This is the first article in a series where I will discuss the many financial benefits associated with serving in the U.S. military. As a veteran, and as someone who has taken advantage of many of these benefits, I wish I knew about some of these benefits much earlier in my career. The goal of this series is to create a consolidated synopsis of as many programs as possible so that members of the military and veterans can optimize their benefits.
The United States military retirement system is designed to provide service members with financial security after their dedicated years of service but is highly complex and difficult to navigate. For many years, the military had only one retirement plan, called High-36 Retirement Plan, or High 3. This required the service member to serve at least 20 years before becoming eligible. However, many individuals did not serve a full 20 years and left without any retirement savings whatsoever. The Thrift Savings Plan (TSP) was expanded in 2001 from only federal civilian employees to include members of the uniformed services.
The TSP now serves as the cornerstone of the U.S. military retirement system, offering service members and federal employees a defined contribution retirement savings plan. Similar to a 401(k) for civilians, the TSP provides a tax-advantaged way for military personnel to save for retirement. Until 2018, there was no match in the defined contribution portion of the retirement plan and therefore not as much of an incentive for service members to contribute.
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What is the Blended Retirement System?
With the introduction of the Blended Retirement System (BRS), service members can now receive up to a 5% match of their base pay. Anyone who joined after January 1, 2018, is automatically enrolled in BRS.
In addition, they are automatically opted in at 5% of their basic pay. Even if they change their contribution rate to 0%, they will still receive a basic pay automatic contribution from the government of 1%. The only vesting requirement is that a member serve two years to be eligible for matching and automatic contributions. (For those who joined before January 1, 2018, and opted into the BRS, they are immediately vested in the matching contributions but need to serve two years to be vested in the automatic contributions.)
A service member is immediately vested in all other TSP funds in their account, including their own contributions, and its earnings. The plan has the same age requirements and deferral limits (with one exception as described below) as other workplace 401(k) plans.
For the sake of this discussion, we will focus most of the discussion on the TSP and how it applies to the BRS.
Understanding military pay
Service members receive three different types of pay: basic pay, allowances and special and incentive pay. The allowances, which include housing and subsistence, are tax-free and can be a significant portion of take-home pay, upwards of $60,000 per year or more! All of these types of pay are determined by pay grade, where a service member is stationed, their rating or specialty and whether they have dependents.
TSP contributions are selected through service members’ myPay online account (or NP2, once it becomes active). They can elect to contribute up to 92% of their base pay, or up to 100% of special, incentive and bonus pays. They can make any combination to traditional (pre-tax) or Roth (post-tax) as well, and TSP will automatically stop contributions once they reach the contribution limit ($23,000 for 2024; plus, an additional $7,500 in catch-up contributions for those age 50 or older). As a reminder, there are no income limits to contribute to a Roth 401(k) like there are for Roth IRAs. Regardless of the elected contribution type (traditional or Roth), matching contributions will always be in pre-tax dollars. Of note, the match described above applies only to base pay contributions, not allowances or incentive pay.
Since the government’s match to a person’s TSP is calculated based on contributions each pay period, it does not benefit participants to front-load, or max out, their contributions early in the year. In that case, they would be missing out on additional matching contributions later in the year.
The good, the bad and the ugly of TSP
The TSP is a defined contribution retirement savings and investment plan, which means the employee and employer can both contribute to the plan, vs a defined benefit plan, sometimes called a pension (see “The famous pension” section below).
One of the most significant advantages of the TSP is its low-cost structure. The plan offers a range of investment funds with low expense ratios (or fees), which can significantly impact the long-term growth of retirement savings. These funds include a mix of stocks and bonds, allowing service members to tailor their investments to their risk tolerance and financial goals. The TSP's fund options include:
- G Fund (Government Securities Investment Fund)
- F Fund (Fixed Income Index Investment Fund)
- C Fund (Common Stock Index Investment Fund)
- S Fund (Small Cap Stock Index Investment Fund)
- I Fund (International Stock Index Investment Fund)
The expense ratios, indicating how much an investor will pay annually to cover operating expenses, for these funds vary from 0.048% up to 0.079%.
In addition to the automatic 5% enrollment of basic pay, service members are automatically enrolled into the Lifecycle Fund (L Fund), or target-date fund, at a year appropriate for their retirement age.
Upon retirement or separation from service, the TSP funds are eligible to be transferred to an IRA or Roth IRA. Of course, a veteran can leave the dollars in the TSP, but there are many advantages to rolling the funds into an IRA. In addition to having more investment options in an IRA, IRA account holders can also perform Roth conversions and make qualified charitable distributions (strategies one is unable to execute from a TSP account).
In 2022, TSP began offering a new Mutual Fund Window (MFW) option to supplement the limited offering of funds. This gives participants access to thousands of more funds. However, there are administrative fees, annual fees and trading fees in addition to the expense fees specific to the mutual fund chosen. These fees amount to $150 annually and $28.75 per trade! There are also minimum account balances required to even begin investing in these mutual funds and a maximum percentage of an account that can be allocated to this portion. All in all, even though TSP has limited investment options, it is usually a better choice for most individuals than this costly alternative.
