilian-style retirement system similar to a 401k plan; retirement pay wouldn’t be paid until age 60-65 (or Social Security age)
  • Retirement benefits would vest after 3-5 years of service
  • Authorize “gate pays” and separation pay to encourage separation from active duty or to continue service on active duty

Let’s take a look at each of these and how they might affect military members.

Military Retirement Changes: Defined Benefit Plan

Perhaps the biggest proposed change is moving away from the traditional pension style system to a defined benefit plan, similar to a civilian 401k plan. In this proposed system, military members would receive a mandatory Thrift Savings Plan account into which annual contributions would be made by their member service (the average DoD contribution was listed at 16.5% of annual pay).

There are several versions of the defined benefit plan discussed, with vesting starting as soon as 3-5 years of active duty service. These plans would also be portable into the civilian sector and back into military service if there is a break in service.

Individual members would have the ability to contribute “gate pays” or additional funds to their account and each service would be able to contribute additional funds to members based on high deployment schedules, hardship, troops who are at risk, for bonuses and as a retention tool, and for other reasons as each service sees fit.

What this proposed plan is – and isn’t. Basically, this proposed plan is what you would find at many companies in corporate America – a 401k plan with matching benefits which would vest after serving a few years with the company. After your defined benefit plan vests, you could take it with you when you go to another company. What this plan is not, is a pension plan, which pays servicemembers a defined benefit at a specific time.

Will Current Servicemembers Be Grandfathered in?

The proposal by the Defense Business Board did not plan on changing any benefits to current retirees. So if you have already retired, then your benefits probably won’t be touched, at least by this set of proposals.

But there were two different scenarios given regarding how these proposed changes would be implemented for current military members – a low cost proposal and a high cost proposal – low cost meaning low cost to the government, and high cost meaning high cost to the government. Let’s take a look at both options.

The low cost proposal would go into effect as soon as it was voted into law and would affect current military members on a graduated basis. For example, if you had already served 20 years, you would be grandfathered into the old system and would receive your pension benefits under that plan. If you had had fewer than 20 years of service, you would get a combination of the old retirement plan (the pension, or annuity) and the new plan (the 401k style plan). To receive the pension, military members would still be required to serve 20 years. Here is how the “low cost” proposal would affect current servicemembers.

  • 20 years of service or more, no change
  • 15+ years of service, 37.5% of base pay in a pension plan, and the rest under the 401k-style plan.
  • 10 years of service, 25% of base pay, and the rest under the 401k-style plan.
  • 5 years of service, 12.5%, and the rest under the 401k-style plan.
  • New recruits, new retirement system.

The high cost proposal would mean that everyone currently in the military would continue to be under the current retirement system and could receive their normal pension after they reach 20 years of service or more. The new retirement system would only affect servicemembers who join active duty after the new retirement system is voted into law and takes effect.

Will a New Military Retirement System be Voted into Law?

Military Retirement Pay ChangesRight now it’s too early to tell. This is only one recommendation for change and it has been sent back to be studied further and will be presented again in February of 2012. Though we don’t know what will happen, we can say two things for certain:

  1. Something will need to change with the military retirement system.
  2. It will be fought tooth and nail by military interest groups.

1. The numbers don’t lie. Like the Social Security System and Medicare, the military retirement system is quickly growing out of control. Changes need to be made – how or when, I don’t know. But I would hope that the government would find a middle ground between the current retirement system and any proposed changes.

2. Any changes to the military retirement system will be highly contested by military and veteran organizations. And rightly so. Military servicemembers put their lives at risk and make more physical and emotional sacrifices than the average office worker who earns a 401k and a pat on the back. The military retirement system is just one manner in which military members are rewarded for their sacrifices.

I also don’t believe the changes should affect anyone who is 1) already receiving military retirement benefits, or 2) already serving with the understanding that they are eligible for benefits under the current retirement system. Taking away benefits from someone after they had earned them or made life changing decisions based on what they would receive is not the way to take care of the people who protect our freedom.

