Author: Daniel Kopp, CFP ®

Categories
Financial Planning

Estate Planning Basics For Military Members

Picture of Estate Plan - Last Will and Testament

Estate Planning Basics for Military Members

One of the most common questions I get from military members related to estate planning is along the lines of “but I already have a will from the JAG – what else is there to do?” Estate Planning isn’t just for the independently wealthy. It’s for anyone who is loved and wishes to make the inevitable path of loss and grief easier for loved ones—including protecting underage children. 

It can also feel daunting, but we’ve broken it down for you into the basics. Because everyone’s circumstances differ, you may want to discuss the best way to apply these steps with the JAG or estate attorney. None of the following is considered legal advice and is for your education only. Consider the steps to put your estate plan in order.  

What is Estate Planning?

Estate planning is the process of establishing and maintaining a plan that outlines who will receive your assets after you pass away. There are many important documents required, some legal and some that are simply for the benefit of your loved ones. It’s a stressful time when a family member dies—having a solid estate plan can go a long way toward easing burdens.

An estate plan also helps when an individual is incapacitated, too. Moreover, estate planning includes not only your financial assets but also other items and general last wishes.

Why Is Estate Planning Important?

Estate planning is important because it puts in writing how your assets will transfer after your death. Common documents and products include a will, trust, insurance policies, and healthcare-related forms. Estate planning is simple for those with relatively few assets, but it quickly turns complex for high-net-worth individuals and families. Creating an estate plan with an experienced financial planner and estate attorney is thus important to avoid headaches after you pass away. New laws, regulations, and financial products make estate planning a complex area of long-term planning.

Assets Considered Part of an Estate

You might wonder what is included under the term “estate.” Just about everything you own. Writing down a list of all your assets is a good first step toward crafting a basic estate plan. Note everything, including retirement and investment accounts like your TSP, properties, cars, jewelry, collectibles, cash, and insurance policies. The list goes on! Knowing what you own along with the total value of your assets helps a financial planner strategize the optimal estate plan for you.

What’s ideal about financial accounts, though, is that you can generally name a beneficiary to whom a specific account will go upon your passing. That makes executing an estate plan simpler. Other non-financial assets pass through to your heirs based on how your will is constructed.

  1. Inventory and estimate the value of your stuff

You may think you don’t have enough to justify estate planning, but once you start looking around, you might be surprised by all the tangible and intangible assets you have.

The tangible assets in an estate may include:

Homes, land or other real estate

Vehicles, including cars, motorcycles or boats

Collectibles such as coins, art, antiques or trading cards

Other personal possessions

The intangible assets in an estate may include:

Checking and savings accounts and certificates of deposit

Stocks, bonds and mutual funds

Life insurance policies

Retirement plans such as workplace 401(k) plans and individual retirement accounts

Health savings accounts

Ownership in a business

Once you’ve listed your tangible and intangible possessions, you need to estimate their total value. Consider the following:

Home values: If you don’t have a recent appraisal, write down a ballpark figure of your home’s value using online tools such as Zillow, Trulia or Realtor.com. 

Bank and investment totals: Statements from your financial accounts

Sentimental possessions and family heirlooms

  1. Account for your family’s future

What future needs will your family members have in your absence? Consider income needs, medical care, and who will raise your kids if you’re not there.

Do you have enough life insurance beyond SGLI? If your assets cannot provide for the care and raising of your children, including future educational needs, consider including term life insurance to bridge the gap for those who depend on you.

Name a guardian for your children — and a backup guardian, just in case. This can help sidestep costly family court fights that could drain your estate’s assets.

Document your wishes for your children’s care. Don’t presume that certain family members will be there or that they share your child-rearing ideas and goals. Don’t assume a judge will abide by your wishes if the issue goes to court.

  1. Establish your directives

A complete estate plan includes necessary legal directives or instructions. If your estate is small and your wishes are simple, the JAG documents may generally suit your needs. These programs typically account for IRS and state-specific requirements. However, with increasingly complex estate needs like blended families, special-needs considerations, multiple properties across various states, or higher net worth estates, there is often a need for an estate planning attorney to go beyond the basics that JAGs usually cover. 

These directives include most or all the following:  

