One of my friends asked me to write about the impacts to your cash flow when you retire. While your cash flow may go up or down based upon a lot of non-military factors, such as relocation or your follow-on career, this blog post will attempt to address the military-specific changes that occur, and which you should take into account when you’re planning for separation or retirement.
If you’re retiring, you should plan your post-military career finances as if you’re not getting a pension. It might not be possible in all situations, but if you’re able to plan without having to count on your pension as part of your total compensation, then you have additional flexibility to address unexpected issues as they come up.
Before we discuss the pension, let’s make sure to clarify what your post-military pay looks like. Many people don’t consider the fact that you will no longer get housing allowance, subsistence allowance, or COLAs. More importantly, when you look at post-military careers, you need to take into account that these were tax-free allowances, and that you will need more before-tax income to make up the difference.
With that said, let’s take a look at what your pension will look like. For the benefit of the broader audience, I will assume that you are retiring under the High-36 program (not High-3 as many people refer to it), and not under either Final Pay (for those who entered prior to September 8, 1980), or CSB/REDUX (for those who chose the option at the 15-year mark with a $30,000 payout).
First, let’s clarify the definition of what your pension will look like, and what the online pension calculators do not take into consideration. Under High-36, DFAS will calculate the highest 36 months of pay into the retirement calculation. If you’re retiring after 2 years TIG, that means 1 year of your lower paygrade goes into this calculation. Also, if you’re retiring after exactly 20 years, then 2 years’ pay will be at >18 years, and 1 year will be at >16 years (your 17th year). Your highest 36 months’ pay will be averaged out, and multiplied by your service percent multiplier, which starts at 50% at 20 years, and increases by 2.5% for each whole year beyond that.
In my situation, I’m retiring as an O-5 with 2 years TIG, at 20 years and 2 months. The online calculator gives me a monthly calculation of $4,231.40, while I came up with $4,040.78 (both pre-tax figures) when taking these factors into consideration. Obviously, I hope that DFAS will give me an additional $200 per month, but I’m not planning on it.
Once you’ve determined what your pre-tax pension will be, you need to adjust for taxes. I’ll break this part into two sections: monthly withholdings and your annual tax liability. Regarding your monthly withholdings--When you retire, your tax withholdings will be determined by how you fill out your DD Form 2656-Data for Payment of Retired Personnel. This form, which directs DFAS where to send your pension after retirement, also calculates your dependent data & tax withholdings, similar to an IRS Form W-4. Within this form, you can request DFAS to withhold at a higher tax rate (which may be beneficial if you expect a large salary from your post-military job), or you can claim as many dependents and exemptions as your family status allows, to minimize your tax withholdings. The IRS website has a withholding calculator so you can estimate your monthly tax withholding.
However, your monthly withholding is only an approximation of your tax liability. Your tax liability depends on your total income (including what you bring in outside of your pension), as well as your family situation, and deductions or credits for which you may be entitled. When you do your annual tax return, you’re actually calculating your tax liability and reconciling it with the estimated payments that have already been made to the IRS. Your refund (or payment due) is really the final calculation that tells you how close you were. Recognize that your first year or two of post-retirement will be a huge adjustment, and you may find yourself in a completely tax situation than what you’re used to. If you don’t feel comfortable doing this yourself, you should talk with a tax professional (not just a tax preparer), such as a CPA, attorney, or enrolled agent to discuss in more depth. However, if you do this by yourself, just keep in mind that you may need to revisit this.
Once you’ve determined your estimated tax withholding, you’ll want to account for the other programs that you’ll sign up for, such as:
· Survivor Benefit Plan -6.5% of your pay. However, this is deducted from your pay prior to taxes. You are not taxed on this amount, so take this into consideration when calculating your expected tax bill.
· Tricare Prime-$23.55/month for single or $47.10 for family plan for 2016
· Tricare Dental-depends on location. Tampa rates range from $30.29/month for a single-member plan to $108.98 for a family plan.
· VGLI-Rates tables are here . However, for a 42-year old to replace $400K in SGLI, the monthly cost is $68.00 per month.
Let’s look at a fictional scenario using the numbers I outlined above. My estimated pre-tax, pre-deduction pension was approximately $4,048, give or take. Below are the costs that I would take into consideration:
· Gross: $4,048.00
· SBP: $263.12
· Taxes (a 28% withholding rate on my post-SBP pension): $1059.76
· Tricare Prime: $47.10
· Tricare Dental: $108.98
· VGLI: $68.00
· Expected take-home: $2,501.00
As you can see, this would be quite a shock if you’re not expecting it—a 40% drop, right when you’re getting used to not having a full job. This doesn’t take into consideration all of the other items. Your best bet is to do the math in advance, budget for it, and move on. You can try to cut out some of these items to make the most out of your pension. However, VGLI, Tricare, & SBP are all very important insurance aspects of your post-military life, and you should consider the cost of replacing them or going without before you make your decision.
As always, this blog serves to answer your questions and address concerns, particularly in a manner that other financial planners may not understand. If you like this blog, please forward it on to other people who may benefit. If you have issues or concerns, or if you have a question you'd like to have me answer, please feel free to contact me. You can reach me through my website, www.westchasefinancialplanning.com, or via email at firstname.lastname@example.org. In the meanwhile, take charge of your life!