Category: Military Retirement

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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
Military Pay Military Retirement Taxes

Is My Military Retired Pay Tax Free if I have a VA Disability Rating? – NO!

Military Retirement Tax Free

Is My Military Retired Pay Tax Free if I have a VA Disability Rating? – NO!

 

Every year I have a handful of clients ask me if their military retired pay (a.k.a. pension) is tax free because they have a disability rating from the Department of Veterans Affairs (VA). When I ask why they believe their military pension is not subject to taxation they forward me “the email.” It is semi-official looking and seems to be from someone who ought to know what they are talking about. The email cites an IRS publication and sometimes (depending on which version you get) a court case.

 

It’s all twaddle. Your military retired pay is taxable income.

 

Like everything involving tax rules there are exceptions to the general rule. That is doubtless where the confusion originates. “The email” makes it seem like many more veterans qualify for the exception than do. The simple test to apply is this – do you have a written determination from the VA or your branch of the service specifying that your disability is combat-related. If that answer is ‘no” then you are paying taxes on your military retired pay. (If the answer is “yes”, you might still have to pay taxes on it, but you have no hope of being tax free without that official determination.)

 

Until recently I had to provide a long explanation to recipients of “the email,” some of whom ardently believe their retired pay was not taxable because they had a VA disability rating. I would have to explain that the court case did not apply, that IRS publications are not legally authoritative, and that the passages cited are being taken out of context. The explanation got much shorter recently, as one veteran took her case to the US Tax Court. The judge ruled against her, and his explanation sheds some light on the tax status of military retired pay.

 

You can read the full Tax Court Memo here.

 

T.C. Memo 2022-42; Tracy R. Valentine v. Commissioner filed April 28, 2022

 

Valentine is an Army veteran who was honorably discharged in 2002 after 22 years of active duty service. She had a disability rating of 60% that was increased to 90% effective May 1, 2016. For the first 4 months of 2016 she received VA disability payments of $1100 per month. For the remaining 8 months of 2016 she received $1700 per month in VA disability payments. The IRS does not dispute that these payments from the VA are tax free (excluded from income).

 

Valentine also received $23,801 from her Army-based retirement plan in 2016. She received a form 1099R from DFAS, reporting the entire amount as taxable. When Valentine filed her 2016 tax return she reported the taxable income from her military pension as $3,158, excluding the remaining $20,643 as not taxable income. The IRS disputed her claim that part of her military pension should be excluded from income and issued a Notice of Deficiency (NOD). Valentine exercised her right to challenge the NOD and petitioned the Tax Court for relief.

 

At Tax Court Valentine testified that IRC Section 104(a) and 104(b) entitle her to use the VA disability rating to exclude both the VA disability payments and a portion of her military pension from taxable income. Valentine represented herself at Tax Court and did not cite specific sub-paragraphs of the IRC to support her claim.

 

In his ruling Judge Gustafson provided some analysis of the tax code. There are two separate provisions in the tax code that could render a veteran’s military retired pay excludible from income. Under section 104(b)(2)(C) a veteran may exclude a portion of the distributions from income if they qualify as “amounts…received by reason of a combat-related injury”. Valentine did not provide any testimony or evidence at trial to indicate her disability rating was combat-related. Therefore section 104(b)(2)(C) does not apply.

 

The other provision is contained in section 104(b)(2)(D). A veteran may exclude a portion of the distributions from income equal to an amount they “would be entitled to receive as disability compensation”. There is legislative history supporting the court’s interpretation of this to mean that it does not apply if one is already receiving disability compensation from the VA. As Valentine was already receiving disability compensation from the VA, section 104(b)(2)(D) does not apply.

 

The Bottom Line

 

Bottom line: The US Tax Court ruled all the retirement distributions Valentine received are “properly includible in her gross income”. Military retired pay cannot be excluded from income solely because one has a VA disability rating. Valentine was also subject to penalties and interest on the tax owed for not reporting the income on her 2016 tax return.