  1. Last Will and Testament: This is the most well-known document in estate planning. Most people know they should have a will, but the majority of Americans do not have one. According to a 2020 Gallup survey, just 45% of U.S. adults reported they had a will. A will is the foundation of an estate plan. The document outlines to whom your assets will go upon your death. Assets mentioned in a will still must go through the probate process, however. A will can be inexpensive and simple to make online, but they are often costly and elaborate for high-net-worth families. Moreover, a will is not a ‘set it and forget it’ estate planning document – it must be maintained just as a financial plan is updated as life events happen. Naming an executor (as well as backup names) of an estate is a critical component of your last will and testament, too. Finally, individuals should be aware that the will is made public through the probate process, so be thoughtful about what is included in the document.
  2. A durable financial Power of Attorney (POA) allows someone else to manage your financial affairs if you’re medically unable to do so as it is “durable” even through your incapacity. This includes paying your bills and taxes and accessing and managing your assets. A limited power of attorney can be helpful if the idea of turning over everything to someone else concerns you. Be careful about who you give power of attorney. They may have your financial well-being — and even your life — in their hands. 
  3. Advanced Healthcare Directive (AHCD), Medical Care Directive, or Living Will: An AHCD outlines what healthcare-related actions should be taken if you are unable to make decisions. You can also give a trusted person medical power of attorney to make medical decisions if you are unable to do so (in a coma for example).
  4. HIPAA Authorization: This document can save a lot of time and anxiety since it gives consent to share your medical records with third parties.
  5. Trust documents: Trusts allow you (the Grantor) to give someone else (a Trustee) control over how assets are controlled and held for the benefit of a third party (a Beneficiary). When constructed properly, assets in a trust avoid both probate and estate tax liability. A living trust, sometimes called a revocable trust, enables you to designate portions of your estate toward certain things while you’re alive. If you become ill or incapacitated, your selected trustee can take over. Upon your death, the trust assets transfer to your designated beneficiaries, bypassing the court process (probate) that may otherwise distribute your property. Those with minor children may especially want to consider a trust to provide financial protection for them so they don’t otherwise inherit large sums of money at age 18.
  6. Beneficiary forms: You might be overwhelmed by all that goes into making and maintaining an estate plan. One thing you can do today that is quick and easy is complete beneficiary designation forms on all your financial accounts. IRAs, 401(k)s like the TSP, and brokerage accounts often offer short forms to accomplish this estate-planning task. Financial accounts with a named beneficiary efficiently transfer upon your passing. Bank accounts have a “transfer on death” option as well. Don’t leave any beneficiary sections blank. In that case, when an account goes through probate, it may be distributed based on the state’s rules for who gets the property. Name contingent beneficiaries. These backup beneficiaries are critical if your primary beneficiary dies before you do and you forget to update the primary beneficiary designation.
  7. Guardianship: More important than money is what happens with your children and other dependents. No estate plan is complete without a directive on who will care for your loved ones when you pass away. Guardianship is commonly outlined in a will.
  8. Letter of Intent. A letter of intent is a document left to your executor or a beneficiary. The purpose is to define what you want to be done with a particular asset after your death or incapacitation. Some letters of intent also provide funeral details or other special requests. While not legally binding, letters of intent can inform a probate judge of your wishes if the will is deemed invalid or more importantly, give guidance to your loved ones with more information about your wishes. 

Estate Taxes

Although this generally doesn’t apply to most military families, avoiding estate tax is among the primary goals of crafting and strategizing an estate plan for wealthy individuals. For these people with a net worth above the federal estate tax exemption, the so-called “death tax” can run into the millions of dollars. Ultimately, you want to ensure your heirs receive as much of your assets as possible. A savvy financial advisor helps individuals and couples create an optimal estate plan—that includes taking tax minimization actions years in advance of retirement.

The top federal estate tax rate is 40% for 2023. The estate tax exemption amount, also called the exclusion, is $12.92 million per individual and $25.84 million per couple. That means if the cumulative value of your assets exceeds those amounts, you could face substantial estate tax liability. The good news is that there are strategies you can act enact to reduce what you might owe. In general, the higher your net worth, the more value a financial advisor knowledgeable in estate planning brings.

Another key amount is the annual gift tax exclusion, which is $17,000 per donor, per donee ($33,000 per couple). For example, I can give anyone $17K and my spouse could give that same person another $17K.  This is commonly misunderstood that if you want to give (or receive) an amount above that annual exclusion amount that you have to pay tax. That is not correct! There is just some paperwork (IRS form 709) that needs to be filled out come tax-time that reports using a portion of your lifetime exclusion (the $12.92M figure earlier) for the gift. Thus, no gift tax is owed unless you use all of that up. 

Get Started Today

Everyone needs an estate plan even if the value of your assets is significantly below the federal estate tax exemption. If so, you can simply visit the JAG to update or create a plan. In addition, any number of online sites like Trust and Will offer ways to draft and formalize your estate plan document. If you get out of active duty and work in a civilian company, many employers offer estate planning services in their benefits packages—check with your Human Resources department at work to see if that’s the case for you.

But here’s the thing: While your net worth might be well under the exclusion amount today, decades from now that might not be the case. Consider that compounding investment returns, business growth, and even tweaks to the federal tax code might change your situation. Getting started today with certain estate minimization techniques can prepare you for an easier tomorrow.

Conclusion

Taking time today to craft an estate plan helps ease your loved ones’ burdens after you pass away. A solid estate plan outlines who will receive what after you die and this important piece of financial planning includes directives on what actions to take if you become unable to act on your own. Whether you should hire an attorney or an estate planning professional to help you create your estate plan depends on your situation. 

If you have doubts about the process, consulting an advisor to help you take the best steps for your situation might be worthwhile. The advisors in MFAA can help you determine whether this is a process you can tackle yourself or one for which you should hire a professional. We’re here to help!

 

Categories
Military Retirement

Blended Retirement System: Evaluate the Lump Sum Option

Balance
Photo by Elena Mozhvilo on Unsplash

Unlike some civilian pensions, there is no option to take the full military pension as a lump sum. However, servicemembers retiring under the Blended Retirement System (BRS) must carefully evaluate the lump sum option when retiring.  One of the components of the Blended Retirement System (BRS) is the ability to take either 25% or 50% of the discounted lump sum value of the servicemember’s pension at the time of retirement.  

