Category: Taxes

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
Investing Taxes TSP

Which is Better—A Roth or a TSP?

Roth Versus TSP

Which is Better—A Roth or a TSP?

If my math is correct, half of the readers of this article’s title are about ready to blow up my inbox, half would just like to know the answer, and half haven’t read this far.  Clearly my math isn’t correct, but let’s dive into this question, and the real question that’s usually behind it— “Which is better—Roth or Traditional?”

If you’ve been in the military for a minute, you probably have heard that question, “Which is better—a Roth or a TSP?”  It comes from the very real confusion cluster that is the financial world.  Few primary schools teach personal finance and the topic is at best optional in college.  Most of us learn it through trial and error if we learn it at all.

The answer to the question “Which is better—Roth or TSP” is the same as the answer to “Which is better—Tesla or cars?”  There’s no direct comparison because one is a subset of the other.

TSP Basics

Let’s start with the TSP (Thrift Savings Plan) which is an employer-sponsored, qualified (read: tax advantaged) retirement savings plan.  It’s similar to civilian 401(k) plans (Which doesn’t mean much if you’re still back at the Roth or TSP question, I know).  The TSP allows you to defer part of your paycheck each month, receive preferential tax treatment, and grow the dollars through compounding until you need to use them in retirement.

If you joined the service after 2017, then you’re eligible for the government to match your contributions up to 5% after 2 years of service—which is free money!

The TSP limits your contribution to a certain amount each year based on IRS guidelines and it’s $20,500 in 2022.  Participants over age 50 can contribute an extra $6,500.

What is Roth?

Roth is the last name of the senator that sponsored the legislation creating Roth retirement accounts.  Roth is a synonym for “after-tax,” meaning that you’ll pay your typical income tax on the dollars that you contribute to a Roth account such as the Roth TSP.  The benefit of Roth treatment is that contributions grow without being taxed each year.  Then in retirement (generally after age 59.5), you get to access those dollars tax-free.

Roth treatment is incredibly powerful in that it allows savers to pay a generally low tax rate on dollars when they’re young or in the military and not making much and then avoid higher tax rates in retirement when their tax rates are higher after a lifetime of earning and saving.

Roth treatment can also be though of as “tax insurance.”  We don’t know what future tax rates will be.  Many experts predict that they will have to be higher to afford programs like Medicare and interest on the national debt.  Roth dollars won’t be taxed in retirement, so savers can mitigate future tax risk.

What is Traditional?

Before Roth came along, there was just “TSP” and no need for the adjective “Traditional.” Traditional is a synonym for “pre-tax” or even “tax-deferred.”  With a Traditional retirement account like the TSP, savers skip paying taxes on the contributions as the money is earned, but have to pay taxes when they access the money in retirement after age 59.5.

Savers are allowed to contribute to either or both Roth and Traditional “sides” of their TSP account in a given year, but they can’t exceed the IRS limit unless they’re in a combat zone.  I.e., you can put $10,250 into Roth TSP and Traditional TSP in 2022, but you can’t put $10,251 into both.

Which is Better—Roth or Traditional TSP?

Now that we’ve got the right question squared away, we’ll look at the indigestible answer… it depends.  The most general way to start answering this question for each taxpayer (or family if filing jointly) is to ask, “Do I want more money in my pocket this year, or in my retirement years?”

A contribution to the Traditional TSP puts extra dollars in your wallet this year.  If you’re in the 22% bracket and you contribute $1,000 this year, you’ll have $220 extra in your pocket because you deferred the tax bill until sometime in retirement.

Moving past the most basic question, some families will want to evaluate, “Am I in a temporarily higher tax bracket this year?” Let’s say you receive a large bonus and will have outsized income in a certain year.  It might be appealing to hold on to more of your pay by making Traditional contributions in a high-income year.

An even more sophisticated approach would be to evaluate whether a Traditional contribution might lower your tax bracket for the year.  For example, in 2022, the cutoff between the 12% tax bracket and 22% bracket for a married-filing-joint couple is $83,550, which is really $109,450 after adding the $25,900 standard deduction.  If income before a TSP contribution is $109,450 and the planned TSP contribution was $5,000, then taxable income becomes:

$109,450 – $5,000 – $25,900 = $78,550

$78,550 is squarely in the 12% tax bracket and the tax savings on the year is $600.  So, by choosing to put at least part of the TSP contribution into the Traditional “side,” it’s possible to lower one’s overall tax bracket and tax bill.

Dialing up the sophist-o-meter a bit, let’s address capital gains.  Capital gains tax is the tax we pay when we sell something for more than we paid for it.  If you sell a stock at $100 per share, but you paid $50, then you have a $50 capital gain per share.

Uncle Sam taxes capital gains in one of two ways—long-term or short-term.  Long-term capital gains receive preferential treatment in that they’re taxed at 0%, 15%, or 20%.  These are lower than ordinary income tax rates for most people paying capital gains tax.  Short-term capital gains are taxed at ordinary income tax rates.

It just so happens that the cutoff between the 0% and 15% long-term capital gains brackets is $83,350 for a married-filing-joint couple…essentially the same as the 12% to 22% transition for ordinary income.