 

I have had clients contact DFAS, explain they have a VA disability rating, and request the tax withholding on their military retired pay stop. When DFAS stops the withholding the veterans assume DFAS agrees that the pay is not taxable. That is not true. It simply means that DFAS will stop tax withholding on your military retired pay if you request it. When the 1099R is issued it will state that all the retired pay is taxable. Since the IRS also receives a copy of your 1099R, they will expect you to declare it on your individual income tax return and pay taxes on it. If you don’t, they will issue you a Notice of Deficiency and charge you penalties and interest for failing to report it.

 

I am a veteran with a VA disability rating. I want my military retired pay to be tax free. I am also a tax professional. If my military retired pay was tax free I’d know about it. If our military retired pay was tax-free I would be writing about it. My colleagues would be writing about it. The VA, VFW, DAV, and the American Legion would all be writing about it. The IRS would have pages of FAQs about it. You wouldn’t find out about it through an old forwarded email that tells a story too good to be true.

 

If you still have questions, the Military Financial Advisor’s Association has both tax professionals and financial planners with tax planning expertise that can help with your unique situation.

 

 

 

 

Categories
Military Retirement

Should you Buy Back your Military Time?

Should I Buy Back Military Time

Should you Buy Back your Military Time?

What is military buyback? If you served on active duty in the military and then become a federal civilian employee, that military time may count as time in service for calculating your FERS or CSRS pension. We’ll look at which military time can count, how much it will increase your federal employee pension, what it costs to buyback that military time, the impact of a buyback on your military pension, when to buyback, and some how-to’s to help you answer the question “is it worth it for me?”

What military service time counts? Your service has to have been on active duty. Periods of active duty while in the any of the military reserves, including your annual active duty training, count. However, National Guard active duty only counts if it was Title 10, section 233(d), or under a call by the president. Regular monthly training and call ups by the states do not count. Your service must have been honorable and performed before you separate from civil service. And a deposit has to be received before you retire (that’s the buyback).

How much will a military buyback increase your federal employee pension? First you need to qualify for a FERS or CSRS pension, which generally means you have to actually serve at least 5 years as a federal civilian. Then the military time you deposit, nicknamed a buyback, is added to the years you actually work as a civilian for calculating your FERS or CSRS pension benefit.

A FERS Example

Here’s a FERS example. The pension formula for FERS employees is the average of your High-3 salaries times your creditable service times your multiplier. If you have 24 years of federal civilian service, a high-3 pay of $110,000, and will retire before age 62, your pension would be $110,000 x 24 years x 1%. That’s $26,400 a year. The military time you buy back is added to your creditable service.

What happens if you were to buy back 6 years of military time? That’s the same $110,000, x 30 years (instead of 24). And because you now have 30 years of service (instead of 24) your multiplier is 1.1% giving you a FERS pension of $36,300. That’s $9,900 more every year in your FERS pension. Live 25 years in retirement and that’s almost $250,000 more FERS pension with the buyback.

Buying back military time may also help you to retire earlier. Regular FERS employees can retire without a reduction at your Minimum Retirement age with 30 years of service, at age 60 with 20 years of service, or age 62 with 5 years of service. Buying back military time could nudge you over one of those age hurdles. It might not make sense to retire as early, but it’s nice to have the option.

What is the cost? The reason depositing military time is nicknamed a buyback is because you must pay cash to have your military time credited to your federal service. Human Resources will calculate the exact amount for you. In general, for FERS employees it will cost about 3% of your total military base pay you are depositing. For example, if you deposit 3 military years and during each of those years you earned $30,000, $30,000, and $35,000. That’s $95,000 total of military base pay x 3% which is $2,850.

When can I buyback military time?

You can buyback any time after you start federal civilian service. But your buyback must be complete before you retire. You cannot retroactively buyback time after you retire as a fed. If you serve as a federal employee for longer than 3 years before buying your time back, you will also pay interest on that amount.

