I’ll admit it. When I first heard the military was going to transform its retirement benefits by decreasing the pension and providing a match to the Thrift Savings Plan (TSP), my first reaction was, “They’ve gone and screwed up a good thing!” I’m a numbers guy so I immediately started making spreadsheets to compare the old plan and this new plan – this aberration (queue every skeptic you’ve ever heard) – they were calling the Blended Retirement System. I was trying to prove how awful it was, but the relentless rules of humble arithmetic don’t lie. It didn’t take long before I figured out this new BRS could be pretty darned good. I say could be because there is one thing that could still make this new BRS system all screwed up when compared to the legacy pension system. And that one thing is YOU.
Like the vast majority of private sector retirement plans, military members must now participate and make decisions within their retirement plans. These decisions will have a substantial and enduring impact on your finances for the rest of your life. Gone are the days when all you had to do was avoid the enemy, work long hours, and deploy to generally uncomfortable places far from home and you’d amble into a great retirement for your efforts. With the BRS you still get to do all that hard work and other fun stuff, but you must also make some key decisions along the way if you want that great retirement at the end.
Sean and I sat at the whiteboard the other day discussing those decisions, and we boiled them down to seven. Without further ado, here they are:
- Maximize the Matching Money. This decision is so obvious it borders on a “no-brainer”. This is the part of the new system that offsets the reduced pension benefit. If you don’t take advantage of it you are making a very costly mistake. You are being offered an opportunity for the government to give you a 4% raise. All you have to do is save 5% of your pay in a tax-advantaged account to get it. The government is trying to give you money – show up and take it! Whether you were automatically enrolled in BRS or you opted in, the minimum contribution you make to your TSP every year should be the one that gets you the maximum match.
- Get your allocation right. The single most important factor in whether or not your investments will help you achieve your long term financial goals is the way in which they are allocated among asset classes. Asset classes are things such as stocks, bonds, cash, commodities, real estate, etc. To meet your financial goals you need to have the right mix of asset classes to grow your investments while managing risk. The fund selections within TSP, while limited, are completely sufficient for your needs. There are even life-cycle funds that choose a reasonable asset allocation for you based on the year you are most likely to retire. What you should avoid – if you are decades from retirement – is piling a significant portion of your TSP account into the G-fund. It might be “safe” for the short term, but investing for retirement – heck, even investing in retirement – is a long-term game. The G fund most likely won’t grow sufficiently to support you in retirement.
- Keep Your Beneficiary Election Updated. Your choices are restricted when it comes to leaving your pension to someone else via the Survivor benefit Plan. Not so with TSP. You can name any beneficiary you want. Just make certain that you name a beneficiary, and that you review your beneficiary selection annually. Don’t make your loved ones wade through probate court to get access to your retirement accounts when you pass. Review this at least once a year.
- Don’t Take the Money and Run. The biggest winners by far in the new BRS system are those who don’t plan to make the military a 20+ year career. Under the legacy system they never received anything from Uncle Sam on their way out the door – just whatever TSP money they had contributed (and its growth). With the immediate vesting of the TSP, people who separate will be able to keep Uncle Sam’s contributions to their account, too. Just don’t do what far too many Americans do when they are changing jobs. DO NOT cash out your current job’s retirement account on your way out the door. After 3 or 4 years on a job, many Americans look at their retirement account balance and decide, “That’s too small to keep. I’ll just cash it out.” This is almost always an enormous mistake. Not only will you set yourself up for a higher tax bill, but you will also put yourself further behind on investing for your retirement. The power of compounding can make even small accounts pack a big punch decades later. Don’t make a rash decision and deprive yourself of the benefits of compounding.
- Don’t Roll It Over When You Separate. Don’t ask Sean or I about this unless you have some time to kill – it’ll take you more than just a few minutes to get us off our soapboxes. You can leave your money in TSP after you leave the service, and you probably should. Not “75% probably”, more like “99.99% probably”. There are plenty of people calling themselves financial advisors who will tell you they can do a better job than TSP with your money if you roll it out to an account they can manage. In the vast majority of cases that statement is provably incorrect. But asset gatherers continue to make their living by convincing you to move assets into accounts they “manage,” because they get paid more when more and bigger accounts have their names on them. Though you can’t make new contributions to your TSP after separating, you can still manage your allocations. We believe the best financial advisors will in most cases keep you in your TSP account at least until it’s time to start taking income from it, and fine tune your allocation to fit your overall plan.
- Invest Your Continuation Pay. Participants in the BRS plan are eligible to receive a one-time lump sum of continuation pay at the 12-year point of their careers. The amount will be a multiple, based on a variety of factors, of monthly base pay. It’s not life-changing money, but it will do better for you if you have a plan for that money in advance and then stick to your plan. You don’t have to invest it into your TSP, but you could. If you do, take care to do so in a fashion that doesn’t max out your annual contribution before the end of the year. If you do this, you’ll miss out on some matching funds. Other great investment ideas for your continuation pay include giving your kids’ education funds a boost, making larger contributions to your IRAs (if you can), or even investing it for your retirement in a taxable account.
- Review Your Roth vs Traditional Contributions Each Year (And Especially Prior to Deployment). TSP has both Roth and Traditional options. The differences between the two are tied largely to the timing of the taxation on the money. Roth contributions are taxed now. Traditional contributions are taxed later. While there are some rules of thumb, the decision on which is best is not a one-size-fits-all situation. Your unique facts and circumstances can substantially – and maybe even dramatically – impact the best choice you can make. Additionally, your unique facts and circumstances can change year over year as your family grows (or shrinks), you get promoted, your spouse gets promoted, etc. Deployments to tax-free zones can also impact this decision. You should sit down at least once a year and review your circumstances to make sure your Roth/Traditional selection is still the best one for you. One last word of caution about deployments. If you’re one of those folks who takes maximum advantage of Combat Zone Tax Exclusion (CZTE) to stuff tax-free money into your tax-free (Roth) TSP account, be very careful about how you manage this, especially if you’re also taking advantage of annual addition limits to get even more than your (currently $19K) annual contribution limit into your TSP. (Your BRS match will contribute toward that limit whether you’re deployed or not.) If you’re eligible for CZTE, it’s pretty likely you’ll also draw hostile fire pay or other special pay that you don’t normally see. You can drop every nickel of that into TSP as annual additions. But if those contributions aren’t made as traditional contributions, you may run the risk of maximizing your Roth contribution (which is hard-capped at $19K) before the end of a calendar year…at which point the bot monitoring your TSP account may actually shut down all contributions for the remainder of the year. We agree, it doesn’t make intuitive sense. It’s complicated. If you really want all the gory details, Doug Nordman has written at length about it. But the short version is that it’ll be much easier to get this right up front than to try to “fix” it after the fact…if fixing it is even possible.
The legacy retirement system was, and still is, a wonderful pension. But the BRS is here now. It’s pretty darned good just on its own merits, and for many of you it may be even better than the legacy system – if you manage it well throughout your military career and the rest of your life. If you want to learn more, we’ll be hosting a webinar on this topic next month. And as ever, The Military Guide, Military Dollar and Kate Horrell all have troves of good reads available on it. And of course, if you have a question about something specific, you can always give us a call or drop us a note.