The “so what?” is that by using a traditional TSP contribution to lower taxable income into the 12% bracket, one also can take advantage of the 0% long-term capital gains tax bracket.  If you have stock with capital gains and need to sell some for a goal, you can do so right back up to the top of the 0% long-term capital gains bracket and pay $0.00 on those gains!

The Real Question

While it is important to evaluate the tax opportunities in a given year to assess Roth versus Traditional, the real question is this, “Am I in a higher tax bracket today, or will I be in a higher tax bracket in retirement when I access my TSP savings?”

Let’s say you’re in a 25% bracket this year and you also expect to be in a 25% bracket in retirement when you withdraw money, then there is no mathematical difference between Traditional and Roth TSP.  Want proof?  Plug the following formulas into Excel.

  • =FV(0.1,30,-1000,0,0)*0.75
  • =FV(0.1,30,-750,0,0)

The first is the future value of pre-tax contributions of $1,000 compounding for 30 years at 10% and then taxed at 25% upon distribution in retirement.

The second is the future value of after-tax contributions of $750.  We use $750 to model the effect of a 25% tax as the money is earned.

They both return $123,370.52.  But there’s a hidden twist here—would you really contribute less just because you had to pay tax on the dollars as you earned them?  Probably not.  Most of us will find a way to contribute the same amount regardless of the tax in the year of the contribution.

Thus, =FV(.1,30,-1000,0,0) = $164,494.02 and we can see that we end up with a significantly increased nest egg for choosing Roth.

But how do you know what tax bracket you’ll be in during retirement?  The reality is you’ll need a crystal ball, time machine, or other imaginary tool.  We can only make estimates.  Estimating our income, spending, and savings seems daunting, but it’s likely the easy part.  Estimating future tax rates, including state income tax rates is a bit more difficult.

A common technique is to just use current tax law and then revise projections as tax law changes.  Using that method, let’s look at Figure 1. This example illustration incorporates a family’s projected income, savings, and spending over their remaining life time.  The result is that we can see that the family will pay tax rates from the mid 20% range until retiring early at age 55.   At that point, the expected tax rate is 15% until age 70 when Social Security kicks in and creates a new income floor and higher tax bracket.

Roth versus Traditional 1

This family has a couple of options.  By contributing to Traditional accounts pre-retirement, they can hope to Roth-convert some or all of their Traditional dollars during their low tax years.  They would skip paying 22% to 25% in hopes of paying 15%.

Any Traditional dollars remaining after age 70 would, at-worst, be taxed at about the same rate they would have been at the contribution.  This choice requires an estimation not just of earning, saving, spending, and tax rates, but also how many dollars can be Roth-converted during the early-retirement window before ending right back up in a higher tax bracket.

If instead, the family contributes to Roth accounts prior to retirement, then several additional considerations arise:

  • From age 55 to 70, there could be a missed opportunity to “fill up” low tax brackets like 15%. The family might have unnecessarily paid 25% on some dollars.
  • After age 72, Roth IRA dollars don’t have to be distributed, but Traditional dollars do. These “Required Minimum Distributions (RMD)” create a higher income floor.  (Note that Roth TSP/401(k) accounts do have RMDs.  Roth IRAs don’t. Most people will rollover their Roth TSP/401(k) to an IRA prior to RMD age.)

Figure 2 shows a different family’s profile.  Prior to retirement at age 67, the family earns in the mid-20% to low-30% tax rate range.  They have a small “bathtub” from age 67 to 72 where they can do Roth conversions, but after that, they’ll be trapped in the 30%-plus range for their remaining years.

Roth versus Traditional 2

This family would likely want to mainly contribute to Roth accounts in order to minimize the impact of a high-income floor in retirement.

You can imagine that slight changes in a family’s planned earning, spending, saving, and estimated tax rates have drastic effects on their future tax profile.  This brings us to the key questions that we must answer to make the Roth versus Traditional decision:

  • Do I need extra cash in my pocket this year? Is it worth the risk of higher taxes later?
  • Can I change my tax bracket with a Traditional contribution this year? What benefit do I gain?
  • Do I expect my tax rates to be higher or lower in retirement?
    • If higher, more Roth dollars are your friend.
    • If lower, you leave a tip for the tax man by contributing to Roth today.
  • Do I generally think tax rates will be higher in the future? Roth contributions are an insurance policy against those tax rates.

Cleared to Rejoin

The Roth versus Traditional decision can be complicated.  We have to decide if we want more income this year, or lower taxes in a few decades.  To be as accurate as possible, we need to have reasonable estimates of our lifetime earnings, saving, spending and tax rates.  Ultimately, we have to answer, “What is the effect this year… and all of my retirement years?”  That’s no small task.

A few additional concepts to consider may help:

  • The current tax brackets are very low by historical standards, implying higher rates at some time(s) in the future
  • Interest on the national debt and support of Medicare for the Baby Boom generation will require higher government revenue in the coming years.
  • 30 years after you contributed, are you likely to regret having estimated wrong by a couple percent on your future tax rate, or are you more likely to really like that a sizeable chunk of your retirement income is tax-free?

Fight’s On!

