By Dr. Charles Patterson, WCI Columnist
Members of the armed forces are privy to unique retirement benefits that provide additional layers of long-term security. Between an inflation-adjusted defined benefit plan, lifelong affordable healthcare, and access to conservative fixed-income funds, stable sources of income are reliable as long as the US government doesn’t implode. For the officer-physician, these benefits constitute a safety net that should be strongly considered when planning their asset allocation while in the military.
Today, I will provide a framework from which to understand military retirement resources and argue that an aggressive asset allocation is appropriate for long-term portfolio performance optimization.
What Are the Typical Sources of Income in a Military Retirement?
You made it to 20 years of service, congratulations! Regardless of your diligence in saving, you are entitled to the retirement annuity. This pension program comes in multiple flavors (as described below), and it's inflation-adjusted and tax-favorable.
The “High-3” or “High-36” System is the legacy-defined benefit program and the default for those entering service between 1980 and 2018. Under this plan, retirees receive a lifelong pension, calculated by multiplying 2.5% by the highest 36 months of basic pay during your service time. If you retired as a colonel at 20 years of service (having served as a colonel for three years), you would be entitled to approximately half of your basic pay every month for the rest of your life. For reference, this would be in excess of $5,500 monthly in today’s dollars. The fraction of base pay paid in retirement increases with years of service, such that a retiree with 30 years of credited service will receive a higher proportion (75%) of their base pay. However, under this system, there is no Thrift Savings Plan (TSP) contribution match. Further, it is cliff vested, meaning that if you separate at anytime prior to 20 years of service, you are not entitled to annuity benefits.
In 2018, the Blended Retirement System (BRS) came online, and it's currently the only system allowed for new recruits. Under this plan, service members now get a TSP contribution match (up to 5% of base pay). The pension difference between the BRS and the above legacy system is the fraction used with the multiplier: 2.0% instead of 2.5%. So, the pension benefit is decreased by 20%, but with the 5% TSP match, members who separate before the qualifying 20 years of service come away with more. Considering that only one in five service members stay to 20 years or beyond, this affords more flexibility in the “should I stay or should I go” calculus.
More information here:
What You Need to Know About the Thrift Savings Plan (TSP)
VA Disability Compensation Benefits
When retiring from the military, members are evaluated for service-related illnesses or injuries that may entitle them to disability compensation. This is added monthly income, and it exists in addition to affordable health benefits available by virtue of their military service.
Military members pay into Social Security just as their civilian counterparts do and are entitled to benefits in the same manner. Accordingly, regular rules apply with regard to the age of eligibility, survivor benefits, etc.
As discussed in detail below, service members have access to the TSP and IRAs (along with their spouses). Most will qualify for Roth contributions depending on bonuses, their spouse’s income, and other individual factors. We will also note here that service members may pass their GI Bill benefits to their spouses and children, which should be included in the savings calculations for higher education. Speaking of savings, taxes on military income are exceptionally low and virtually non-existent when deployed. While not savings in and of themselves, retirees enjoy free access to the base commissary (grocery store), exchange (department store), fitness centers, and a vast array of resources and services from financial planning to vacations. All of these benefits can defray the costs of living in retirement if elected to be used.
A career in the military is generally a much shorter duration than in the civilian world. Thus, it is not uncommon to have a master sergeant who enlisted at age 18, served 20 years on active duty, and retired at 38. And so for the rest of their life, regardless of their employment status, a paycheck will flow monthly. Admittedly, this sum is not much to live off by itself, but couple it with an encore career (perhaps with its own 401(k)), and a later “true” retirement looks quite palatable.
Because of time spent in undergrad and medical school, a physician in the military will typically be eligible for retirement no earlier than age 45 but more likely between 47-49. This leaves the peak earning years open for a more lucrative civilian practice, all with the safety of knowing that financial security is not predicated on suffering arduous work hours, tolerance of bureaucracy, and the acceptance of a culture ambivalent to moral injury. That sounds quite lovely, I think.
Alternative Income Streams
Many physicians will add additional income streams along the way, whether it's real estate income, a side hustle, or a small business. These are well-documented and fabulous ways of avoiding principal withdrawals from retirement accounts outside of required minimum distributions (RMDs).
What Is an ‘Aggressive' Portfolio?