What are your thoughts on these proposed changes to the military retirement system?

photo credit: USAF

Planning for Retirement from the Military

Planning for retirement can be difficult, whether you are retiring from a military position,civilian position, or a combination of both. However, career military members may have an added benefit most civilian sector employees do not – the opportunity for two retirements: one from the military and one from the civilian workforce. This dual retirement option provides veterans with a unique situation when determining how to save for retirement. The following tips can help military veterans adequately save for retirement from their military and/or civilian careers:

Determine Your Retirement Income Needs

Trying to figure out your annual income needs when you will be 65 years old can be challenging when your retirement date is still several decades away. You have to factor in your future lifestyle requirements, rising TRICARE costs and other rising health expenses,  inflation, and various other factors.  Even though you might not be able to get an exact number, you can still come up with a rough idea that can act as a saving guide. Here is one method to manually determine how much you need for retirement:

Determine future income needs. If you plan on having a similar quality of life in retirement as you have now, then start by using your current income requirements, then adjust for inflation. Let’s look at an example and you can adjust these numbers based on your income and requirements (and don’t worry about knowing how to do the math, you can just copy and paste the equation into Google’s search engine and Google’s calculator will give you the results quickly and easily). You can also use a hassle-free site, such as RetirementCalculator.com, to run some basic retirement planning calculations.

Assumptions: Today’s income requirement is $45,000 per year (median US Income is roughly $45,000), inflation will be 3%, and you have 25 years before retirement. You can use the following equation to adjust for inflation:

Inflation Adjusted Income Requirement = Today’s required income * ((1 + inflation rate)^ Number of years to retirement)

Inflation Adjusted Income Requirement =$45,000 * (1.030 ^ 25)

Inflation Adjusted Income Requirement = $95,000 (rounded up)

Next, account for future retirement income. Using the assumptions above, you will need approximately $95,000 per year in retirement to maintain the same standard of living in 25 years as you enjoy now. But that doesn’t mean you need to save enough money to withdraw $95,000 per year from your retirement accounts. You also need to account for your retirement income, such as Social Security benefits and your military or private pension(s). Be sure to take into account what these benefits might be worth in the future, not the present day value. Again, we are dealing with a 25 year time frame, so use your best estimate.

Once you have this number, subtract it from your annual living requirement of $95,000. For example, if you anticipate your military pension and Social Security Benefits to be worth $50,000 per year, you will need to come up with an additional $45,000 per year, not the full $95,000. Also keep in mind that you can increase your social security requirements if you wait longer to begin receiving benefits.

Account for additional retirement accounts and investments. Many people have other retirement accounts such as an IRA, Thrift Savings Plan, or 401k. This money will also work toward your retirement and should be accounted for when you make your retirement calculations. Additionally, be sure to keep in mind any other investments you may have, such as rental properties and other investments held in taxable investment accounts.

Determine your remaining retirement income needs. Once you have a good idea of how much you will earn from your pensions, retirement accounts, and other investments, you can subtract these numbers from your annual income requirements to get a better idea of how much more money you need to save for retirement. This will be your savings goal.

Start Retirement Planning Early

The earlier you begin planning for retirement, the better. In fact, military members should start retirement planning early, since a military pension might not be enough money for retirement by itself. Military members have access to the Thrift Savings Plan (TSP), which is similar to a civilian 401(k) plan. Like a 401(k) plan, the TSP offers military members a way to make tax-deferred investments. A Roth version of the TSP is scheduled to roll out in 2012, giving military members another retirement account option. TSP members can make withdrawals from their TSP during retirement, or they can roll their TSP into an IRA when they retire or otherwise separate from the military. This gives TSP members more long term flexibility in managing their investments.

