In our fourth episode of the sheepdog financial podcast we do a deep dive into the blended retirement system. One of the key benefits of the military is the retirement. The retirement system used to be a simple 20 years and out pension. The National Defense Authorization act of 2016 changed that and created a new retirement system for military members. The new Blended Retirement System (BRS) blends the traditional legacy retirement pension, also known as a defined benefit plan, with a defined contribution plan known as the Thrift Savings Plan (TSP). The BRS went into effect on January 1st of 2018. The BRS significantly changes the military retirement system and for many will be their first opportunity to save and plan for their retirement regardless of how long they serve.
Read the Transcription here;
| Intro: | 00:09 | Welcome to Sheepdog Financial, you will get answers to your
financial questions. Learn to plan for your financial future and have the type of life that people dream of, brought to you by Trisuli Financial Advising, a fiduciary financial advisor practice focused on military members and their finances. Your host of Sheepdog Financial is Scott Vance. |
| Scott Vance: | 00:34 | Hello. Today we’re talking about the military retirement system. Most people know the military is being able to do 20 years and retire. That has changed recently with the innovation of the blended retirement system. So we’re going to talk a little about the legacy system. I’ll talk very briefly about that, see where we stood. The blended retirement system, we’ll talk in depth about that, and then the choices within blended retirement system. So the legacy retirement system, most military is being able to do 20 years and get out. That money was basically computed by taking 2.5 times the years served times your retired base pay.
Bad thing about this retirement benefit is that if you don’t make 20 years, you’d get nothing. So some studies have shown that 19% of active and 14% of reserves actually qualify for the military traditional military retirement. So this is something to keep in mind and there’s a key reason why we transferred over to a blended retirement system. |
| Scott Vance: | 01:32 | So before we get into comparing the blended retirement system to the traditional, it’s probably best if we define a couple of things first because this will probably include a lot of words and definitions that you don’t know off hand. The first word to understand in the blended retirement system is defined benefit. So defined benefit is essentially a retirement account that your service maintains so that they can give you a fixed payout when you retire. This is basically the way that the traditional or legacy retirement system or the annuity part of the blended retirement system works. It sets up the formula based on the number of years – your number of years, your final base pay times a percentage – defines the amount that you’ll receive, hence the defined benefit that you will receive through out your retirement. In comparison, defined contribution is essentially the amount contributed to the retirement plan is defined by yourself prior to retirement, so this is a retirement plan under which the service member and service contribute to an individual account, in military, the Thrift Savings Plan (TSP) and that their savings plan invests in equities and bonds to grow your account and provide a retirement benefit. |
| Scott Vance: | 02:37 | The next thing to understand is PFM and PFC, Personal Financial Manager or Personal Financial Counselor. These are accredited |
| managers or counselors. They provide information about the
blended retirement system, the Thrift Savings Plan, and other strategies to support the positive retirement financial choices that you make. They’re provided through your service at no fee and should be available at any base which you might be stationed at. The next definition to understand is service automatic contribution. Once the service member has served 60 days, the member’s service will contribute an amount equal to 1% of the member’s base pay. Each payday it goes into the Thrift Savings Plan account. If you have not set up the Thrift Savings Plan, account one will be set up for you and that’s where that 1% contribution will remain. The next definition is a service matching contributions. These are contributions made by your service to the Thrift Savings Plan, so on top of that 1% that goes in there, these are contributions made by your service to Thrift Savings Plan to match the amount that you contribute as well. |
||
| Scott Vance: | 03:35 | After the completion of your first two years of service, the first 3% that the service member contributes to the Thrift Savings Plan, is matched dollar for dollar, but then the next 2%, totaling 5% contribution by the service member, is matched 50 cents on the dollar. Well, this means if you contribute the full 5% of your salary to the Thrift Savings Plan, the service itself will contribute essentially 4% of that salary to your Thrift Savings Plan. The TSP has a traditional, or pretax account. This means that you basically defer paying taxes so you’ll get the deduction in the year that you contribute, but later on when those funds come to you in retirement, they’ll be taxed as income at that time.