BRS Lump Sum Details

  • Of note, the earliest anyone under BRS will actually be eligible to get the lump sum will be in 2026. Active duty BRS enrollees had to have less than 12 years of service on 1 Jan 2018 which means that it will be 8 years from then before the first possible lump sum can be awarded at retirement after 20 years of service.
  • The retiree must make the decision to select the Lump Sum payment NLT 90 days before their retirement date.  For the Reserve Component, the member must make the decision NLT 90 days before first becoming eligible to receive retired pay under the non-regular retirement program (usually at age 60).
  • The servicemember may elect to receive the discounted present value of either 25 percent or 50 percent of the gross estimated retired pay.
  • DFAS will make lump sum payments to the retiree NLT 60 days after the date of retirement.
  • The subsequently reduced pension lasts until the member reaches full retirement age (FRA) according to the Social Security Act.  FRA is currently 67 for most servicemembers. The member’s FRA is grandfathered in at the time when they make the lump sum selection in case the FRA would otherwise rise later on.
  • The retiree may choose to receive the lump sum payment in up to four annual installments paid over no more than 4 years.
  • Survivor Benefit Plan (SBP) under the Lump Sum
    • The retiree remains eligible to elect to cover their spouse, dependents, or qualified insurable interests through SBP. The next update to DoDI 1332.42, “Survivor Annuity Program Administration” will address the manner in which premiums are handled when a member elects a lump sum distribution.  
  • Retirees who accept the lump sum distribution may not seek any kind of retroactive review or challenge of the amount.
  • Lump sum payments to retirees remain subject to the same conditions as military retired pay for divorce decrees and other court orders.

Time Value of Money

Before getting into the specific lump sum methodology, we need to cover the financial concept of the Time Value of Money.  Receiving money today is worth more than receiving the same amount money in the future because you can invest money today at a given rate of return.  A simple example can help illustrate the point – would you rather have $100 today or $100 a year from today?   If you could invest $100 at a safe 5% rate, next year you could have $105 ($100*.05 + original $100) instead of $100.  This example illustrates the point that money is worth more today than in the future because of what you can do with it in the meantime.

Present Value of an Annuity

We also have to understand how to value a pension to understand this principle better.  Ultimately, a military pension is an annuity that will pay the retiree a guaranteed stream of income for their rest of his or her life.  The formula to determine the value of a retiree’s lump sum is calculated by the Present Value of an Annuity where a discount rate is used to determine how much the future set of cash flows are worth in today’s dollars.  Go watch this Investopedia video if you would like another example.

Blended Retirement System Lump Sum Discounted Value Calculation:

Lump Sum Options Graphic

The Time Value of Money means that any lump sum payment the retiree will receive will be discounted back into today’s dollars.  In the E-7 example (linked here), the retiree might receive close to a total pension sum of $976,000 (using a 3% annual inflation adjustment) from age 39 – 67. The discounted value of $976,000 in the present would only be worth about $348,000.

  • According to the BRS Implementation Memo, computing the discount for the lump sum will be determined by taking the inflation-adjusted, 7-year average of the Department of Treasury High-Quality Market (HQM) Corporate Bond Spot Rate Yield Curve at a 23-year maturity plus an adjustment factor of 4.28%. The inflation-adjustment applied is the Department of Treasury “Breakeven Inflation Spot Rate Yield Curve.”
  • The Deputy Assistant Secretary of Defense for Military Personnel Policy (DASD (MPP)) calculates the discount rate annually by June 1 of each year. It’s effective as of January 1 of the following year.
  • The current BRS Lump Sum discount rate for 2024 is 6.26%
  • A general way to think about this is borrowing from your retirement pension at an interest rate of 6.26%. That’s pretty steep when you consider the guaranteed nature of the pension.  

I’ve created a very rough lump sum “guessestimate” calculator on Google Sheets.  

Bottomline

A military pension is incredibly valuable so the decision to take the lump sum is a serious decision.  Given how many servicemembers elected REDUX in the past, there is clearly a temptation to elect to receive a large cash sum.

I’m absolutely a huge fan of the BRS overall, but the lump sum has some headwinds.  Based on an adjustment factor of 4.28% plus the prevailing market conditions, it will be very difficult for any military retiree to gain more through investing the lump sum amount than he or she would have earned keeping the full pension.  Add in the taxes paid on the large lump sum payment/s and the decision to take the lump sum becomes even worse.  

Rather than taking a lump-sum option, servicemembers may have other resources available for large cash needs. A few alternative ideas include:

  • Starting a business: Low-interest SBA loans, Boots to Business program
  • Buying retirement dream house: VA lending with 0% down
  • Paying off consumer debt: NFCC plans that will be more manageable with the higher monthly retirement income

Based on all of this, I cannot recommend that anyone should take the BRS lump sum as it is a steep discount for what the servicemember could otherwise get as the guaranteed pension.  Happy planning!

Resources:

A Guide to the Uniformed Services Blended Retirement System

Official Department of Defense BRS website

 

Categories
Financial Planning

What Military Members Need to Know About the Future of Social Security

Social Security Trust fund value over time and projected through 2035 highlighting the future of Social Security
Source: 2022 Annual Trustees Report, Table VI.A3 (pp 165-166), Table VI.G8 (p 227)

What Military Members Need to Know About the Future of Social Security

If you’ve read the headlines, you’ve probably heard that Social Security is in financial trouble. In fact, Social Security posts a disclaimer on your statement, saying that  “by 2035, the payroll taxes collected … will be enough to pay only about 80% of currently scheduled benefits.” In other words, if Congress does nothing by 2035, 20-25% of all Americans will experience a permanent reduction in their payments.

If you, for example, expected to earn $3,000 a month in benefits, you may only receive $2,400 a month instead. But don’t panic yet. Let’s look at how Social Security works and what might be done to fix the problem.