 

Author’s Note:  This article focused almost exclusively on Roth versus Traditional for TSP (and 401(k)) contributions.  There’s a good deal more to know about IRA considerations, so please don’t extrapolate Roth TSP directly to Roth IRA without diving into the nuances.

Categories
Taxes

2021 Tax Updates

Understanding 2021 Tax Updates

(before you file your taxes)

This meme pops up in my social media feed from time to time: It’s clever and a bit funny, but the sad truth is that it would be pointless to teach the specifics of taxes in school. Unlike parallelogram rules, tax rules change every year. Things we learned in high school that might be helpful during tax season would likely be superseded before we finished our first semester in college. In this age of activism and immediate results, our Congress just can’t help themselves. They must legislate! This year was no different. There are numerous changes to the tax laws for 2021. Some you likely know about, others you might not. Here I will cover the handful likely to impact a significant portion of military and veteran families.

Child Tax Credit

Congress made several changes to this popular tax credit. They expanded it, changed the age range, made some of it payable in advance, and made it fully refundable without restrictions. Here are the details
  1. The maximum credit was expanded from $2,000 to $3,000 ($3,600 for children under 6.) There is an AGI limitation on this expanded amount. The expanded amount begins to phase out above AGI of $150,000 for married couples filing jointly, $112,500 for taxpayers filing as head of household, and $75,000 for all other filers. (The unexpanded (regular amount – $2,000 begins to phase out at $400,000 AGI for married couples filing jointly.)
  2. Qualifying children under the age of 18 are eligible for the credit. (In prior years it was qualifying children under the age of 17.)
  3. Part of the 2021 Child Tax Credit was eligible to be paid as an advance. The default was for the IRS to pay 1/12th of the estimated 2021 credit each month to taxpayers from July to December of 2021. You may have received checks or direct deposits to your bank account. Or you may have elected out of some (or all) of the advanced payments. Either way, you will need to rectify the amount of Child Tax Credit for which you are eligible with the amount of Advanced Child Tax Credit already received to determine how much more Child Tax Credit you will receive at the time you file your 2021 federal tax return. The IRS should send you a letter 6419 telling you how much Advanced Child Tax Credit you have received. Verify this letter against your records to ensure they match. Then keep the letter for tax prep time!
  4. The 2021 Child Tax Credit is fully refundable for all taxpayers. In prior years the refundable portion was limited and subject to earned income restrictions. This year it is fully refundable.
The enhancements to the Child Tax Credit were made as part of emergency / pandemic legislation, and are therefore temporary. These enhancements all expire at the end of 2021. Many lawmakers have expressed an interest in extending these enhancements into 2022, but as of this posting, this has not yet happened.

Child and Dependent Care Credit (Child Care Credit)

In past years this credit has likely drawn more sighs and eye-rolls than any other. The government has long admitted child care (or care for a disabled dependent) was necessary for taxpayers to work. Then they offered a ridiculously small credit in comparison to the actual costs actually of such care. Only $3,000 of expenses from one, or $6,000 for multiple dependents were qualifying expenses. A mere fraction of the real-world costs. Then, anyone who earned enough to actually pay those expenses could only claim 20% of the qualifying expenses as the credit. Essentially you got $600 for one child, $1,200 for 2 or more children. In 2021 this credit got significantly beefier. Eligible expenses grew to $8,000 for one dependent, $16,000 for two or more. The income ranges on the percentages grew even more dramatically for most families, with a new top rate of 50%. If you have 2 or more dependents, your child care credit might have grown from $1,200 to $8,000 in 2021! Additionally, in 2021 this credit is refundable for the first time. These Child and Dependent Care Credit enhancements were a big win for working families. They are also only temporary but may be extended or made permanent by subsequent legislation.

Student Loan Debt Cancellation

Money that is borrowed, but not repaid, is treated as income, and subject to income taxes under our tax laws. There are a few exceptions to that general rule, and starting in 2021 you can add student loan debt to that list. If you have student loan debt forgiven, charged off, or otherwise canceled in 2021, it may be excluded from income on your 2021 tax return. This applies to nearly all legitimate student loan debt, whether it was government-backed or private. This law applies to student loan debts canceled between 2021 and 2025.

Assorted Others

Two rules that were in effect for last year, but are hanging around for this year are worth reviewing. The first is the Recovery Rebate Credit. This is the credit you receive if you did not receive your Economic Impact Payment (“stimulus check”), or did not receive the correct amount of Economic Impact Payment. All taxpayers need to know the amount of Economic Impact Payments received in 2021 (round 3 of the stimulus, issued in late March/early April) because this amount is used to calculate your Recovery Rebate Credit. If you don’t remember, the IRS will send you letter 1444 to remind you, or you can log into the IRS website (after you prove your identity) and check it yourself. Spouses filing jointly will both need to check their tax accounts to get the entire amount the IRS sent. The other is the expanded charitable deduction. In 2020 taxpayers could deduct $300 of charitable contributions (cash only, not donated items) in addition to the standard deduction. This is in effect again for 2021, but with a couple of modifications. First (and best!) is that married couples filing jointly can now deduct up to $600 of charitable contributions in addition to the standard deduction. In 2020 they were limited to just $300 per return. Secondly, the deduction is a deduction this year and not an adjustment. In 2020 the deduction was an adjustment to income, which would reduce adjusted gross income (AGI). (Often called an above-the-line deduction.) In 2021 the expanded charitable deduction comes after AGI is calculated. Since it no longer reduces AGI, this deduction no longer helps make you eligible for other AGI-based tax credits and benefits.  In trying to do the right thing for America, Congress often injects a tremendous amount of complexity into the tax code. This year was no different. They heaped tax breaks on us, but they also heaped a mountain of paperwork on the administration of those tax breaks. Military and veteran families enjoy targeted tax benefits, but they should also make sure they are taking advantage of the tax benefits available to all Americans. If you are unsure of your eligibility for a tax benefit, or how to take advantage of it, please consult with a tax professional familiar with military and veteran tax issues.
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!