This is different than the TSP Roth. You don’t get the upfront deduction, but the bonus is when you do take the funds out retirement, they come to you nontaxable. And the last term to discuss is called vesting. |
| Scott Vance: | 04:27 | The vesting is essentially the right for you, as a service member, to keep the money and interest earned in your Thrift Savings Plan, to include the money that the service contributed for you as a matching contribution. So under the blended retirement system, vesting is based on the length of time the service members in the uniform services. Once you’re vested, that amount of money in your account cannot be taken away from you. Well, we’ve talked a little bit about the legacy retirement system and then we defined some of the key terms to understand and now we’re going to get a little bit into the blended retirement system itself. The two key main parts of the blended retirement system are the defined benefit and the defined contribution part. We’ll talk first about the defined |
| benefit plan. The blended retirement system provides a defined
benefit plan. This is the monthly pension payment for life after 20 years or more of active duty service. |
||
| Scott Vance: | 05:17 | This is similar to the traditional legacy retirement system. Some of the key things to understand with the defined benefit plan in the blended retirement system is the multiplier. So that’s the percentage of your basic pay that you receive for each year service. For the blended retirement system, the multiplier is 2.0% and the traditional legacy system that number is 2.5%.
Now most people would think that 0.5 really doesn’t make that much of a difference, but when you figure those numbers out over years of service and over your salary, it does make a very big difference in your monthly pay. The key things to remember with that multiplier is, the longer you serve, the higher your benefit will be, but one of the, factors in your computation of your retirement benefit is obviously the multiplier. The second is the number of years of service. If you retire from active duty after 20 years of service, under the blended retirement system, you’ll receive 40% of the average of your highest three years of base pay. |
| Scott Vance: | 06:14 | That percentage increases by 2% for each additional year that you serve. So compare that to your legacy retirement system at 2.5% you would do receiving 50% of your base pay starting at 20 years of service. The other thing to keep in mind with the defined benefit is that it keeps up with inflation. Defined benefits get an annual cost of living adjustment, commonly referred to as COLA. COLA basically keeps pace with inflation so that the same dollar you receive today will be the same dollar 20 years down the road. The defined benefit plan is very similar to the legacy retirement plan of the military and it’s just changed just slightly, a little bit. Basically, the biggest change is that multiplier number from 2.5% under the legacy retirement to 2.0%. The next big change in the blended retirement system is the implementation of defined contribution portion. The defined contribution portion of the blended retirement system is a way for you, as the individual, to save for your retirement. |
| Scott Vance: | 07:11 | This plan can be used whether you plan to serve just for two years, six years, eight years or the full 20. Additionally, if you go beyond that, those 20 years, you’ll be able to save more. The way this savings is set up is through your TSP account. You have two choices there, whether you want to go to the Roth or a traditional TSP account. Like we talked about in definitions, the Roth lets you contribute money now with no tax deduction and then receive those funds in retirement and pay no taxes. The |
| traditional TSP allows an upfront tax deduction, but then 20
years down the road when you’re retired and you start taking funds out, those funds will be taxed to you as income. So one of the key things to understand with a defined contribution portion, once you’re in the service for 60 days, a TSP account is created for you. |
||
| Scott Vance: | 07:56 | Once that TSP account is created, you will start to receive an auto match by your service. So right up front, within 60 days we’ll get a 1% auto match, whether you contribute or not. That will continue throughout your time in service, and once you’ve served two years of active duty, you’ll be vested in that auto match. That amount will be available for you to use for your retirement whether you stay in the service after two years or not. The 1 to 4% match starts after you’ve been 25 months in the service. So once you’ve served those two years, you’ll be eligible to receive a one to 4% match. You’re invested in those matching funds upon deposit by your service. So say if this month you deposited 2% and your service matches that 2% deposit, when those funds are actually deposited, which generally would occur at the beginning of the month, just like your pay does, you’d be vested so you could leave the service on that next day and keep those funds. |