Understanding Social Security

Social Security works by taxing the paychecks of those who are currently working. These taxes are your contributions that pay benefits to those who are eligible (retirees, widows, disabled, etc.). You can think of Social Security as a wealth transfer between generations, generally from younger workers to older retirees, but also to beneficiaries (mostly widows and children) .

In contrast, your own contributions to your TSP and the ultimate benefits of your military pension (assuming you vested by minimum service requirements) are legally owned by you the contributor. You own that money, even if your employer goes bankrupt or out of business. That’s not how Social Security works.

The Social Security Administration (SSA) takes 12.4% a year out of your wages. You pay 6.2%, and your employer pays 6.2%. You, as an employee, pay half (6.2%), and your employer (the DoD) pays the other half. One common exception is for the self-employed. In that case, you are your own employer, and you pay the entire 12.4%.

Payroll taxes account for over 90% of the money that goes into SS, called “program receipts.”

Program receipts go to a type of savings account called the Old Age, Survivor, and Disability Insurance (OASDI). OASDI is a trust fund managed by the US Treasury that immediately pays benefits to those who are eligible. When program receipts (what goes in) exceed immediate benefit payments (what goes out), excess funds are invested in US Treasury bonds and held in reserve for future periods. When program receipts are insufficient to cover immediate benefit payments, bonds in the trust fund (if available) are redeemed to cover the shortfall.

Nearly all program expenditures go to paying benefits, with less than 1% spent on administration. Eligible beneficiaries include retirees and their families, surviving spouses and dependents, and those who are disabled and their families.

How Social Security Calculates Your Benefits

The program calculates how much benefit you will get using a formula based on your average monthly work earnings over 35 years. The formula averages your highest-paying working years and adjusts the amount for inflation. The result is called your Average Indexed Monthly Earnings (AIME). Your AIME is then used to calculate your potential SS benefit. This is called your Primary Insurance Amount (PIA).

How to Calculate AIME

The formula for your AIME is as follows: 1) take how much you earned in every year, up to the maximum contribution or benefit base for that specific year; 2) for years prior to the year in which you turned 60, inflate those amounts using the national average wage index; 3) rank your pre-60 indexed earnings along with your 60+ unindexed earnings from highest to lowest; 4) add up the highest 35 yearly figures; 5) divide the total by 420 months to get your AIME. Note that to qualify for retirement benefits, you must have 10+ years of earnings on which you paid Social Security payroll taxes. And, if you paid into Social Security for <35 years, all non-contributing years are considered zeroes in the AIME formula.

The formula for your PIA is the sum of three separate percentages of portions of your AIME. The percentages of the PIA formula are fixed by law at 90%, 32% and 15%, respectively. Since the percentages are declining for each portion of your AIME, the PIA formula is progressive. The dollar amounts in the formula (called “bend points”), which govern the portions of the AIME, change annually with changes in the national average wage index. For 2023, if your AIME is greater than $6,721, your PIA = 90% x ($1,115) + 32% x ($6,721 – $1,115) + 15% x (AIME – $6,721). For example, if your AIME is $8,000 your PIA in 2023 would be $2,989.

The PIA formula is progressive, meaning Social Security provides proportionally higher monthly benefits to lower-income workers. For example, retirement benefits may replace about 45% of a middle-income worker’s AIME vs. about 27% for a high-income worker. This is good news for most lower income people. Social Security can replace a greater share of their income needed in retirement.

How much retirement benefit you receive depends on your age when you apply or “file.”

Graph showing Social Security Claiming at different ages across different AIMEs
Compared to filing at your normal retirement age (NRA) (black line), filing at the latest age possible of 70 increases your benefit by 24% (orange line), while filing at the earliest age possible of 62 reduces it by 30% (blue line).

Will Social Security Have Enough to Pay Your Benefit?

For almost four decades, Social Security has been cash-flow positive (more was paid in than paid out). In 2021, however, program benefits paid out were more than taxes paid in for the first time since 1982 (more was paid out than was being paid in). By 2020, the trust fund held about $2.91 trillion, enough to fully cover 2.6 years of program expenditures (everyone collecting benefits).

Given the magnitude of the benefits to be paid out (over $1 trillion a year) and the nation’s aging population, the program must rapidly use up its reserves to meet its obligations.

For every 65-year-old potential retiree in 1985, there were 5 workers aged 20 to 64 potentially paying into the SS system. In 2020, there were only 3.5 workers. Those in charge of the trust fund predict that, by 2035, there only will be 2.7 workers for every retiree and just 2.3 by 2080. In other words, fewer and fewer taxpayers will be supporting each eligible beneficiary, or alternatively, each taxpayer will be supporting more and more beneficiaries

The Board of Trustees of the OASDI trust fund (“Trustees”) predict the trust fund will be depleted by 2035, at which point program receipts (payroll taxes) will be enough to pay about 80% of promised benefits. In short, the trust fund will run out, but all the Social Security benefits will not.

Social Security Trust fund value over time and projected through 2035 highlighting the future of Social Security
Source: 2022 Annual Trustees Report, Table VI.A3 (pp 165-166), Table VI.G8 (p 227)

What Can Fix Social Security?

Experts propose a few solutions to the problem. One is to increase how much Social Security takes out of a worker’s paycheck by a few percentage points (pay higher taxes). Another solution is to reduce the size of benefits. The longer Congress delays, however, the bigger the problem becomes and the more drastic the solutions.