Maximize Post-Military Employment and Investments

Many military members are eligible to start earning a military pension in their late 30′s or early 40′s, which is young enough to begin a post-military career. In some cases, veterans are able to earn enough service time to gain another pension from a private company or from a different government organization. The possibility of dual pension plan incomes, in addition to Social Security Benefits, can greatly increase your quality of life in retirement and potentially allow to to retire more quickly than you anticipated.

Even if you aren’t able to receive another pension from your post-military employment, you can do your best to increase your savings in retirement accounts such as the TSP if you remain in government service, or through an IRA or 401k. Contributing as much as you can to these retirement accounts will help provide you with the retirement income you need to maintain a nice quality of life in your retirement years.

Finally, Take Advantage of All Benefits Available to You

There are a variety of state and federal benefits available to veterans, including health care, base and commissary privileges, educational benefits, homestead exemptions, and more. It is recommended to meet with a veteran benefits advisor in your local area who can help you better understand which benefits might be available to you, and to help you better understand how to qualify and apply for those specific benefits.

*A few notes: This article covers a few basic assumptions and should only act as a rough guide for do-it-yourself investors. It is highly recommended that you meet with a professional financial planner before making the final decision to retire. If you are younger you might find it helpful to meet with a financial planner every few years to ensure your retirement plan is on track.

Traditional and Roth IRA Contribution Limits

Tax season is a great reminder to make retirement account contributions if you don’t do it throughout the year. The good news is that tax laws are written so that you can make contributions for the previous tax year until the tax filing deadline. Even though the calendar year may be over and done with, you can still contribute to your IRA until the tax deadline, which is April 15, in most years. Just take note that if you make IRA contributions between January 2 and April 15th, you may need to specify which tax year you are contributing to because you can also contribute to the current year IRA during these dates.

Traditional IRA and Roth IRA. There are two main types of IRA accounts available to most people – they are the Traditional and Roth IRA. The short and quick explanation is that Traditional IRA contributions are made with pre-tax money, the investments grow tax free, and the money is taxed upon withdrawal. Roth IRA contributions are made with money that has already been taxed. It grows without the drag of taxes and is withdrawn without any additional taxation. There are certain income limits and other rules involved with regarding deductions and eligibility.

Traditional and Roth IRA Contribution Limits

The maximum you can currently invest in a Traditional or Roth IRA is $5,500 if you are under age 50. Those who are age 50 and older are eligible for catch-up contribution of $1,000 and can contribute up to $6,500.

It is important to note that you can only contribute up to the maximum limit across all individual IRA accounts (self-employed retirement plans may have different rules). I am under 50 years old, so I would be able to contribute any combination of $5,500 between any IRAs I decide to open. For example – $3,000 in a Traditional and a $2,500 Roth IRA, or $3,000 in a Roth IRA + $2,500 in a Traditional IRA, etc. so long as it does not exceed $5,500.

Traditional IRA Deductibility and Roth IRA contribution phase out levels

Your ability to make a tax deductible Traditional IRA contribution and Roth IRA qualifications are based on your  modified adjusted gross income (MAGI), which is calculated on your tax form. The following numbers are for the 2014 tax year.

Roth IRA phase out. The IRS has specific income restrictions regarding who can contribute to Roth IRAs. The income limits are based on your Roth IRA eligibility begins phasing out for single filers with a MAGI between $114,000 – $129,000, and for married filing jointly between $181,000 – $191,000.

Single filers with a MAGI above $129,000 and married filing jointly with a MAGI above $191,000 are not eligible for Roth IRA contributions. See Roth IRA rules, or IRS pub 590 for more information.

Traditional IRA deduction phase out. The Traditional IRA phase out schedule determines whether or not you can deduct your contributions against your taxes. The phase out for Traditional IRA deductions for single filers begins at $60,000 and ends at $70,000. The range for married filing jointly is between $96,000 and $116,000. It is important to note that tax filers with income limits above the deduction levels can still contribute to a Traditional IRA, however, they will not be able to deduct it against their taxes.