 

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!

Categories
Investing Real Estate Savings Taxes

Top 7 FAQs for Military Real Estate Investing

Top 7 FAQs for Military Real Estate

Understanding Real Estate Investing for Military

There are numerous ways to engage in real estate investing. There’s flipping, commercial offices, wholesaling, investing in notes, and the most popular among military families – residential rentals. Becoming a landlord may be the most popular form of real estate investing for military families by default. With steady incomes and incentives to buy houses heaped on service members, many become homeowners. When you own a house and receive military orders to another city your choices are limited. You either sell it, or you turn it into a rental property. Whether by plan or by fate, becoming a landlord is a solution often chosen.

Real estate investing also has a natural appeal to many military folks. Military families are do-it-yourself, ‘bootstrap’ people. There’s an air of self-determination around real estate investing. A sense that you are more in control of your destiny with real estate than you are with traditional investments.

Initiative and hard work seem like they can be turned into profit with a property on Main Street in a way that can not be realized with securities on Wall Street. Financial professionals describe it as inefficiencies in the real estate market that can be profitably exploited. I believe it is true, although more difficult to master than it seems.

The major obstacle to getting started in real estate investing is typically the initial cost. You can get started in TSP for 1% of your paycheck. With an app like Acorns you can open a brokerage account with your spare change.

To get into real estate investing takes capital, often tens of thousands of dollars of capital. It’s a big commitment. 

Big financial commitments generate questions. Access to VA loans and other programs lowers the barriers to entry into real estate investing, but most military families have at least one member with enough sense to know you don’t spew cash at an idea like becoming a landlord without looking a little before you leap. I am asked about it frequently.

Following is a list of the seven most common questions I am asked by people who are contemplating investing in residential real estate rentals. Each of them probably merits its own article, but I’ll try to give you some useful short answers here. 

Is real estate a good investment?

Let me break this news to you gently; it’s not about the real estate, it’s about you. Money can be made in real estate investing, but the path to it isn’t for everyone. In addition to technical know-how, a successful investor must have the ability to avoid frustration and derailment when people disappoint you. Because in residential rental real estate you have to deal with people, and people disappoint.

Sooner or later you will discover some tenants are vandals, some property managers are lazy idiots, and some contractors are thieves. If you believe the hype I see all over the internet about how easy it is to make money in real estate, you should not invest in real estate.

The successful landlords I know are hustling every day for their profits. The rest are trying to get back to even.

What are the tax benefits of real estate investing?

With respect to being a landlord, OWNING rental properties can have many tax benefits. SELLING rental properties usually has significant (and painful) tax consequences. Landlords are business owners. They own and operate residential real estate for the purposes of collecting rents.

The biggest expenditure in such a business is the cost of the property being let to the tenant(s). As a business owner, you can recover the cost of the buildings on your property by deducting them from your taxes over the lifetime of the building. This cost recovery process is known as ‘depreciation’, and its effects can make a tremendous impact to your bottom line while you own the building. However, if you sell the property you will likely owe the IRS for all the depreciation previously claimed on the building.

In addition to depreciation you can deduct all the ordinary and necessary operating expenses of a business. There are numerous ways to take advantage of this situation, but none of them will turn a bad investment into a good investment.

If you are thinking about getting into real estate investing do so because you want to make money from the investments and then take advantage of the tax benefits to maximize your profits. DO NOT get into real estate investing with the primary motive of reducing your taxes.   

Why don’t financial advisors give real estate investing advice?

First – a few of us do. But, I get it. We are so difficult to find as to be indistinguishable from non-existent. Take heart, our numbers are growing! The primary reason there are so few of us is related to how the financial planning field evolved.

Financial planning, so the story goes, was the love child of a few insurance salesmen and stock brokers trying to do the right thing. All the first generation planners came from one of those two fields. You sold insurance and did financial planning or your sold stocks and did financial planning. Nobody sold real estate and did financial planning. The second generation of financial planners were nearly all “investment managers”. They took a piece of the action (a percentage) of all the assets they could gather and manage. Still no real estate.

The third wave is coming. In this wave we take a more holistic approach to financial planning. Some are even calling it ‘life planning’. Some advisors have observed that in life many people invest in real estate, so we are starting to include it in the plans we build with our clients. We are mostly self-taught, though. For example, the inclusion of real assets in a portfolio is not covered in the CFP (R) curriculum. (I am working to get that changed, btw.) 

