That’s a bold headline, especially if you a retired enlisted military member only bringing in a little over a thousand dollars a month in retirement pay. But it’s true. A military retirement is worth well over a million bucks. In some cases it is worth millions of dollars.
Before we get too deep into this, I want to define what I am talking about. I’m talking about two factors – the long term value in regard to how much you will receive in direct pension over the lifetime of your retirement benefits and the value of the retirement benefits including healthcare coverage, and other benefits. Combined, these benefits are easily worth over a million dollars, even if you don’t have the spending power of a million dollars right now.
How Much is Military Retirement Really Worth?
Let’s look at an example of retirement pay for an average military career. Since military members are eligible for retirement benefits at 20 years, we will use a reasonable rank and service time for our examples.
It is reasonable to assume that the average enlisted member will be able to retire at 20 years having achieved the rank of E-7, and the average officer should be able to retire at 20 years at the rank of O-5. Of course there will be outliers based on when you served, your career field and other factors, but these ranks and service times should apply to the majority of careers (if anything I am aiming on the conservative side because many people choose to serve longer than the 20 year mark, earning an extra 2.5%-3.5% on their retirement pay per additional service year, depending on whether they take the high 3 retirement plan or the Redux retirement plan).
Example Monthly and Annual Military Retirement Pay
As we mentioned, we will look at a military retiree with 20 years service at the ranks of E-7 for enlisted and O-5 for officers. The base pay for these ranks in 2009 is:
- E-7 Monthly: $3,995.40
- E-7 Annually: $47,944.80
- O-5 Monthly: $7,697.40
- O-5 Annually: $92,368.80
Most retirees at 20 years will receive 50% of their base pay, which would equal the following amounts:
- E-7 Monthly: $1,997.20
- E-7 Annually: $23,972.40
- O-5 Monthly: $3,848.70
- O-5 Annually: $46,184.40
How much is Military Retirement Pay Worth Over a Lifetime?
The next factor to consider is that military retirement pay will be there day in and day out. There are few places in the world that someone can receive a lifetime pension starting at or around age 40. Many military retirees will receive a monthly cash payment for over 40 years. When you add in cost of living adjustments and inflation adjustments, we’re talking about some serious cash!
Using the numbers above from a recently retired E-7 or O-5, we get the following lifetime payments (note: these military retirement pay numbers are not adjusted for inflation and do not include any COLA increases; this is not a planning tool, but for illustration purposes only. Your specific retirement benefits will vary based on your situation):
- E-7 retirement pay for 20 years: $479,448.00
- E-7 retirement pay for 30 years: $719,172.00
- E-7 retirement pay for 40 years: $958,896.00
- O-5 retirement pay for 20 years: $923,688.00
- O-5 retirement pay for 30 years: $1,385,532.00
- O-5 retirement pay for 40 years: $1,847,376.00
Even without COLA or other inflation adjustments, we can see that we are reaching some serious numbers. Each additional year you serve before you retire can add another 2.5% to your monthly and annual pay, and each higher pay grade you achieve can add hundreds, or even thousands of dollars per year. As previously mentioned, the numbers used in this article are meant to be a conservative estimate.
Value of Military Retirement Medical Benefits
OK, there is a minimal TriCare payment, but compared to what civilians pay, it is basically a non-issue. Benefits for retired military members are also guaranteed – they won’t drop you after you have required expensive procedures or for pre-existing conditions. Guaranteed medical coverage is a huge blessing in today’s American society. Here is a little more information about kinds of insurance available to civilians: comparing individual and group health insurance. Hopefully that will hep you better understand the value of military retiree medical benefits!
Military sponsored medical benefits are incredibly valuable, especially as you get older and when they cover your spouse. There are very few civilian plans that are similar to this. Most people spend several thousand dollars per year for basic medical coverage, and this doesn’t include out of pocket expenses for doctors visits, medical procedures, prescription medication and other associated costs. It would not be unreasonable to place a value of $10,000 per year on military retiree medical benefits, even for a healthy individual. Add a spouse to the benefits, guaranteed coverage, little to no out of pocket expenses for complex medical procedures, and other factors, and the medical benefits alone can be worth hundreds of thousands of dollars or more over the course of a lifetime (and in some instances, into the millions of dollars for people who receive complex medical care over a long term period).
Commissary, Base Exchange, and other Base Benefits
I won’t even try to assign a value to these benefits because they don’t apply to all military retirees equally. Some people may practically live on base, visiting the base clubs, shopping at the exchanges, using the gyms, auto hobby shops, etc. and other people may not live near a base and may not be able to take advantage of any of these benefits. So this category falls in the “good deal if you can get it” benefit, but not a core part of the equation. But it is still worth mentioning because many retirees save a lot of money each year by shopping on base.
How to Calculate the Present Value of a Military Retirement Pension
One challenge to the analysis is that the military pension includes a cost of living adjustment, so the amount of the income stream has to rise every year by the rate of inflation.
Another problem is that no one knows how long the pensioner will live, so it’s difficult to predict how long the pension will be paid out.
Finally, the calculated lump sum has to be invested in a safe and stable asset to make sure that it survives for decades. Unfortunately, the safe and stable assets have a very low yield, so it takes a larger lump sum to produce an income stream big enough to pay the pension.