| Scott Vance: | 08:51 | Now those funds that are vested, your TSP is referred to a portable account, meaning that you can take it with you wherever you go. Depending on the amount in that TSP account, you could either leave it in there, which is a very good option. The TSP is known at the very low cost, very good retirement plan, or you can roll it into an IRA or if you have an employer plan, depending on the employer plan, they may allow you to roll it into theirs. So for example, if you took a new job with an employer that has a 401k. Some 401k employer plans will allow you to roll your TSP account into it. Probably the the main thing here is to simplify your life and have all your funds in one account. Now you’ve been in the service and you begin contributing, your TSP account has been started for you. |
| Scott Vance: | 09:34 | So there’s a lot of questions about where your funds will be invested. The services contributes to a age-appropriate life cycle plan. These are investments that are adjusted based on your age and expected retirement date to be more aggressive when you’re younger and to move to a more safer investment, as you get closer and closer to retirement. Should you want to move to something that you feel is better such as the C fund, which is a common stock fund or some of the other funds at the Thrift Savings Plan has, you could do that, but the L Fund that is |
| considered closest to your retirement point is where those
funds will be if you don’t make any choices to change those funds. So we’ve spoken a little bit about the two main changes with the blended retirement system. So far we’ve not spoken about two additional smaller parts to the blended retirement system. |
||
| Scott Vance: | 10:25 | The first is continuation pay. The members covered by the blended retirement system are eligible to receive continuation pay. This is a one-time, mid-career bonus payment in exchange for an agreement to continue serving for additional years. Each service is kind of specific on this, so we’ll keep it at the broad point, but continuation pay is payable between the completion of eight years of service, and before you complete 12 years of service, from your pay entry basic date. Depending on the service they determine when exactly you’ll become eligible within that 8 to 12 year window. So check with your service to specifically take a look at that. This is a one-time bonus and this is in addition to any other career specific bonus you may receive. Some of the things to keep in mind for eligibility, this is only eligible for active duty. AGR have their own formation of this, but is similar to this. The amount it can be is from two and a half to thirteen times your base pay, as determined by your individual service. |
| Scott Vance: | 11:21 | If you take a large continuation payment in a year, it may bump you into a much higher tax bracket, or make you ineligible for some tax credits and tax deductions. The service allows you to elect – elect means you have to choose – to receive that continuation payment in four equal payments over four years. |
| Scott Vance: | 11:43 | So we’ve talked about the two main parts of the blended retirement system, the defined benefit and defined contribution, and we’ve also talked a little bit about continuation pay. So the last thing to talk about the blended retirement system is the lump sum payment. Under the BRS, service members are eligible to elect to receive a discounted portion of their retired pay up front. For example, instead of taking $1,000 a month for the rest of your life, you elect to take
$800 a month for the rest of your life, but you get a $10,000 payment right now. Decision to elect a lump sum retirement totally up to you, but if you do not choose a lump sum option, you’ll receive your full retirement pay upon eligibility. |
| Scott Vance: | 12:22 | If you opt for a lump sum, you’ll need to decide if you want to take 25 or 50% of your future retirement payments that you receive in one lump sum or four equal annual payments. Then |
| once you hit 67, if you took that lump sum payment, monthly
retired pay reverts to the full amount. So if you hit 67 and you took the lump sum payment and you reduce down to that $800 a month, once you hit 67, that returns to that full retirement benefit of $1,000 per month. So some of the key trade-offs, and aspects to understand. The first is a trade-off, obviously, you take 25 or 50% of your retirement benefit up-front, you have to think if you’re going to need those funds in retirement later on, and then obviously what you’re going to use those funds for. |
||
| Scott Vance: | 13:13 | Maybe the idea of starting a business or buying your home, your forever home. I wouldn’t suggest taking those funds for a brand new car or something that’s maybe less than conducive to your happy retirement. So, the idea here, the key trade off is that you give up that future income for the money now and you would want to use that money now for something that’s hopefully will have payoffs in the future. |
| Scott Vance: | 13:38 | Next thing to keep in mind is the timing for active duty. So if you’re choosing a lump sum option, as an active duty service member, you have to notify your service no less than 90 days before your retirement date. So the funds are paid no later than 60 days from the retirement. |
| Scott Vance: | 13:54 | So essentially 90 days out, before retirement, you have to have had notified your service of your choice with the idea that funds cannot be paid later than 60 days from before your retirement date. It’s obviously to keep from messing things up and then you end up not getting the money. Just keep that timing in mind. |