Graph showing Social Security Assets, Income, Expenses and resulting deficiency
Source: 2022 Annual Trustees Report, Table IV.B6 (p 75)

To understand what it will take to fix Social Security, the Trustees analyze the program’s cash flows over the next 75 years and beyond. To start, the Trustees sum up the present value of future program receipts, add them to the current balance of the trust fund and subtract the present value of future expenditures. What’s left is an estimate of the program’s financial shortfall over that period. For example, the Trustees estimate the program needs $20.4 trillion of additional assets today to pay all promised benefits over the next 75 years (that’s 1.1% of GDP over that time).

The Trustees estimate that to close the $20.4 trillion shortfall, and pay all promised benefits over the next 75 years, requires an immediate and permanent increase in payroll taxes of 3.24 percentage points, a reduction in benefits of 20.3%, or some combination of the two. Unfortunately, if Congress delays until the trust fund is depleted in 2035, the required changes will be larger—e.g., a 4.07 percentage point increase in payroll taxes, a 24.9% reduction in benefits, or some combination.

Planning in Light of Uncertainty

Does this mean you should be planning on a future without Social Security? I don’t think so. Although the program clearly requires reform, as it did in the 1980s, it is far from bankrupt. It just needs modifications.

Sadly, Congressional action around Social Security tends to arrive at the last minute. Legislators will likely need to shore up the program’s 75-year shortfall using a combination of tax increases and benefit cuts.

For planning purposes, you may need to update your financial plan. For example, in 2023, we could see a 2.035 percentage point increase in payroll taxes (half paid by the employer and half by the employee) and a 12.45% decrease in benefits for all beneficiaries beginning in 2035.

All things equal, this means your financial plan may require more saving and support less spending, especially if you’re younger. That said, no matter the changes, Social Security will likely remain the best longevity insurance most Americans could ever hope for, so take the “doom and gloom” news you hear with a grain of salt. For military retirees with a pension on top of Social Security, they should be even less concerned than the general population.

Social Security and retirement planning are just a few of the thing the MFAA advisors are great a helping their clients figure out.  If you’ve got financial questions, consider scheduling a call with one of our advisors.

 

Categories
Financial Planning Military Pay Taxes TSP

How Much is Your Military Compensation Actually Worth?

Understanding Your Entire Military Compensation

For any servicemembers who are transitioning out of the military or perhaps daydreaming about what that might look like someday, many of them have never considered the full impact that transition will have on their finances and total compensation.  Most of the servicemembers that I talk to are surprised after they separate and don’t have the same salary, benefits, or total compensation as they did in the military.  So what can you do about this if you’re set to separate or are thinking about it?

Every year, usually in early April, DFAS publishes the Personal Statement of Military Compensation (PSMC) with the intent to help make servicemembers’ full compensation more readily visible.  While DFAS states that this may be helpful in applying for credit or loans, the true benefit lies in understanding what your equivalent compensation would need to be outside of the military to maintain your same standard of living.

So what is compensation? 

In this context, compensation refers to the entire sum of salary, benefits, and other financial support that servicemembers receive.  The majority is “direct compensation” — money paid directly to you — while the rest is called “indirect compensation” — things that financially benefit you but aren’t a direct payment.  Indirect compensation can either be financial compensation or non-financial.

One example of indirect financial compensation is healthcare.  When an employer helps pay for your healthcare coverage, that’s indirect financial compensation since you otherwise would have to pay that amount.  Indirect compensation can also be non-financial like leave.

Direct compensation is readily apparent because these are clearly listed on your LES while indirect compensation might not be as immediately clear.  The goal of this post is to help you understand the full picture of all of your compensation.

It’s important to take a look at each detail of the PSMC since each analysis can differ based on personal circumstances.  You can access your PSMC through myPay right underneath where you can view your LES.  This article will probably be most helpful if you have your own PSMC to go through.    We will look at an example PSMC for this post and show you how to analyze your own.

Navy members should note they will have to visit the PSMC website calculator directly at:
https://militarypay.defense.gov/Calculators/RMC-Calculator/

Direct Compensation

DFAS pre-fills in your basic pay, special pay and bonuses, expense allowances (OHA, COLA, etc.), as well as an estimate of the added value of indirect compensation which is usually based on the federal tax advantage of BAH and BAS.  This provides the starting point for you to add in some personal analysis about all the indirect compensation and add your estimate back in at the end to get your total compensation figure.

To help illustrate some of these concepts more concretely, we will look at an example of a hypothetical O-3 compensation.

  • Basic Military Compensation: $85,047.96
  • Special Pay and Bonuses: $2,472
  • Total Direct Compensation: $87,519.96
  • Added value of Service-estimated indirect compensation: $3,275.21

Estimating Your Indirect Compensation

As you estimate the various forms of indirect compensation, don’t stress getting each figure down to the exact dollar amount.  The goal is to gain a more complete understanding of what that benefit might cost you if you had to pay for it yourself so estimating is OK.  It’s also usually best practice to estimate conservatively on these figures so you don’t have a highly inflated final compensation figure to compare against equivalent civilian compensation.

If you aren’t sure what a benefit is worth, ask friends or family for help especially if they aren’t in the military and they could give you a more realistic picture of what benefits are worth outside of the military.  Below is an explanation of how you can go about calculating each of the indirect compensation categories on the PSMC.

Military Taxes

In the PSMC example above, DFAS has estimated that based on the current BAH and BAS, this person is saving $3,275.21 a year by not paying federal income tax on those two allowances.