What about CSRS federal employees?

CSRS employees joined federal service before 1987. The multiplier for CSRS employees is about 7%. And the rules for CSRS employees are more complicated. If you are a CSRS employee that will not be eligible for Social Security, no deposit or buyback is required. You will get full credit for military service performed after 1956.

If you’re a CSRS employee that will be eligible for Social Security, the military time you buy back will count towards eligibility for retirement and computation of your pension. If you don’t buyback any time, your military time will only count towards eligibility for retirement. Unless you retire before you’re eligible for Social Security at 62, then your military time will count toward your pension computation just up until you reach 62.

All federal employees, did you serve long enough to qualify for a military pension? You can buyback all those years and add it to your federal retirement. No matter when you buyback, you can continue to receive your military pension while in still serving as a federal employee. BUT you must waive your active duty military pension when you begin your civilian pension. You can’t double dip. This often does not make financial sense.

How is your VA Disability pay affected by a buyback?

It isn’t. You will still receive your VA disability pay, including Combat-Related Special Compensation (CRSC) after buying back military time. And unlike a military pension, your federal civilian pension will not be reduced by your disability pay, regardless of your VA disability rating. This may tip the scales in favor of a buyback.

What about a military reserve pension that starts at age 60? You can receive that, whether you buyback military time or not. So, buying back active reserve time often does come out as a great deal, so be sure to run the numbers.

How do I get the exact cost of a buyback for me, and maybe do a buyback?

 

Stop by your federal civilian human resources department and ask for help. Here’s what you can expect:

Step 1, find your DD 214 the Report of Transfer or Discharge. That shows your military record and was given to you when you left military service. If you can’t find your DD214, you can request a copy from the National Personnel Records Center by filling out a Standard Form 180.

Step 2, complete a form RI 20-97 Estimated Earnings During Military Service and mail it along with a copy of your DD214 to your appropriate military finance center.  The finance center should then send back your statement of estimated earnings.

Step 3, gather up your estimate of earnings, your DD214, go to your current Human Resources Office and fill out an SF 2803 Application to Make Deposit or Redeposit.

Step 4, HR will then compute the amount of your military deposit using the Military Deposit Worksheet, let you know the amount, and options for making payments.

Once you know the military deposit cost, you can compare your options and decide if you want to do a buyback, when and how to pay for it. You can payoff it all at once or in payments over time. Note you’ll owe interest on payments once you’ve had 3 years of federal service.

If your numbers are very close, remember your military pension gets a full Cost of Living Allowance (COLA) every year. But a FERS pension gets “COLA lite” which can be up to 1% less in high inflation years.

Let’s recap. Active duty military service and Title 10 reserve active duty can be deposited to increase you federal civilian time in service. This can increase your civilian pension and/or help you retire earlier. Depositing military time will cost you, thus it’s nicknamed a buyback. If you don’t pay for the buyback within the first 3 years of civilian service, you’ll also owe interest.

Putting it All Together

If you left military service before retirement, a military buyback is very likely a great deal.

If you are eligible for a Reserve retirement at age 60, you CAN receive both that and a civilian pension that includes a buyback. This will also likely be in your favor.

If you are receiving a regular active duty military pension you would have to forfeit that in almost all cases if you do a buyback (you can’t double dip). If your military pay was significantly less than your federal civilian pay is now and/or your military retired pay is being reduced by your VA disability it may be worthwhile to do a buy back.

Run the numbers. And remember, your application to buyback military time must be approved and paid BEFORE you retire from civilian service.

The right answer is unique to each military family.   Working with a financial planner who understands your military benefits from firsthand experience can help you frame your decision within the context of your family’s financial plan.

 

The financial planners at the Military Financial Advisor Association can help you work through the various BuyBack scenarios so you can make the decision that best meets your family’s needs.

 

Categories
Financial Planning Goals Insurance Military Pay Military Retirement Savings Taxes

Military Retirement: Should You Take SBP?