Did you contribute too much to your IRA? The deduction and phase out limits may affect your ability to make contributions. Find out what happens if you contribute too much to an IRA.

More information about IRAs

Individual Retirement Arrangements (IRAs) are great investment vehicles, and I highly recommend investing in one if you are able to do so. The benefits you receive from the tax deferrals are a great way to grow your investments without the drag of taxes slowing you down your investments.

Max out your IRAs if possible. It is important to max out IRA investment if possible because you only have one opportunity to do so. Once the window of eligibility closes, it is closed for good.

What Happens If You Contribute Too Much to an IRA?

An Individual Retirement Arrangement, or IRA, is one of my favorite vehicles to save for retirement because it offers a wide variety of investment choices and lots of tax savings. But when you don’t follow the rules, an IRA comes with hefty penalties. A common mistake is contributing too much to an IRA.

What Happens If You Contribute Too Much to an IRA?

In this article you’ll learn about traditional and Roth IRA contribution limits, IRA contribution deadlines, and how to correct an excess IRA contribution so it costs you as little as possible. (If you’re interested in learning more about all the different types of retirement accounts that can help you accumulate an impressive nest egg, be sure to read my new book, Money Girl’s Smart Moves to Grow Rich.)

When Is the IRA Contribution Deadline?

The deadline to contribute funds to an IRA for the 2010 tax year is April 18 of 2011. So if you didn’t max out an IRA last year, there’s still time to contribute more money for 2010! The maximum allowable contribution for a traditional or Roth IRA is $5,000 if you’re under age 50 and $6,000 if you’re age 50 or older. If you have more than one IRA, you can contribute to both of them as long as the total amount doesn’t exceed your allowable limit. For example, you could contribute $2,500 to a traditional IRA and $2,500 to a Roth IRA.

What are the Income Limits for Roth IRA Contributions?

If you contribute to a Roth IRA and end up making more money than you expect, you might have to withdraw all your contributions. That’s because contributions to a Roth IRA are allowed only if your modified adjusted gross income doesn’t exceed the following IRA contribution limits:

  • $120,000 for taxpayers who file as Single, Head of Household, or Married Filing Separately (if you didn’t live with your spouse during the year)
  • $10,000 for taxpayers who file as Married Filing Separately (if you did live with your spouse during the year)
  • $177,000 for taxpayers who are Qualifying Widow(er)s or Married Filing Jointly

What If You Contribute Too Much?

But what happens if you overloaded an IRA by mistake? It’s not uncommon for people to realize at the end of the year that they contributed more than their allowable limit. The good news is that excess contributions can be corrected without penalty if handled in a timely manner.

Let’s say Polly is 30 years old, earned $40,000 in 2010, and contributed a total of $6,000 to her traditional IRA. Since her allowable limit is only $5,000, she has an excess of $1,000 in the account. If Polly withdraws the excess plus any earnings it made, on or before the due date of her tax return, it’s like it never happened!

If she can’t complete the necessary paperwork for an IRA withdrawal before taxes are due, she can file for a tax extension using Form 4868, Application for Automatic Extension of Time. Filing for an extension will give Polly until October 17, 2011 to file—plenty of time to correct her IRA goof.

How to Correct an IRA Contribution Mistake

I mentioned that Polly has to withdraw both her excess contribution and the earnings it made. The excess contribution can be withdrawn without any tax or penalty, but that’s not the case for income she made on the excess. Let’s say she made $50 on the additional contribution of $1,000. Because she wasn’t supposed to earn that additional money, withdrawing it is considered an early distribution.

Distributions you take from an IRA before you reach age 59½ are subject to a hefty 10% penalty. So Polly has to make things right with the IRS by paying ordinary income tax plus the 10% penalty on the $50 she made from her excess contribution of $1,000.

What Happens If Excess IRA Contributions Are Not Corrected?