Another thing to consider here is combat zone tax exclusion (CZTE).  The PSMC doesn’t list this as part of the analysis, and it could easily be argued that this is a direct benefit to help offset some of the challenges of deployments.  For many servicemembers however, a deployment might mean going down one tax bracket from 22% to 12%, but more senior servicemembers or dual-military could really reap benefits here if they own more significant taxable investments and drop from the 24% tax bracket to the 12% and its equivalent 0% tax rate on long-term capital gains and qualified dividends.

Junior servicemembers could also drop below the income threshold to be eligible for the Earned Income Tax Credit (EITC) which could mean quite a bit of extra money at tax time.  For this example, we won’t consider CZTE in my calculation, but others might choose to do so, especially if you deploy on a more regular schedule.

  • Formula: (Projected) State Income Tax x Current Basic Pay = State Income Tax Benefit
  • CZTE Formula: # of Months Deployed x Monthly Federal Tax Deduction = Benefit

Military Medical Care

Tricare is undoubtedly the biggest indirect financial compensation for most servicemembers and their families.  For servicemembers who haven’t had a full-time job outside the military, most are insulated from what almost everyone else in the country has been going through over the last several years.  Medical insurance can be incredibly costly for many Americans so this area of compensation is critically important to understand.

As a financial planner who helps people find and evaluate health insurance on their own through the federal and state exchanges, I just cannot stress how amazing this level of medical coverage is!

How much is Tricare worth to you?

One way to measure this is to see how much it would cost you to buy Tricare Standard coverage without the military paying for any of it.  This option exists as the Continued Health Care Benefit Program (CHCBP)  provided by Humana.  Similar to COBRA, this plan can give you temporary health coverage for 18-36 months when you lose eligibility for Tricare.  Basically, it means that you pay 102% of the total insurance premiums which in this case were previously all paid for by the military.

In FY20, CHCBP premiums would be $1,599 per quarter for individual coverage and $3,605 per quarter for family coverage.  In addition to these premiums, there will be yearly deductibles and cost-shares similar to Tricare Standard.  That comes out to a minimum of $6.396 (individual) or $14,420 (family) respectively a year.  Plus, consider that is also a tax-free benefit while on AD so it’s worth even more than just an equivalent cash payout.

Another way to compare the value of Tricare is to see what health insurance coverage would cost you on the healthcare.gov exchanges.  This gives you a very good example of how much you could otherwise be spending given your specific family circumstances as healthy, young individuals can acquire more minimal coverage much cheaper than CHCBP while families might see some major sticker shock.

Many of my military clients who get out and suddenly have to pay the full costs of tens of thousands of dollars a year towards healthcare they purchased on the exchange experience DRAMATIC sticker shock. Even employer-provided health insurance will almost always be far more expensive than anything they paid on AD.

Practice expectations management prior to separating and don’t expect your health insurance to offer as much for as little as Tricare costs.  The bottom line is this: don’t undervalue your Tricare coverage!

Pro tip: consider switching from AD to the Reserve Component to still have access to subsidized medical insurance through Tricare Reserve Select at still a low personal cost.

  • Formula: Expected Civilian Annual Health Insurance Cost – What You Currently Pay Annually for Tricare Prime/Standard = Your Benefit

Military Pension + BRS Match

The legacy military retirement benefits only consist of the High-3 system as an all-or-nothing pension that requires vesting at 20 years of service. As such, it’s a little harder to directly value compared to the Blended Retirement System (BRS) direct matches which are more straightforward.

For the BRS contributions and match, just add those percentage amounts based on the basic pay rate right into your calculation. The BRS matching rate is comparable to many civilian employers’ 401(k) matching.

One of the good friends of MFAA, Doug Nordman, has done a great job giving some estimates of what that military pension is worth. The trick of course is that the pension is still worth “nothing” until you actually vest in it so there’s no real way to say you’ve earned half of the pension’s value just because you have served 10 years.  To quote Doug, “Stay in the military if you’re challenged and fulfilled, but don’t join just to stick it out for a pension.  If the pension is your only motivation then you won’t last past the first obligation.  When the fun stops then you should leave active duty for the Reserves or National Guard instead of grimly clenching your jaw and gutting it out for 20.”

Still, it is critical to understand just how incredibly valuable an active duty military pension can be as an E-7 pension can be worth around $1.4 million at the time of retirement and an O-5 pension could be worth as much as $2 million!

This part of the PSMC analysis doesn’t produce a number to add into your overall compensation, but it does help you think through the calculus of staying in or getting out.  The more years of service that each servicemember has should also weigh heavily in this consideration as it’s easier to make the decision to get out after only 4 years vs. 15 years.

Thrift Savings Plan (TSP)

The TSP offers incredible cost savings as it is dramatically cheaper than the average expense ratio of traditional mutual funds or many employer-sponsored 401k plans.  In 2021, the TSP had a net expense ratio of only about 0.05% while the average expense ratio of the civilian TSP equivalent of a 401(k) and average mutual funds are much more expensive!

That means that if your TSP balance is $1,000, you are only paying about $0.50 a year in fees while that same $1,000 in an average 401(k) would cost you $5 – 10 (per $1K) a year based on plan administration or investment expense ratios.  Over time, that fee differential becomes a huge drag on investment returns — to the tune of tens of thousands or even hundreds of thousands of dollars — which you can see for yourself using this Vanguard tool.