The answer to these puzzles involves the mathematical process of “discounting”.
Accountants and actuaries devote entire careers to studying asset yields, human longevity, and other risks. They calculate the statistical probability that a certain lump sum will be able to pay a particular pension for the necessary number of years.
The good news for pension recipients is that the calculations are much more accurate when the analysis is simultaneously applied to hundreds of thousands of pensions as a group. Even better, the Department of Defense can rely on the number-crunching skills of another giant bureaucracy of inflation-adjusted payments: Social Security.
The mathematical details of discounting an inflation-adjusted annuity are well beyond the scope of this post. There’s not an easy formula to convert that $100/day pension to a precise lump sum. However, there are a few simpler estimates that are reasonably close to the more complicated methods.
The easiest estimate assumes that a military pension keeps up with inflation. This eliminates the more complicated factors of correcting future dollars for inflation. If a military pension keeps up with inflation then the pension’s value in today’s dollars stays constant. The lump-sum value of the pension is the total amount to be received during the rest of the veteran’s life:
- Lump sum = (annual pension amount) * (remaining life expectancy)
A 38-year-old veteran receiving $3000/month with a COLA might reasonably look forward to 35 more years of life. The estimate of the present value of their pension would be
- Lump sum = ($3000/month) * (12 months/year) * (35 years) = $1,260,000.
The life-expectancy estimate ignores other discounting factors in favor of simplicity and speed. Its main advantage is that a veteran can quickly estimate a lump sum for their own personal expected lifespan. Veterans in good health with long-lived ancestors may decide that they have 40 or even 50 years of retirement, raising the current value of their pension.
Another quick estimate is to assume that the pension is the income stream from a lump sum of Treasury Inflation-Protected Securities (TIPS). TIPS are an extremely safe and stable asset with built-in inflation protection. The market for buying and selling TIPS is huge and liquid so their prices are fairly accurate.
One flaw of this estimate is that, unlike a military pension, when the pensioner dies there’s still a lump sum of TIPS generating a stream of income. Another drawback is that a TIPS’ maturity (now a maximum of 30 years) is usually less than the pensioner’s remaining life expectancy.
The advantage of this estimate is simplicity and speed:
- Lump sum = (annual pension) / (TIPS annual percentage yield)
A January 2009 Treasury auction sold 20-year TIPS at an inflation-adjusted annual percentage yield of 2.5%. So for that $3000/month pension,
- Lump sum = ($3000/month) * (12 months/year) / (.025/year) = $1,440,000.
Another estimate of the lump-sum value of an inflation-adjusted pension is a commercial annuity. The annuity market is generally regarded as liquid because insurance companies compete to offer the “best” price without losing money. However, they still charge more than the actual value of the annuity to make their profit.
Insurance companies could be unable to make annuity payments or even go bankrupt and should be considered a riskier source of annuity payments than TIPS or other government bonds.
One of the “less risky” annuities comes from an agency sponsored by the federal government– the Thrift Savings Plan. TSP annuities are actually purchased from an insurance company and are not guaranteed by the federal government, but the insurance company is presumably charging a smaller fee (to sell a large volume of annuities) and the annuity’s cost would be closer to its value.
TSP annuities are priced each month and do not offer full protection against inflation. The advantage of estimating a pension’s lump-sum value from a TSP annuity is its lower price and the TSP website’s calculator. Assuming that the $3000/month pension is paid to a 38-year-old veteran and limited to 3% annual inflation:
- Lump sum (TSP website annuity calculator) = $1.4 million.
$1.4 million is the price that a veteran would pay in the market to buy a TIPS portfolio or an annuity that would yield their inflation-adjusted pension of $3000/month for the rest of their life. Other research analyzes the theoretical cost of annuities and discounted values– only the cost and not its market price. (This includes a research paper on military pensions– the citation is in the book.)
These estimates range from about $1 million to $1.2 million. They’re only theoretical estimates. These annuities can’t actually be purchased like the assets of the other estimates, but they’re a more conservative estimate of the probabilities of longevity and other risk factors.
Let’s get back to the veteran who’s just finished 10 years of service and is wondering if it’s worth staying in the military for another decade. After an analysis of the pension’s present value, which sounds more compelling now: $100/day, or lifetime income of over $1 million?
Your military retirement is worth millions
Thousands of dollars coming in on a regular basis quickly add up over the years. Add in increases for inflation, essentially free health care, and other benefits and you can see how the value of a military retirement can quickly be worth millions of dollars over a lifetime.
I didn’t stay in long enough to qualify for military retirement benefits – I separated from the USAF with an Honorable discharge after 6.5 years of service. Part of me looks at the military retirement system with a bit of longing. It is a great system for those who qualify and I would love to be able to receive military retirement benefits for the rest of my life. However, separating from the military was the best move for me at the time and I have no regrets regarding my separation or my military service. I am proud to have served and the military is a large part of who I am today.
*disclaimer about this article: The calculations are for illustrative purposes only and do not reflect the exact retirement benefits you will receive. This is a simplified look at military retirement benefits and does not take many factors into consideration, including taxes, disability benefits, inflation, COLA, and other factors.