Once you realize that you contributed too much to an IRA, contact your IRA custodian or tax professional right away. An excess contribution that isn’t withdrawn by the deadline is subject to a 6% tax penalty each year that it remains in your IRA. It’s important to try to prevent excess IRA contributions from occurring in the first place, but it’s even more important to get them corrected on time to avoid significant taxes and penalties.

Five Ways To Find Money To Maximize Your Roth IRA Contributions

The maximum amount of money you can sock away in a Roth IRA is $5,000 each year if you are under the age of 50 years-old. If you saved the $5,000 contribution limits every year from the time you graduated college until you retired at the ripe old age of 65, you would be sitting on a nest egg of approximately $1.6 million assuming an 8% annual rate of return. But, for a lot of us, especially those just starting out, $5,000 per year seems a little daunting. So, I thought it might be fun to help you find the money. You already have it. You are already spending it. To break it down a little bit, $5,000 per year equals $415 per month. $415 is approximately $104 per week. Do you realize that $5,000 is $13.70 per day? You need to find $13.70 every day to arrive at the magic number of $5,000 per year to invest in a Roth IRA. It can be done. Here’s how…

Five Quick and Easy Ways To Find $13.70 Per Day

  1. Do Not Eat Out For Lunch – Even eating at McDonald’s costs an average of over $5 per meal, and if you go out to a finer establishment, the bill could be even higher. If you do that every day, the cost out of your pocket can really skyrocket. And, many junior enlisted members are already having money taken out of their paychecks because it is assumed by the government that they are eating in the dining facilities provided on the base for lunch. Eat there. Many of you have already “paid” for it.
  2. Curb The Partying – For many young Soldiers and members of the military, going out on the town is a way of life. But, if you are going out every Friday and Saturday night, the costs of getting into the clubs and drinks could quickly add up over the course of the month.
  3. Cut Back On The Energy Drinks – Military members work some crazy hours, and they love their energy drinks. But, energy drinks are almost as expensive as a fancy cappuccino and it only gets worse if you drink several over the course of a day.
  4. Reduce The Amount You Smoke – Assuming that a pack of smokes costs $4, a pack a day habit can cost you over $120 each month.  The price is much higher in many parts of the country. Reducing the amount you smoke will save you hundreds per month, over a thousand per year, and thousands over your lifetime – not to mention the health benefits.
  5. Brew Your Own Coffee – This tip is every financial planner’s favorite since David Bach made it famous in his classic book, The Automatic Millionaire. But, the average cost of a cup of coffee in a fancy coffee house can run you about $5 now. If you buy one on the way to work every morning or during the middle of the day, you can spend over $25 per week. Brew your own at home for as little as $0.50 per pot.

You don’t even have to do all of these things at the same time. You just have to get to that magic number of $415 per month. Simply cutting back on a few of these things can get you to that magic number.

Why Is It So Important?

Time is the most important thing that you have on your side when you are young. $5,000 invested each year starting when you are 22 years-old until you retire from the military at age 42 would be worth over $228,000, assuming an 8% annual rate of return. If you continued to max out your Roth IRA after leaving the military service until you reached the retirement age of 65, your $5,000 per year could grow to $1.64 million thanks to the power of compounding interest. Can you really not find that extra $415 a month now if it would earn you $1.6 million? Is your daily pack of cigarettes or morning coffee really worth that?

Too many young people make excuses as to why they cannot invest money for their retirement. They do not see the immediate return, and so they forgo their financial future for instant gratification. I am not advocating living a recluse’s live holed up in your barracks eating ramen noodles. But, I do think that there are quite a few simple opportunities for young investors to control their spending in order to save $13.70 per day which translates into that magic $415 per month or $5,000 per year and use that money to start a Roth IRA. What would you do with $1.6 million dollars in retirement? Do you know that an immediate annuity of $1.6 million dollars could pay you almost $80,000 per year or more for the rest of your life?

