Dear Fellow Pilots,
Don’t ever take a job based entirely on pay. From tradition, to tax advantages, to social consciousness, most employers offer an overall “compensation package” that is far more valuable overall than just the hourly wage or salary they offer. One of the most important parts of any compensation package is funding for some type of retirement plan.
One of the best benefits that the military offers is its retirement package. Most civilian employers abandoned traditional pension plans years ago because they represent huge financial burdens. Thankfully (for us), the military’s pension plan is backed by tax dollars and isn’t likely to declare bankruptcy and disappear any time soon.
This article covers retirement for an Active Duty military pilot. Part 2 will discuss retirement for pilots serving in the Guard or Reserve.
Table of Contents
- The Old System
- The New Blended Retirement System (BRS)
- TSP Investment Options
- Maximizing your TSP
The Old System
Until just a few years ago, the military pension was an all-or-nothing proposition. Many people still serve under this system, so we’ll cover it. Under this system, your monthly retirement check is 2.5% of your monthly base pay multiplied by the number of years you served before retiring. If you serve a full 20 years on active duty you receive 50% of your base pay, every month, for the rest of your life. You’ll also be eligible for Tricare Retired Reserve, some of the best and cheapest health insurance in the world.
Most corporations have abandoned pensions because they’re just too expensive to support. The US military has the luxury of funding this pension plan with tax dollars, which is a great deal for us. (Be sure to thank and apologize to your parents next time you see them.)
Let’s put this into practical terms by looking at the annual pay for an O-5 with at least 20 years of service. We’ll assume he or she is assigned to Eglin AFB, has a family, and is earning the maximum amount of flight pay allowed by law. The first part of our chart assumes our pilot receives a $35,000 per year retention bonus, though we’ll consider the case without any bonus as well. Here’s what this pilot’s pay would look like:
|O-5 – 20+ Years||Monthly||Annual|
Unfortunately, the military pension only considers base pay when running its calculations. This pilot will receive a monthly check equal to 50% of the average of the highest 36 months of his or her base pay. This yields
|Old Retirement System||$4,458.05||$53,496.60|
Personally, I wouldn’t refuse $53K per year. A human being incapable of living a wonderful life on this income needs to reexamine his or her priorities in life. However, it’s important to note that this is a far cry from the $184K he or she was making the year before. This $53K per year drops our pilot to just the top 35% of Amercians by income. Although we associate this pension with retirement from the military, most pilots will choose to continue working when they leave active duty.
Thankfully, airline pay is higher than its been in decades. Even if a pilot has to do a Regional Airline Touch & Go (see the four-article series on that topic in this issue of TPNQ), the military pension should be able to make up much of the difference between first year airline pay and final year military pay. (Look for a more detailed post on airline pay here on BogiDope in the near future.)
The New Blended Retirement System (BRS)
Although the military gets access to tax dollars to fund its pension obligations, Congress has realized that this is a huge drain on our country’s resources. As a result, they’ve devised a new Blended Retirement System. If you plan to stay in the military for at least 20 years, the BRS is a slightly worse deal for you. However, if you leave Active Duty (for the airlines, the Guard/Reserves, or both) with fewer than 20 total years of service, the BRS is a huge benefit.
The BRS changed the pension portion of a military retirement to pay out 2% of base pay, instead of 2.5%. For 20 years of service this now equates to 40% of your base pay, instead of 50% under the old system. (You still get the same great deal on healthcare.) Here’s the difference for the pilot in our previous example:
|Old Retirement System||$4,458.05||$53,496.60|
This difference of just under $10,700 is a lot of money. If a pilot retired at age 43 and lived to be 80, the pension portion of the BRS would pay nearly $400,000 less than the old pension system. Even by age 60, the pension portion of the BRS would have paid out $181,888.44 less than the old pension system.
Thankfully, the BRS adds one more element. Under the BRS, the US government will match up to 5% of a pilot’s contributions to the Thrift Savings Plan (TSP.) There are some silly rules for specifying how much of his or her own money a pilot has to contribute to maximize that match. The bottom line is: you are a fool unless you contribute at least enough to get the government’s full 5% match.
Assuming that the TSP earns an average of 5% interest, after inflation, a pilot who receives the maximum TSP match for his or her entire career should end up with a total of $121,285.74 in government match dollars in his or her TSP at 20 years.
Since the TSP works like a 401k, IRA, and other similar retirement accounts, the owner isn’t allowed to withdraw any of the funds until age 60 (at least not without a significant financial penalty). If we assume that those funds continue to earn interest at 5% from age 43 to age 60, these government match dollars should grow to $277,989.15.
We can compare this to a pilot under the old retirement system who received $10,700 more per year than a pilot on the BRS. Assuming that this pilot invested that annual $10,700 difference at 5% interest after inflation, he or she would end up with $300,997.39. Although a difference of $23K probably seems like a lot today, it won’t seem like much difference when you’re 60. Many variables could influence this comparison, but the overall takeaway here is that in the long-run the BRS pays almost as much as the old pension system did.