Should I form an LLC for my rental property?

Many people believe you must have your houses in an LLC to qualify for certain tax benefits. This is not true. There are no tax benefits to placing your rental properties in an LLC. 

Zero. 

None. 

Your rental property business is a business whether it is within an LLC or not. Your ability to deduct business expenses is not impacted by forming an LLC.

There may be legal considerations for forming an LLC in terms of limiting your liability. That is a question for a lawyer. I am licensed to give tax advice. I am not licensed to give legal advice. 

When is the best time to sell my rental property?

In terms of tax strategy – never. As I wrote above, OWNING rental properties can have significant tax benefits. SELLING rental properties frequently turns those significant benefits into significant burdens.

In many cases the most efficient tax strategy for rental properties is probate. When you die owning depreciated property your heirs inherit it with a cost basis reset to current market value. The tax burden is transferred to the government and is no longer a problem for you or your family. 

If you absolutely must get rid of the property, then the second-best time to sell is likely today. The tax burden on the property is most likely going to grow over time, so getting rid of it now is like ripping off the band-aid. Just get it over with.

That said, every case is different. You should have a tax professional knowledgeable in real estate issues evaluate your situation before you act. 

How does the ten-year extension for military people work?

Home sellers can exclude a significant amount of capital gain (frequently all the capital gain) from the sale of their primary residence as long as they meet certain guidelines. The short version of how to qualify for that exclusion is called the ‘2-in-5’ rule. You must live in the house for 2 of the 5 years immediately prior to the sale. There are additional rules, but those are the basics. That means you could move out of your house and turn it into a rental property for up to 3 years, then sell it, and still qualify for the exclusion from capital gains. (Because in the 5 years immediately preceding the sale you lived in the house for at least 2 of them.) 

Military families receive up to an additional 10 years to this ‘2-in-5’ rule if they were moved more than 50 miles from the residence on military orders. This means military families could live in a house for 2 years, take a PCS move to another state, turn the house into a rental property and sell it up to 13 years later AND still qualify for the capital gains exclusion. It’s a pretty nifty benefit!

A related question I frequently get is ‘how long do we have if the military member retires while living at the other duty station?’. The answer is that once the service member retires the extended period stops. Military families receive UP TO 10 years. When you retire your extension stops and you essentially have 3 years from the retirement date to sell the property before you will have to pay capital gains on the sale.

My depreciation is wrong on my prior tax returns, how do I fix it?

The short answer is to hire a professional to do it for you. 

The medium answer is that you can only fix a depreciation issue by amending returns if it was wrong on only one filed return. Once it’s been wrong on two filed tax returns you must submit an application to the IRS to change your method of accounting. This is done on form 3115, and it is a very complicated form. On the last page of the instruction book for form 3115 it estimates that it takes more than 36 hours to learn and prepare form 3115.

Save your time, hire a professional. If you prepared your own tax return and you didn’t get the depreciation right, then it is unlikely you will get form 3115 right.

The outcome of filing the form 3115 depends on how your depreciation was wrong. If you had been under depreciating the property, then you would get an adjustment allowing you to take a one-time additional beneficial depreciation adjustment on your tax return. (You get to claim an additional expense that year.)

If you had been over depreciating the property then you also get to take a depreciation adjustment to your tax return, but you won’t like it as much. The amount of over depreciation gets declared as additional income that year and you must pay tax on it. There are some strategy elements regarding the timing of these adjustments, so you should consult a tax professional knowledgeable in real estate investing before you act.

The Bottom Line

Real estate investing can be financially and emotionally satisfying when done well. At Redeployment Wealth Strategies we have some military families who are profiting nicely with their real estate investments. Unfortunately, we have a larger number of clients who got on that real estate investing highway before they thoroughly researched their situation, and now they’re looking for the off-ramp.

We urge you to carefully consider whether real estate investing is right for you before you make that large capital commitment to participate. Learning the hard way can be very expensive.

As financial advisors, members of the MFAA help people just like you navigate the questions, challenges, and planning opportunities related to investing in real estate. We would love to be of help and have a free consultation.

Find an advisor here!

Categories
Financial Planning Investing Savings Taxes

Do Military Families Really Need a Financial Planner?

military families financial advisor

Do Military Families Really Need a Financial Planner?

I am frequently asked some form of this question, and my short answer is, “Yes, military families need a financial planner.” You may think I believe military families need a financial planner because I am a financial planner. And while I would never turn away a new prospective client, my reasoning might be even sneakier than you think!

Every military family needs someone to do the things a financial planner does. These include, but aren’t limited to:

  1. Develop specific and measurable financial goals consistent with their values
  2. Develop saving, spending, investing, and tax strategies to efficiently meet those goals.
  3. Develop risk mitigation strategies for the unexpected: 1) Insurance against loss of income;  2) Insurance against catastrophic loss;  3) Contingencies to reach plan goals even if the planner isn’t there to see it
  4. Accountability to execute the steps of the plan
  5. Establish efficient asset transfer when the plan has ended
  6. Periodic review and update the plan as life happens

It is not always necessary to outsource those duties to a professional financial planner. The person performing those tasks can be a family member. There is an endless supply of free information about financial planning on the internet. Much of it is good enough to help individuals do a creditable job managing their family’s financial plan. If you do it yourself, the price is right, there are no issues of trust, and (you don’t need to tell me) financial planning can be fun!