Roth IRA Qualifications

Opening an Roth IRA is easy, but you have to meet certain requirements in order to eligible for a Roth IRA. For example, you must have earned income, meet specified income limits, contribution deadlines, and open your IRA through an approved IRA custodian, generally a financial institution such as a bank or brokerage firm, or through an authorized IRA custodian (many independent financial advisors meet this qualification). There are many Roth IRA rules to follow – so let’s take a look and see if you are qualified to open a Roth IRA.

Earned Income Requirements for Roth IRA Contributions

Earned income generally includes all income from your salary, wages, services provided, professional fees, tips, commissions, profit sharing, and bonuses. Forms of income that don’t qualify as earned income include interest, dividends, royalties, rental income, capital gains, disability, social security income, or income from annuities. The general rule is that if you worked to generate the income, it qualifies as earned income; income that you receive which doesn’t require work often doesn’t count as earned income.

There is an exception to this rule for military members. Many military members earn tax free combat pay while deployed. This income is not generally considered earned income because it is tax free. However, the HEROES Act allows military members to contribute to an IRA even if they have no earned income due to tax free pay.

Income Limits for Roth IRA Contributions

In addition to meeting the requirement of having earned income, you must qualify for the income limits. If you earn above a certain threshold, then you will not be eligible to contribute directly to a Roth IRA. However, you may be able to do a Roth IRA conversion, which is where you first contribute to a traditional or non-deductible IRA, then convert it to a Roth IRA. Here is more information about Roth IRA conversions.

Income limits are based on the Modified Adjusted Gross Income (MAGI), which is found on your IRS Form 1040. Roth IRA income limits are as follows (for 2014 tax year):

Single, head of household, or married filing separately:

  • Full contribution with AGI below $114,000
  • Income limit phase out begins at $114,000 and ends at $129,000
  • No eligibility with income above $129,000

Married Filing Jointly:

  • Full contribution with AGI below $181,000
  • Income limit phase out begins at $181,000 and ends at$191,000
  • No eligibility with income above $191,000

What is a phase out? That means the tax payer is only able to contribute a portion of the maximum contribution at the beginning of the phaseout, then nothing once they reach the income limit.

Contribution Limits and Deadlines

Contribution Limits. If you are under age 50, you can contribute$5,500 to your Roth IRA, and persons age 50 and over can make a catch-up contribution of an additional $1,000, for a total of $6,500. This is an annual limit and you cannot make up for lost time and make additional contributions if you didn’t make them in previous years.

Contribution deadlines. The contribution deadline for Roth IRAs is the same as the tax filing deadline, April 15th. You can contribute to a Roth IRA as soon as the calendar year changes, and you have until April 15th of the following year (or perhaps a day or two later if the tax deadline falls on a weekend or national holiday). You can not extend the IRA contribution deadline if you need to file a tax extension.

Open Roth IRA at an Approved Institution

The final element to qualifying for a Roth IRA is to open it at an approved financial institution. Basically, the IRS offers special tax benefits for opening a Roth IRA and they want to ensure they are properly coded, managed, and tracked for tax reasons. So you aren’t able to open it and keep it in your home. But the good news is that you can open a Roth IRA in many locations. For example, many brokerages, banks, credit unions, savings and loan associations, financial planners and most FDIC insured financial institutions qualify as an IRS-approved financial institution. The forms are easy to fill out and you can literally open an IRA in 10-15 minutes if you already have an account with the financial institution in place – if you don’t have an account you can add another 15 minutes to the process. Here are some top Roth IRA companies.

What to do if You Don’t Qualify for a Roth IRA

If you don’t qualify for a Roth IRA you may still be eligible to contribute to another IRA, then later convert it to a Roth IRA. For example, if you meet all of the Roth IRA qualifications with the exception of the income limits, then you may be able to contribute to a non-deductible IRA, which is a Traditional IRA that isn’t tax deductible. Then you can convert your Roth IRA and re-characterize your non-deductible IRA as a Roth IRA. Just keep in mind there may be some requirements, such as accounting for any gains.