  • Formula: (Amount Currently in TSP x 0.01) – (Amount Currently in TSP x 0.0005) = Benefit

Life Insurance (SGLI), Dependency and Indemnity Compensation (DIC), and Survivor Benefit Plan (SBP)

Let’s analyze SGLI, DIC, and SBP in the context of the actively serving member to apply this to the PSMC, but understand that these concepts also apply to retirees albeit with some differences.  Many companies offer some type of group life insurance that is tied directly to employment and SGLI functions just like this.  Although individual servicemembers pay for SGLI, this guaranteed insurance is still pretty low-cost, but most importantly helps ensure servicemembers can stay insurable post-military with VGLI should something happen to them while in the military.  These are the other benefits broken out:

  1. Should you pass away, your family or designated beneficiary will also automatically receive a death gratuity payment of $100,000 regardless of whether you have SGLI coverage or not.
  2. If your death is determined to be in the line of duty and if you are married, your spouse will also receive monthly non-taxable Dependency and Indemnity Compensation (DIC) payments of at least $1,357.56 and an additional $336.32 for each surviving child are payable. DIC is generally adjusted annually for inflation.
  3. The family will also receive one year of BAH based on the current rate they were previously receiving.
  4. If you die while on active duty in the line of duty, your family is protected by SBP at no cost to you. The formula for this looks like this:  SBP = 0.55 x (2.5% x YOS x average of the highest 36 months basic pay).
  5. Due to some recent changes to how DIC and SBP work together, you should research the most current status to determine how much if any offset is given between these two payments.
  6. For our example here, we will just assume a surviving spouse and one child at $20,316 a year.

So how much life insurance would you approximately need today in order to provide a $20,000 a year inflation-adjusted annuity for the rest of your spouse’s life?  I plug the requirements into the calculator here (I used ~3% for the interest rate as inflation) which says that annuity is worth about $509,000 in today’s dollars given a spouse’s age of 30 and IRS expected life span.

That means I would need to carry an additional $609,000 ($509K + $100K death gratuity) in life insurance today to provide that same level of benefit to a spouse.  For the sake of estimating, we’ll use the SGLI rate of $0.07 per $1,000 of coverage at $609,000 x $0.00007 = $42.36 a month or $511.56 a year. [Note: You could potentially get a lower term life insurance rate than this rate given underwriting characteristics]

The equivalent costs of term life insurance vs. SGLI are usually easy to compare and many servicemembers often carry life insurance through companies like AAFMAA, USAA, or Navy Mutual.  Many people though don’t think about pricing out the income streams that their families could also earn through DIC and SBP when considering their life insurance needs.

Pay Raises

The PSMC next has you calculate the value of annual pay raises, longevity increases, and promotion raises.  While the annual raises haven’t always tracked directly with inflation, the longevity increases, and promotion raises both offer standardized opportunities for increases in pay.  This one is a lot more difficult to measure though and depends on you remaining in the military so we will skip it for this analysis. 

One important consideration for you though might be the comparison here between regular raises in the military and whether or not your civilian career offers the same chances to regularly grow your pay.

Commissary and the Exchange

This category is very dependent on how much each family uses the Commissary and Exchange.  Recent PSMC estimates list out that the average Commissary benefit is about $4,600 a year for a family of four with most people saving about 30% of their grocery purchases.  Take into your purchasing habits to fully analyze this one for you.

  • Formula: [(Average Monthly Commissary Spending x 1.24) x 12] – [(Average Monthly Commissary Spending x 12] = Average Benefit
  • Note: To get a more accurate estimate, an older Stars and Stripes article breaks out the average savings by region and can range from around 19% to over 44% for OCONUS.

Federal Long-Term Care Insurance Program (FLTCIP)

This benefit primarily offers long term care insurance for those looking to help cover the cost of nursing home and other end-of-life care.  The goal of FLTCIP is to help preserve your retirement savings should a long-term care need arise.  Those eligible for the FLTCIP include all Federal Employees (Uniformed Service members), their spouses, adult children (including natural, adopted & step), parents, parents-in-law, and stepparents.  Given my current age, current and projected savings rate, and expected financial independence long before my 60s, I don’t have a need for this.  Your situation may be different especially if your parents could purchase through this benefit program.

Note that this benefit is not as good as it once was and is not necessarily something I would automatically recommend.

  • Formula: Other Annual Long Term Care Insurance Cost – FLTCIP Annual Cost = Benefit

Education Benefits

The military offers some pretty incredible education benefits through Tuition Assistance (TA), the GI Bill, ROTC scholarships, Academy appointments, job certifications, and numerous other opportunities.  I’ve written about that using my own example here where I figured out how I turned $80,000 of education benefits into more than $2.1 million in lifetime value!

The primary education benefit to account for here is TA or service-specific associate degree program since it is a function of remaining on active duty whereas the 9/11 GI Bill vests after 36 months of qualifying service (ROTC scholarship and Academy grads take note that you must first finish your education commitment before starting to earn credit towards the 9/11 GI Bill).

If you are currently still serving towards the 36 months to earn 100% of your benefits or are still serving an ADSC because you transferred the benefit to a dependent, include a pro-rated portion in the calculation below.  There will be lots of variation about how much the 9/11 GI Bill education benefits can be worth so you can personalize this to your own unique situation.

Service Activities

Everyone’s use of the services provided by their base will differ greatly so this is another highly personalized analysis.  Among the most financially impactful is the child development center (CDC) since this cost is subsidized based on rank.  For those that utilize the CDC, you can try to determine the cost of a similar daycare off base and compare the CDC cost to add up your benefit.

Other things to consider include the fitness center, auto facilities, hobby shop, outdoor recreation rentals, etc.