Military Retirement - Should you take SBP

Military Retirement and the Big SBP Decision

This article was jointly written by Adrienne Ross, CFP ®, AFC ®, and Pam Bergeson, CRPC

As you’re working your way through your pre-retirement checklist, you may have discovered a couple of decisions that you need to make before you out process one last time from the military.  Of all these decisions, none is more important or more permanent than your decision to accept or decline the military’s Survivor Benefit Plan (SBP).

This blog dives into some of the most common questions about SBP and shares a few examples of when the SBP can be most useful.  It also addresses some of the common myths surrounding the military’s SBP.

What is the Survivor’s Benefit Plan (SBP)? 

The most important fact to know about the amazing military pension you’ve earned during your 20+ years of service is that it ends at your death.  The only way to ensure your spouse and/or your dependents continue to receive a portion of your retired pay is to sign up for the Survivor Benefit Plan.

In the event you pass away before your spouse or your dependent children, SBP continues to pay an inflation adjusted monthly benefit, known as an annuity, to your survivors.  In the case of your spouse, the annuity continues until their death or remarriage in some instances.

What may surprise you is that while you’re on active duty, you’re already covered by SBP at no cost.  If an active duty service member dies of a service connected cause, their survivors are covered by the Survivor Benefit Plan.

Of all the decisions you’ll make at retirement, the SBP election is the most critical because it is largely irrevocable.

Why is your SBP decision so critical?

The exact decision comes in the form of either accepting or declining SBP in the weeks before your final out processing.  If you’re married and decide to decline SBP or accept less than the full SBP benefit, your spouse will need to sign off on that decision during your out processing. The rationale behind requiring your spouse’s concurrence is he or she has the most to lose if you decline SBP.

If you decline SBP, it is very unlikely that you’ll ever have a chance to regain it, your decision is final.   On the other hand, if you elect to accept SBP, you will have an opportunity to discontinue it during the period between 25-36 months after your retirement.  To be extra clear – this window of opportunity to change your mind in your third year of retirement is a one-way decision – exit only.  You can only choose to discontinue SBP, you cannot regain access to SBP.

The only other opportunities to change your SBP decision occur when you have a qualifying major life event that changes the status of your dependents.  The death of your spouse, marriage to a new spouse, or the birth/adoption of a child are examples of potential events that could trigger a short window to change your SBP decision.  The rules surrounding these life events and which ones do or don’t trigger an opportunity to add SBP coverage are complicated and require detailed information to understand fully.

The decision to accept or decline SBP is unique to each service member and their family.  Because there are so many important variables to consider, it is vital to make your own decision with your family’s specifics in mind rather than simply following the decisions of your peers.

Your SBP decision requires careful consideration of your family’s make-up including your ages, age differences, health status and each spouses’ earning potential along with your children’s ages, health, and educational goals, and finally your spouse’s financial interests.  We take a closer look at many of these variables in the next few paragraphs.

Why do you need SBP?

If your family depends on your income, then your decision on SPB is critical to your financial plan.  

If you’re married or have dependent children, chances are they rely on your military pension for a portion of their monthly living expenses.  If your family depends on both your post retirement civilian income and your military retirement income to cover their living expenses, the impact of your passing would be even more devastating.

If your spouse’s lifetime earnings have been hindered by multiple military moves over the course of your military career, they most likely have accumulated fewer retirement assets of their own.  In this case, the SBP annuity may prove even more important in providing long term security to your family.

As difficult as it is to imagine, you must ask yourself if your family had to live without you, and without your civilian income and your military pension, could they pay the mortgage or rent, would your family be able to afford college tuition, and would your spouse have sufficient income to cover their living expenses well into retirement and old age?

What’s so special about SBP?

In today’s retirement savings environment, pensions are rare; a pension with a cost of living adjustment is like finding a unicorn.