| Scott Vance: | 14:13 | The last is the taxes. Again, talking about the income tax bracket, that big payment may place you in a higher income tax bracket. The service allows you to elect to receive that lump sum payment in up to four equal, annual payments, to help you reduce your tax burden. |
| Scott Vance: | 14:30 | We’ve spoken several times about Thrift Savings Plan. A lot of times I get clients that I ask, what is the Thrift Savings Plan? We’re gonna talk a little bit about the Thrift Savings Plan and understand how it works under the blended retirement system. |
| Scott Vance: | 14:41 | So the TSP, or Thrift Savings Plan, is retirement savings and investment plan for federal employees, and that now includes members of the uniform services. It used to just be for federal employees and around 2000 it opened up for military folks as well. It offers the same types of savings and tax benefits as |
| private corporations and businesses that offer to their
employees through 401k plans. So if you’ve been in the civilian world for a while before he came back to the military and you had a 401k, it’s kind of the same thing, just under a different name. The TSP is a defined contribution plan, and if you remember back to our terms, we talked about the retirement income you receive from your TSP will depend on how much you actually contribute to TSP, including the amount that the service matches for you. |
||
| Scott Vance: | 15:26 | So some of the key things to keep in mind with your TSP account. The TSP income depends on how long you make contributions and in what amount, and then also the matching contributions offered by your employer. Keep in mind, for 2018, the limit you can contribute to your TSP is $18,500 ($19,000 in 2019). So if you’re making enough that you get close to that limit, you want to be aware of that and make sure you don’t go over it. Some of the things to keep in mind is when you’re in a combat zone tax exclusion area or direct support areas, basically you’re deployed and your pay is tax freeand the money you contribute to your traditional or Roth TSP account is invested basically tax-free. Those will be held out in a separate line item, so you could see it on your TSP statement that shows the amount of funds that are subject to that. They’re in a traditional TSP account. The contributions that you contribute there, but not their earnings, those specific contributions made will be tax free when you withdraw them. If however you contributed to your Roth TSP account, just like standard, the amount you contribute and their earnings are tax free when you withdraw them. |
| Scott Vance: | 16:34 | Second thing about the combat zone tax exclusion is the
$18,500 contribution limit for 2018, if you’re in a combat zone, that limit does not apply. If you’re 50 or older the TSP account will allow you to contribute more. The IRS, for 2018, has allowed up to $6,000 in additional catch-up contributions, so this would take your total allowed, to $24,500. The key here is that we’re trying to get compounding. You’re trying to get your TSP account to grow through contributions and then compounding. That’s making money on the contributions that you put in there. Through compounding, you can grow your account, and then hopefully when you start pulling funds out in retirement, the bulk of the funds you pull out will be the growth through compounding, and so much less than what you’ve contributed is what’s your ultimate value is. |
| Scott Vance: | 17:24 | So we’ve talked a little bit about the value just to give you an
idea what we’re talking about here. So this is just an example, totally made up numbers, but let’s say your basic pay is $2,000 per month, and then you save 5% into your TSP account. That’s $100 a month. So what does that equal out to over the years? So if you leave the military after 10 years you would have saved about $17,300. Even if you never add any more money after those 10 years, say you stay in the military, but you just stop contributing to TSP, that $17,300 grows to almost $100,000 at 25 years. Then also consider this, that’s not taking into account the matching contributions that your service would be providing. |
| Scott Vance: | 18:09 | So if you’re contributing 5%, your services matching that, that total is basically a 10% contribution or $200 a month. All those numbers in 25 years could mean you have almost $200,000. |
| Scott Vance: | 18:23 | We talked about the blended retirement system and the four components: defined benefit, defined contribution, continuation pay, and lump sum. If you have any more questions, make sure to address this with your pack section or your command financial. They have the resources necessary to help you understand and make sure that your blended retirement system works best for you. We did not speak very much at all about the Thrift Savings Plan. We’ll be doing that in a follow-up episode. We’ll discuss the basics of the Thrift Savings Plan and strategies to ensure you achieve the highest account balance as possible. |
| Intro: | 19:01 | Thank you for listening to Sheepdog Financial. Visit us online at TrisuliFinancialAdvising.com for more military centered financial resources. |