Therefore, my sneaky response that every military family needs a financial planner is just me having a bit of word fun.

You need a financial planner. You just don’t need to hire one if you’re willing to do the work yourself. However, even if you’re willing to be your own financial planner, you might still want to hire one. Here are a few reasons why.

You Prefer to Pay for the Service

I know how to change the oil in my truck. I can change the oil in my truck for less than it costs me to pay someone else to do it. When I was a young sailor, I used to get under my vehicles every 5,000 miles and change the oil and the filter. I’m 55 now, and I’m not crawling under that truck ever again. There are hundreds of things I’d rather do.

Likewise, you can be your own financial planner. You can read and study on personal finances to stay abreast of the trends, opportunities, and ever-changing tax laws. You can burn a Saturday or two each year reviewing your overall financial situation and making some tweaks to your plan to keep it on track. Or, you can hire someone else to do it and go and do hundreds of things you’d rather do.

Professional Financial Advisors have Greater Objectivity about Your Money

There used to be a fellow on public radio named Garrison Keillor. He told humorous stories about his hometown where “all the women are strong, all the men are good looking, and all the children are above average.” The joke is that only the people from that town believe in their superiority – and they believe it because their emotional attachment to their town causes them to lose their objectivity.

The same is true for people and their money. Money evokes strong emotions in people. (Not having money evokes even stronger emotions!) I’ve too often seen successful, well-adjusted people make emotionally-fueled decisions when the markets are gyrating like they were when the pandemic first hit. It can be helpful to have a professional advisor take a more objective view of your finances when the ride gets bumpy.

There’s Something to Be Said for Experience

Have you ever been the licensed passenger with a teen and a new permit? That’s some white-knuckle fun! They kinda know what they are doing, but they don’t know what they don’t know. They haven’t seen things like the car beside them changing lanes without signaling, or an emergency vehicle trying to make a left in front of them, or a gaggle of bicyclists blowing through stop signs. You have seen things like this; hence, the white knuckles!

If you are your own financial planner, then you are a bit like that teenager. You may have studied diligently and learned many things, but you don’t know what you don’t know. You may have studied for many hours, but you’ve only ever seen one financial plan – yours! Professional financial planners have seen hundreds of financial plans. They’ve seen rental homes, student loans, SBP, and tax law changes. They’ve dealt with the things you’re dealing with, and that experience can be useful.

Financial Advisors can Provide Continuity

“Jim” was adept at personal finance. After his military career, he worked in management for a Fortune 500 company. He amassed a portfolio of stock and real estate worth more than $2 million. My very first client was his widow. I was volunteering at a free financial clinic. She was literally the first person I ever tried to advise. She came to the financial clinic because she wanted to learn how to handle money. Jim had always taken care of it when they were married, and she had no clue what to do. When I first met her she was inhabiting only the upstairs of her house because the downstairs zone heater was broken and she didn’t know how to get the money to have it repaired. She was working in the lunchroom of the public school to have money to pay for her daughter’s tuition. She had $2 million, but she was living like a pauper because she was scared to death to access the assets for fear she would screw up something.

I envisioned Jim looking down from Heaven with his face in his palm. There was no way this is what he intended. If they had worked with a financial advisor while Jim was still alive, they could have had a plan to deal with him unexpectedly passing. A plan that kept the heat on and the tuition money flowing without his widow slinging hash in the school lunchroom. A plan that provided simple peace of mind.

Military families do need a financial planner, and the first step in that plan is who will orchestrate it. An individual family member can take on the responsibility of making sure all the required elements of the financial plan are accomplished, but a military family may want to hire a professional financial planner. If they do, we hope they first consider a member of the Military Financial Advisors Association. We believe the education, experience, and fiduciary standards we require of our members are exactly what military families deserve.

Contact one of our advisors to learn more with a free consultation

Browse MFAA profiles

Categories
Taxes

Military Payroll Tax Deferral

military payroll tax deferral

Military Payroll Tax Deferral Explained

On August 8, 2020, President Donald Trump issued a memorandum allowing the military payroll tax deferral for any employee earning less than $4000 every two weeks. The $4000 limit refers to gross, or pre-tax earnings. It is important to notice the memorandum defers the taxes, it does not eliminate, revoke, or waive these taxes.  In essence, the government could collect any non-paid taxes at a future date.  Right now, the repayment date is scheduled for early 2021.  But before we tackle that issue, let’s cover some of the important information surrounding payroll taxes.

Understand Your Military Payroll Taxes

Payroll taxes, also referred to as FICA (Federal Insurance Contributions Act) pay for Social Security and Medicare. These taxes are listed as FICA Social security and FICA Medicare on military Leave and Earnings Statements (LES) and are also often abbreviated on employee paystubs. FICA taxes are split between the employer and the employee. These taxes are levied at 15.3% of earnings up to $137,700. Read more about the Social Security wage base here. There is no wage base for Medicare taxes. In fact, if you are a high-income household, there is an Additional Medicare Tax rate of .90% to wages, salaries, and tips.  Employees pay 6.2% for Social Security and 1.45% for Medicare, with matching amounts paid by employers. For military service members, Social Security and Medicare taxes are paid on all entitlements earned.