Inflation protected.  Your military pension and its survivor benefit are that rare unicorn.  Your military pension adjusts each year to keep up with inflation and your SBP will continue to do so as well.  SBP ensures your survivors continue to benefit from your decades of dedicated service through continued payments from your inflation-adjusted pension.

As the cost of living increases, so does the SBP payment to your survivors.  For example, if your spouse lives twenty years longer than you, the value of their SBP annuity will keep pace with inflation over those two decades.  A payment of $1000 in 2021 could more than double over the course of your spouse’s lifetime.

SBP eliminates two of the most significant risks a widow or widower faces – longevity risk and inflation risk.  

Risk management. Longevity risk is the risk that your surviving spouse will outlive the money you’ve saved for retirement.  With SBP, you don’t have to worry how long your surviving spouse will live, the payments continue as long as he/she is alive, or in some cases, until he/she remarries.

Inflation risk is the risk that the value of the money you’ve saved for retirement won’t keep up with the cost of living over the decades after you retire.  The SBP payments increase each year commensurate with the national inflation rate.  This increase ensures the payment your spouse receives can still cover key expenses as their costs increase.

A third type of risk avoided with SBP is default risk. Default risk is the risk that your life insurance or annuity provider will run out of money or go out of business before paying all the payments they’ve promised you.  Because the SBP is backed by the US Government, the risk of default is nearly zero.

Pre-tax premium.  Beyond eliminating risk in your long-term retirement plan, your SBP premium is paid before your taxes are calculated, meaning the amount you pay is lower than it appears.  For example, if your SBP premium is $300 per month and you’re in the 15% tax bracket; your pre-tax SBP payment is only $255.  For more senior retirees the benefit of SBP’s pre-tax premium is even greater.  A $800 SBP premium for someone in the 28% tax bracket only costs the retiree $576.

Are there situations when I don’t need SBP?  

There are certainly a few examples of situations where you might not need SBP.  First, if you don’t have anyone depending on your income, no spouse or dependent children, you likely don’t need SBP.

If you’re a dual military couple without dependents who’ve earned very similar military retirement benefits, you may not need SPB, or you may be able to take less than the full SBP rate and still cover your future expenses.

This isn’t true of all dual military couples.  When a dual military couple has substantially different career lengths and where there is a significant difference in rank at retirement between the two service members, the SBP decision is less straightforward.

The same comparison is true if your spouse has their own pension through their civilian employer.  Or if the non-military spouse has higher life-time earnings and retirement savings that set them up for a self-sufficient retirement.

What are some special considerations with SBP?

Special needs. If your retirement income will support a dependent with special needs you may want to designate a special needs trust to receive your SBP benefits instead of passing directly to the special needs child, so as not to negatively impact their access to other government benefits.  If this situation applies to you, you’re advised to work closely with an attorney who specializes in special needs trusts in advance of making your SBP election.

Divorce.  If you’re divorced, your former spouse may have a legal claim to a portion of your pension and therefore a court order could require you to obtain SBP coverage.  Learn more about these requirements at this link. https://militarypay.defense.gov/Benefits/Survivor-Benefit-Program/Costs

Reserve Component. The rules for Guard and Reserve retirees differ slightly in terms of when you make your SBP election and the cost of your SBP premium.  We’ll cover the specifics of the Reserve Component Survivor Benefit Plan (RCSBP) in a future post.

If you’re still wondering why you need SBP, let’s explore some of the myths about the costs and benefits of the program. 

Data from 2018 suggests that retirees from each service have different outlooks on the benefits of SBP.  On average, the participation rates of Army and Air Force retirees exceed 60 percent, while Navy and Marine retirees participation remains below 50 percent.  These differences between services may reflect variations in understanding and potentially misunderstanding of the benefits of SBP.  Let’s explore some of the myths surrounding SBP that may impact your decision on SBP.

Some myths about SBP

Myth #1: I can buy term life insurance a lot cheaper than SBP.