Of note, in 2022, TSP did a major revamp of its website to make it easier to use. However, as most government websites go, there were quite a few issues. Statements before June 2022 are no longer available online, and many participants found that their beneficiaries did not carry over to the new system.
The famous pension
The second component to a military retirement for veterans and service members that many people often hear about is the defined benefit plan portion, or pension. Service members must serve at least 20 years, either on active or reserve duty, in order to qualify. If retiring from active duty, pension pay begins immediately, and if retiring from reserve duty, pension pay begins at age 60.
To calculate the amount of pay one would receive depends on a variety of factors, but for most under the BRS, it will be 2% x number of years of service x member’s highest 36 months of basic pay. So, after 20 years of service, members would normally receive 40% of their eligible pay.
The silver lining to deployments
For military personnel serving in combat zones, as declared by executive order, special tax considerations come into play. The IRS offers certain tax benefits that can have a significant impact on retirement savings. One notable provision is the ability to exclude combat zone pay from taxable income for the entire month, even if only one day was spent in the zone. This exclusion applies to both active-duty military and civilians supporting military operations in these zones.
Service members may also be entitled to additional incentive pay such as hostile fire or imminent danger pay. Although these deployments often introduce stressors to individuals and their families, careful financial planning can be a beneficial silver lining.
Since all income earned is tax-free while in a combat zone, if contributing to a Roth TSP, then a service member will never pay taxes on that income or its earnings. However, if contributing to the traditional (pre-tax) TSP bucket, then things get a little tricky because the earnings — just like a normal traditional 401(k) — are taxable upon distribution. So now, they have commingled tax-free income (that will never be taxed) with taxable earnings, as well as any previously contributed taxable contributions from non-combat income. This creates a basis similar to having non-deductible contributions in a traditional IRA. TSP maintains records of tax-free contributions, but it can still become complicated when it is time to withdraw funds.
While deployed to a combat zone, the elective deferral limit also increases to the IRS maximum of $69,000 (for 2024). This can be a huge savings perk because pay has increased by the amount that would be paid in taxes with the capacity to allocate more to their retirement account. Special planning should be taken into consideration because this limit is the total between participant contributions and any agency matches. In addition, any excess contributions above the limit of $23,000 (2024) must be in traditional (pre-tax), not Roth (post-tax) contributions.
More deployment benefits
The Savings Deposit Program (SDP) is a lesser-known gem within the military retirement system. It is a savings account available to service members deployed to designated combat zones. The SDP offers a unique opportunity to earn an attractive interest rate — often higher than prevailing civilian interest rates (10% as of 2023!) — on up to $10,000 of savings during each deployment. This program serves as a short-term, low-risk option for service members to accumulate funds while deployed in high-risk environments. This savings vehicle is similar, with some differences, to a certificate of deposit (CD) that most banks offer, including a much higher interest rate than even most risky investments can offer.
The SDP's interest compounds monthly, is fixed at a rate specified by the Department of Defense and continues to accrue for up to 90 days after leaving the combat zone. After 90 days, the interest drops to 0%, and after 120 days from leaving the combat zone, all funds will be returned. This makes it a safe haven for service members looking to grow their money without the volatility associated with investment markets.
Upon deployment, service members can contribute to the SDP through direct deposit, and the funds become available for withdrawal upon their return.
Continuation pay
After serving eight to 12 years, members may be eligible for a one-time bonus payment in exchange for additional obligated service, called continuation pay. The amount varies depending on a variety of factors, including active duty or reserve status, current pay grade, specialty skills and others. The service member must be covered under the BRS, and the bonus can be as high as 13 times monthly basic pay.
What now?
The U.S. military retirement system is a multifaceted structure that aims to provide financial security to those who have served their country. TSP, with its diverse investment fund options and low-cost structure, empowers service members to build their retirement savings wisely. Tax considerations in combat zones offer opportunities for tax-efficient growth, while the SDP provides a secure method for short-term savings accumulation.
Understanding these components and making informed decisions regarding fund allocations, tax strategies and utilization of programs like the SDP can significantly impact the long-term financial well-being of military personnel. It is important to remember that simply because one leaves the military does not mean their career has to be over. Service members can serve a full 20 years, retire from the military in their 40s with highly sought-after skills and have another successful, potentially 20-year career while earning a military pension.
As service members navigate their careers and plan for retirement, seeking advice from financial professionals who specialize in military benefits can further enhance their financial security and peace of mind.
This information is for educational purposes and is not intended to provide, and should not be relied upon for, accounting, legal, tax, insurance, or investment advice. The contents are not intended to be advice tailored to any particular person or situation. We believe the information provided is accurate and reliable, but do not warrant it as to completeness or accuracy. This information may include financial planning recommendations or investment strategies; however, there is no guarantee that such recommendations or strategies will prove to be correct, and they also may change without notice. We encourage you to speak with a qualified professional regarding your scenario and the then-current applicable laws and rules.
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This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
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