Employers are already eligible to defer payroll taxes under the CARES Act.

The Presidential memorandum defers payroll taxes (just the Social Security portion of 6.2%) from September 1, 2020 through December 31, 2020 for all federal employees. Under the CARES Act employers are already eligible to defer payroll taxes through December 31, 2020. Some self-employed individuals are also eligible to defer their SECA (Self-Employed Contributions Act) taxes. For now, the memorandum does not address employee options for participation if the employer does not choose to participate. There may be further clarifications to come. You can read more about IRS guidance on payroll tax deferral here.

Per the official memorandum, there will be no penalties or interest charges to deferred taxes. The Secretary of the Treasury has been directed to explore options for forgiving the deferred taxes. This means there is a potential that the deferred amounts will not have to be repaid. At this time there is no guarantee that forgiveness of deferred amounts will happen. Deferred taxes owed may have to be repaid in 2021. Currently, deferred taxes must be repaid in full between January 1, 2021 and April 30, 2021. Essentially, your payroll tax deductions would double for the first 4 months of 2021.

Military members have no choice

For civilian employers the program is voluntary. For federal employees, including the military, information published by DFAS indicated that deferral of employee taxes (6.2% of earnings) will not be optional. Currently, there is no way to opt-out of the deferral and no indication that an opt-out option is being considered. For now, federal employees and military service members will see more money in their mid-month pay.  But they may be forced to pay back the increase over the first four months of 2021.

If you are a civilian employee, check with your employer to see if they are participating in the payroll tax deferral. Many are not.  Many employers are concerned about the ramifications of payroll tax deferral.

If you are a military service member or federal employee, there is an easy way to calculate the increase in pay due to the payroll tax deferral. Let’s work through a quick example for a hypothetical September paycheck. The calculation would look like this:

Military Payroll Tax Half-Month Example

Earnings from 9/1-9/15: $4000.00
Monthly payroll tax 6.2%: X .062
Taxes deferred: $248

 

Military Payroll Tax Full Month Example

Earnings from 9/1-9/30: $8000.00
Monthly payroll tax 6.2%: X .062
Taxes deferred: $496

What do you do if you see your calculated increase in pay in your next paycheck? Set the money aside and don’t spend it!
Right now, there is no guarantee of any legislation to forgive the deferred taxes. Repeat for each paycheck through the end of 2021 or until there is more clarification on this issue.

For employees, whether you are civilian, federal, or military, save the payroll taxes for now. If you are military, you have likely experienced being over-paid only to have DFAS reach back months (or years) later with large extra deductions from your paycheck. Consider the payroll deferral like another DFAS error. Save the overpayment. You know they will come for it eventually.

The Bottom Line

As financial advisors, members of the MFAA help people just like you navigate the questions, challenges, and planning opportunities related to your taxes. We would love to be of help and have a free consultation.

Find an advisor here!

Categories
Disability Pay Reserve Component Taxes

What is Concurrent Retirement and Disability Pay?

Concurrent Retirement and Disability Pay

Understanding Concurrent Retirement and Disability Pay

If you are currently serving in the military and receiving disability pay, you are probably familiar with the fact that you cannot receive your disability payment for time you are being paid for military service.  What you may not know, is that this regulation is also applied when you receive your military pension, as the law states that you cannot receive military retired pay and VA compensation at the same time.
There is an exception to this, as in 2004, the Concurrent Retirement and Disability Program (CRDP) was put into place.  In this article we will talk about what CRDP is, who qualifies, and go through some examples to help explain the program.  We will also discuss Combat Related Special Compensation; what it is, how it relates to CRDP, and how to choose when you qualify for both.

Who Qualifies for CRDP?

You are eligible for CRDP if:

  • You are a regular retiree, with a VA Disability rating of 50% or higher, or
  • You are a Reserve retiree with 20 or more qualifying years of service, have a VA Disability rating of 50% or higher, and have reached retirement age, or
  • You retired under the Temporary Early Retirement Act (TERA) with a VA Disability rating of 50% or higher, or
  • You are a disability retiree who earned entitlement to retired pay under any provision of the law other than solely by disability and you have a VA Disability rating of 50% or higher.

Do I Need To Apply For CRDP?

No, no application is necessary, if you fall into one of the categories we discussed above, you will automatically be enrolled.

How Does CRDP Work?