Fact: Depending on your age and health, term insurance may in fact be less expensive than your SBP premium.  What is important to consider is that term life insurance is a temporary solution to a long-term challenge.   Term insurance by its very nature is for a specific term or period of time.  The premium you pay is based on your age and your health; as you age, your premiums will increase dramatically.  Have a history of high blood pressure, smoking or asthma?  These and other health conditions will dramatically increase your premiums. Love to scuba dive or pilot airplanes, you may not be insurable.

Fact: The second part of the “buy term” equation is that you need to “invest the difference” in order to cover your family’s loss of your military pension when your access to inexpensive term life insurance ends.  Because it is difficult to secure affordable term life insurance beyond age 60-65, you will need to use the time between your military retirement and reaching your sixth decade to build up a substantial investment portfolio to offset your lack of life insurance.  The savings you reap between the cost of SBP and the cost of term life insurance needs to be invested in order to earn sufficient gains to cover your family’s expenses and to stay ahead of inflation.  This requires not only persistent discipline to save, but also the willingness to take on investment and market risk to generate long term gains.

Myth #2: I’ve done the math; I’ll save money by not selecting SBP.

Fact: There is way more to your SPB decision than just a math problem.  For that math problem to work in your favor, you need to accurately predict how markets and inflation will behave and then you must accurately predict how you and your beneficiaries will behave.

Inflation & Markets: To adequately replace SBP with term life insurance requires you to accurately estimate several very important unknowns, including inflation over the next four to five decades, investment returns over the same 40-50 years, your life expectancy and your spouse’s life expectancy.  These are some important variables, all of which you have no control over.

In the case of future inflation and investment returns, even economists won’t venture to estimate these factors forty years into the future.   If you’re able to create a scenario where the math works in favor of term life insurance, all you need is a steady increase in inflation or a couple of stock market declines to turn your carefully crafted mathematical solution upside down.

Human Nature: There are also several key behavioral predictions necessary to make this math problem work out.  First is the one mentioned above, you need to follow through with the disciplined investment of the “save the difference” if you buy term life instead of taking SBP.  Then you need to have the aptitude and willingness to take on the necessary market and investment risk to grow your investment in order to come out ahead of inflation.

Next, your spouse will need the aptitude to safely manage the life insurance windfall.  She/he will need to continue to manage these investments, balance risk factors and make decisions about taxes in order to generate sufficient income to pay the bills for the rest of their lives.

Myth #3: Life Insurance proceeds are tax-free, SBP payments are taxable.

Fact: Life insurance proceeds are income tax-free, but once those proceeds are deposited in your spouse’s checking account, she/he will need to invest them in order to generate sufficient income and capital gains to keep up with inflation and replace the loss of your military pension for the remaining decades of their life.   Guess what? Investment earnings are taxed as either income or long-term capital gains, depending on the type and duration of the investment.

Conversely, SBP premiums are paid before tax and life insurance premiums are paid post tax.  This means you can discount the cost of your SBP premium by a factor equal to your tax bracket.  Once you calculate the tax advantaged cost of SBP, there may be very little difference from your post tax term life premiums.

Concluding thoughts on SBP

Unfortunately, myths and misinformation surround SBP.  What’s key to remember is that your SBP decision is the single most important decision you’ll make when you retire from the military because your decision to accept or decline SBP will impact your family when you’re no longer there to support them.

It’s critical to consider all the facts and make an informed decision that best supports your family.  Because this decision can have impacts well beyond a carefully crafted math equation, it is important to consider the lasting impacts on your family and your financial plan.

Sometimes it comes down to one simple consideration: which decision helps you sleep at night knowing your family is protected.  

Because the right answer is unique to each military family, we recommend working with a financial planner who understands your military benefits from firsthand experience. As financial planners who help military families every day, we know from experience that each military family’s SBP decision is unique and depends not just on their present-day budget, but on all the elements that go into a great financial life plan.

The financial planners at the Military Financial Advisor Association can help you work through the various SBP scenarios so you can make the decision that best meets your family’s needs.  Reach out to one of us today!