Aggressiveness here is defined as a willingness to carry a larger proportion of equities in retirement accounts, confident that fixed income in the form of the defined benefit plan will supplant the function of bonds. There exists a cornucopia of reasonable asset allocations to match your preferred level of risk, among them some single-fund plans. But as a general rule, young investors should take more risk (>75% equities) early and decrease their market exposure with age to shield gains from market risks.
For those serving in the military who are open to a 20-year career, it may be reasonable to either maintain a higher fraction of equities (think an added 10%-30% allocation) for a longer period of time. One can even argue that completely forgoing bonds is practical. Yes, there is added risk here. And of course, life circumstances change, and perhaps staying 20 years on active duty becomes less palatable or untenable. But by the time one makes the decision to separate before retirement eligibility, the investing career is still young enough to withstand and recover from most market downturns to which an aggressive allocation is exposed.
How Do Fixed Income and Other Income Sources Influence Asset Allocation?
If you are reading this on the WCI, you are likely a diligent and engaged long-term investor. This means that you are (or at least should be) following the 10 Commandments of The White Coat Investor and seeking financial independence regardless of a desire to retire early. This matters because if you haven’t taken care of the basics and you're not investing regularly, then you are probably better off directing your TSP contributions to a lifecycle fund or a conservative allocation that better shields principal. The G-Fund found in the TSP’s offerings is an excellent adjunct in this. But the premise here is simple: with ample income flows from fixed income sources outside of investment accounts, asset allocation heavily favors aggressiveness.
Broadly, asset allocation is an exercise that serves to maximize returns with respect to one’s risk tolerance in consideration of the investing horizon. Risk tolerance decreases if you are relying heavily on the 401(k)/TSP and do not have access to the pension. Again, this is the case for veterans who have separated prior to the 20-year vesting. The annuity, however, never dries up.
Minimizing living expenses in retirement expands the buffer needed for a risk-tolerant portfolio. If by the time you reach retirement eligibility, you have also paid off your mortgage, saved for education for your children, maxed out retirement contributions, and have the second (more profitable) half of your career waiting, risk tolerance looks very different indeed.
Why Be Aggressive?
Part of mapping retirement spending is projecting what the associated costs are going to be. If you can manage to keep expenses to a rate below the cash flow provided by the defined benefit plan, RMDs, and other above-described sources of income, then you can be well-positioned to maximize growth potential through increased risk. But why?
I find it a good and noble goal to avoid, as possible, ever spending the nest egg. Yes, that is why it is there and absolutely should be used if necessary. You’ve done well by doing good for others, and this diligence affords you the right to wield the tool that is wealth. Simply, wealth is an abundance of that which sustains. It is a tool that needs tending, but if kept in proper order, it will serve your purposes well and prudently. Knowing the history of market returns should motivate the long-term investor to capture them in the future and, in so doing, optimize the tool at their disposal.
That capital is a weighty symbol of your life’s toil and making it work for causes that further your construct of social good is a testament to the beneficence which you have sought throughout your career. Maybe that means leaving large portions to preferred charitable organizations. Maybe it’s leaving it to your offspring who are themselves seeking worthy endeavors. Maybe that means donating it to the federal government because they seem really good with money and you trust them implicitly. But regardless of how these resources are utilized, their growth is maximized with exposure to markets and time. A military retirement allows for aggressiveness even in retirement.
I’ve heard it said that there are easier ways to make a living than joining the military. I’ve heard the same thing about medicine. Certainly doing both (or either) won’t make you rich overnight. But with patience, time, and attention, a military physician can achieve a very comfortable post-career life.
In closing, I would like to share an observation that I am sure you also have noticed in working with veterans. For those who serve or who have served, time in the armed forces is formative, life-changing, and often close to the heart of our self-perception. For some, it may be the cause of strife or resentment. But almost universally, the relationships forged therein are a source of strength, affection, inclusion, and pride.
If wealth is an abundance of that which sustains, then we who serve are endowed with a relational wealth of inestimable value. And we would do well to be just as aggressive when investing in the relationships that color and enliven our days.
If you're in the military, how are you structuring your retirement once you separate from active duty? If you're already retired, would you do anything differently when it comes to your asset allocation? Have you found reasons not to be aggressive? Comment below!