CRDP is a restoration of your retired pay that was not paid to you because you received Disability Pay.  Let’s look at an example.
SFC Smith is a retiree that receives $2,000 per month in retired pay and $142 per month in disability pay.  She has a 10% disability rating from the VA.  SFC Smith’s monthly payments will look like this:

  • Disability pay $142 (non-taxable)
  • Retirement Pay – $1,858 (taxable, her $2,000 retirement pay is reduced by the amount of her disability payment)
  • Total Monthly Payment – $2,000

That is how it worked prior to CRDP, and how it still works for anyone receiving disability pay with a rating less than 50%.
Now, let’s make SFC Smith’s disability rating 60%, with a monthly disability payment of $1,131.  Since SFC Smith is a regular retiree and has a disability rating greater than 50%, she will receive CRDP.   SFC Smith’s payments will look like this:

  • Disability pay $1,131 (non-taxable)
  • Retirement Pay – $869 (taxable, her $2,000 retirement pay is reduced by the amount of her disability payment)
  • CRDP – $1,131 (taxable, restores her retirement pay withheld)
  • Total Monthly Payment – $3,131

As you can see, a pretty nice benefit, that can really add up over years of payments for those that qualify.  For CRDP recipients, they will receive two payments per month; their retirement pay which will include the CRDP amount and the disability payment.

Is CRDP the Same Thing as Combat Related Special Compensation?

No, Combat Related Special Compensation (CRSC) is a separate program from CRDP.  While CRDP is a restoration of retirement pay withheld, CRSC is an entitlement that you are paid, thus reimbursing you for all or a part of the retired pay withheld.  Since it is not considered retirement pay, CRSC is non-taxable.

CRSC Eligibility

To be eligible for CRSC you must:

  • Be entitled to and or receiving military retired pay
  • Be rated at least 10% by the VA
  • Waive your VA pay from your retired pay
  • File a CRSC application with your branch of service

Some pretty big differences here between CRDP and CRSC.  First, the disability rating is lowered from 50% to 10%, however, the disability must be related to combat service.  Secondly, while CRDP will be automatically paid if you are eligible, you must apply for CRSC.  You apply for CRSC on DD Form 2860, which is sent to the specific branch of service that you were in.  Documents you will need to complete the 2860 include your DD-214, VA Determination Letter, Medical Records, and Orders.

How Does CRSC Work?

SFC Smith is a military retiree who receives $2,000/month in retired pay.  As a 20% rated disability recipient, SFC Smith also receives $281 in monthly disability payments.  SFC Smith applied for and receives CRSC and 100% of her disability rating is directly related to combat.  Here is a breakdown of the payments SFC Smith will receive:

  • Retirement Pay – $1,719 (taxable, her $2,000 retirement pay less her $281 disability pay)
  • Disability Payment – $281 (non-taxable)
  • CRSC Payment – $281 (non-taxable)
  • Total Monthly Payment – $2,281 ($1,719 taxable and $562 non-taxable)

In this example, 100% of SFC Smith’s disability was determined to be combat-related.  Let’s also look at an example where that isn’t the case.
SFC Smith is a military retiree who receives $2,000/month in retired pay.  As a 20% rated disability recipient, SFC Smith also receives $281 in monthly disability payments.  SFC Smith applied for and receives CRSC and 50% of her disability rating was determined to be directly related to combat.  Here is a breakdown of the payments SFC Smith will receive:

  • Retirement Pay – $1,719 (taxable, her $2,000 retirement pay less her $281 disability pay)
  • Disability Payment – $281 (non-taxable)
  • CRSC Payment – $140.50 (non-taxable)
  • Total Monthly Payment – $2,140.50 ($1,719 taxable and $421.50 non-taxable)

As the example shows, CRSC will only compensate you for the portion of the retirement pay you waived in order to receive disability payments that were determined to be combat-related.

If You Qualify For Both, Which Should You Choose?

If you qualify for both CRSC and CRDP, DFAS will pay you the amount that will result in a higher monthly payment in the initial year you qualify, which will remain the case until the first CRDP/CRSC Open Season.  During the Open Season, DFAS will mail you an election form where you can choose to receive either CRDP or CRSC.  During subsequent years, you will not receive an election form.  You can still change your choice during the Open Season, but you will need to request the change yourself.
There are two big factors you should consider when choosing whether to receive CRDP or CRSC.

What Percentage of Your Disability is Combat Related?

CRDP will pay 100% of your retirement pay withheld, while CRSC will only pay the percentage related to combat disabilities.  Where this factor really comes into play is if your disability rating changes over time.  For example, let’s say you are rated 50% by the VA and 100% of that rating is combat-related, CRSC will pay 100%, so you elect CRSC.  Five years go by and you file a new claim with the VA for a non-combat rated disability and get assessed as 70%.  Now, you may be receiving only 71% of your withheld retirement pay through CRSC, where CRDP would pay 100%.  It may be more beneficial for you to elect the change.

Taxes, Taxes, Taxes

As with most financial decisions, we have to factor in the effect of taxes.  CRDP is taxable, while CRSC is non-taxable.  This could lead to scenarios where electing CRDP may give you a higher monthly payment, but because it adds to your taxable income, you may be better off electing to receive the non-taxable amount provided by CRSC.
Now that you have a better understanding of CRDP and CRSC, there are multiple variables at play.  As you can see, the decision may not always be black and white.  Working with a member of the Military Financial Advisors Association, who understands the VA and military financial system can help to walk you through your options and recommend the one best suited for you.

Do you have questions or wonder whether CRDP or CRSC is the better option for your situation? Contact one of our advisors to get your free consultation!

Contact an Advisor