Counseling and Assistance Programs

The PSMC helps provide some figures here ranging from $30 an appointment up to more than $5,000 for transition assistance services to help you analyze the costs for free personal financial management counseling, relocation services assistance, transition counseling, spouse employment consultation, and assistance from a wide range of services available from their services’ community centers.  Again, each individual circumstance will differ here. Note that some of these are given as an estimated hourly rate.

  • Personal Financial Counseling/Education: $ 250 – 375
  • Spouse Employment Counseling: $ 585 – 990
  • Transition Assistance Services: $ 5096
  • Non-Medical Counseling: $ 30 – 100

Legal Counseling

Military members and family members can get free legal assistance in a wide range of areas, including consumer law, landlord-tenant law, family law, estate planning, and tax assistance services.  The PSMC again offers their estimates for costs associated with everything from notarization or powers of attorney to tax returns preparation and consultations with an attorney. Note that some of these are given as an estimated hourly rate.

  • Consultations with an Attorney: $ 150 – 175
  • Wills: $ 250 – 3,000
  • Notary: $ 10 – 20
  • Advance Medical Directives: $ 100 – 250
  • Client Correspondence: $ 125
  • Powers of Attorney: $ 60 – 250
  • Tax Return Preparation: $ 147 – 273

Space-A Travel

Space available travel for Uniformed Services members can provide substantial savings over commercial airline fares.  Space available travel is defined by DoD policy as a privilege (not an entitlement), which accrues to servicemembers as an avenue for travel.  This is again a highly individual element likely based on how close you are to frequent space-a travel opportunities.

Tricare Dental Program (TDP)

Tricare dental provides fairly good coverage, but is not quite the comparison as Tricare health insurance is compared to civilian counterparts.  Based on equivalent quotes for comparable coverage, most people could be covered by a similar plan where you live for about $30 – 80 a month.

Other Military Benefits

The PSMC stops its analysis here, but there are a few other benefits to consider.

Leave

The average civilian job has much less paid time off (PTO) than the annual 30 days of leave a year each and every servicemember receives.  Although I’ve never met someone who only uses that leave to take a month straight off each year, one way to think about it is that you are getting paid 12 months’ worth of salary for 11 months of work.

Military life demands many more sacrifices on your time (TDYs, deployments, long shifts, etc.) and there’s certainly no such thing as overtime so perhaps this issue ultimately is a wash.  However, don’t discount the amount of paid time off you do get lest you be surprised when your civilian job starts out with only around 5 days a year.  Expectant or future mothers should especially value the longer military maternity leave as it outpaces most companies in the country as this is a rarer benefit. 

Disability Insurance (DI)

At most other jobs either your company offers some small level of disability insurance or you can purchase this on your own.  While most people might not know what disability insurance covers, they have probably seen this product advertised somewhere thanks to a famous quacking duck.

Disability insurance is coverage that will help pay a reduced portion of your previous salary if you were to get hurt or otherwise be unable to work anymore.  In the military, this is provided by the VA if you were to become seriously injured or disabled while serving in the military.  You would be evaluated and given a disability rating which would then be used to determine how much you get paid.

You would otherwise have to purchase a DI policy on your own to provide this coverage. The average cost for a disability income insurance policy is around 1% – 3% of your annual income (take note that most policies will only allow you to purchase around ~60% of your previous salary).  You would have to get a personalized quote from an insurance agent to get more details.

VA Benefits

Outside of the VA benefits specifically mentioned already, there are a host of other benefits available such as the VA loan, education and career counseling, VA medical resources, and other support.  Evaluate what services you already use or might expect to use when you separate for an estimate here.

Military Discounts

You may never have considered this one, but this perk can really add up as long as you remember to ask about it wherever you shop.  This benefit again is highly dependent on how much you spend and if the places you shop offer it.

Invaluable Camaraderie and Leadership Experiences

This consideration isn’t here to try and put a financial number on this one.  However, one of the biggest trend items from separating veterans is how they miss the close bonds of friendship that are often more like family for most.  You need to have realistic expectations that your average civilian employer will have a different (not inherently bad) culture in this area. 

Summary

Let’s add up some example numbers to see what the total estimated annual compensation is:

  • Basic Pay = $85,047.96
  • Special Pay = $2,472
  • Total Direct Compensation = $87,519.96

PSMC estimate of indirect compensation (federal income tax benefit of BAH/BAS) = $3,275.21

  • State Income Tax = $2,000
  • Tricare = $16,000
  • TSP = $310
  • DIC and SBP = $511.56
  • Pay Raises = $0
  • Commissary and Exchange = $800
  • Federal Long-Term Care Insurance Program = $0
  • Education Programs = $180
  • Services Activities = $400
  • Counseling Assistance = $300
  • Legal Help = $400
  • Space-A = $0
  • Tricare Dental = $216
  • Leave = $0
  • Disability Insurance = $1,740
  • VA Benefits = $0
  • Military discounts = $2,000
  • Total Indirect Compensation Estimate = $24,857.56

Example Total Estimated Compensation = $87,519.96 + $24,857.56 = $112,377.52

Service in the military can bring with it quite a lot of financial benefits that are often underappreciated or not considered when evaluating total compensation.  In fact, most servicemembers earn more in total compensation than their civilian counterparts when you consider similar levels of education and experience.  After this article, I trust you are better able to understand and analyze your PSMC.  This can then help you evaluate equivalent civilian employment opportunities or perhaps even come to the realization that you’re better off staying the military for now.  In any case, make sure to appreciate each of these benefits now whether you’re getting out soon or will stay for a whole career.  In this case, it’s pretty interesting to realize that the total compensation is significantly higher than what the LES says!