The best thing about this new system though is that if a pilot leaves Active Duty service before the 20-year mark, he or she gets to keep the government TSP match dollars! For a pilot who separates after 11 years those funds will probably only have grown to $43,629.35, but that’s a lot better than the $0 that this pilot would have received under the old system. Put another way, the BRS is equivalent to a $4,000 per year raise for a pilot who leaves Active Duty at 11 years.
TSP Investment Options
The Thrift Savings Plan is the Federal Government’s equivalent to a civilian company’s 401k plan. It’s available to all Federal employees, not just the military. A civilian company sets up a 401k plan by hiring a big investment firm to provide services for them. The investment firm charges the company fees, and the two negotiate over which types of investments and contribution rules will be available to employees. Usually, you get a menu of mutual funds to choose from. It’s a good deal, but sometimes those fees get a little out of control and cost us employees a lot of money.
The TSP doesn’t offer as many investment options, but the fees are wonderfully low. There are five major “funds” in the TSP:
- The G Fund just takes your money and buys a bunch of special US Government Treasury bonds. They claim that this investment will never lose money, but the trade-off is that the investment returns will never be very large either.
- The F Fund makes investments designed to match the performance of a popular Bond Index Fund. It’s considered lower-risk, but also means lower returns.
- The C Fund is an S&P 500 Index Fund similar to Vanguard’s VFINX, Fidelity’s FXAIX, and Schwab’s SWPPX. These funds should have volatility that closely resembles the S&P 500 itself, and the average annual rate of return is above 11% over the long-run.
- The S Fund is an index of small cap stocks not included in the S&P 500.
- The I Fund tracks the MSCI EAFE (Europe, Australasia, Far East) Index.
- The L Funds are “target-date” funds that adjust your money in these 5 funds for you. The idea is that early in your career they’ll be invested in riskier, higher-return funds. As you get closer to the end-date for the fund, they move more of your assets into “safer” (less volatile) investments with lower returns. (The G and F Funds.)
If you ask 100 pilots how you should invest your TSP dollars, I guarantee you’ll get at least 101 opinions. Don’t listen to them. Your best best is to consult with a Certified Financial Advisor before you decide where to allocate you funds.
That said, if you’re a do-it-yourself type person, I highly recommend The Simple Path to Wealth by JL Collins. He is a big fan of Vanguard’s VTSAX (and VBTLX if you insist on including a bond fund in your portfolio). You should still consult a professional before you decide what to do, but you could approximate Mr. Collins’ recommendations in the TSP by using the C Fund (or C and S Funds combined) in place of VTSAX, and the F Fund in place of VBTLX.
Since administration of the TSP is funded by US tax dollars, you pay very low fees on these investments. While many actively-managed mutual funds will charge you 1% of your money to invest, the TSP only charges you 0.04%. This equates to 40 cents per $1,000 invested. Some of the large investment houses have started offering zero-fee mutual funds (Fidelity was first with FZROX) but 0.04% is still fantastic.
Maximizing Your TSP
If you only ever contribute to your TSP the minimum required to receive the government’s full match you’re off to a good start. However, you can do a lot better!
For 2019, you’re allowed to contribute a total of upto $19,000 to your TSP, in addition to the government’s match. You can contribute this as before-tax dollars, saving you lots of money in the short-term, or you can contribute this as after-tax dollars to your Roth TSP. That second option won’t reduce your tax bill today, but it will reduce your tax burden in the future. If you plan to work as a professional pilot, I predict that you will have a much larger income when you start withdrawing money from your TSP than you do today, meaning the Roth TSP might be a good deal.
In years when you deploy, you get an even better deal. You’ll be allowed to contribute up to the (2019) maximum of $56,000 per year to your TSP. While you’re in a Combat Tax Exclusion Zone, you should only ever make Roth TSP contributions. They’ll be tax-free on the way in to your accounts because of the combat zone, and they’ll be tax-free on the way out because they’re in a Roth account. You will never pay tax on that money!
If possible, you should save your other (called “Traditional”) TSP contributions for the months during which you are not deployed. This will reduce your taxable income for the year, potentially saving you thousands of dollars.
If you contribute the maximum $19,000 to your TSP each year, and it grows at 5% after inflation, your total TSP balance should be somewhere around $313,558.31 after 11 years on Active Duty. If you retire at 20 years, your TSP balance could be upwards of $749,538.87.
Don’t forget that you’re not allowed to touch the money in your TSP until you turn 60 without a pricey penalty. If that money continues to earn interest during that time, a pilot who separated at 11 years of Active Duty should end up with roughly $1,114,910.71 when he or she starts making withdrawals. A pilot who made 20 years of TSP contributions could have $1,717,956.82 is his or her TSP at age 60.
A good rule of thumb is that if you spend 4% of your nest egg each year your funds should last at least 30 years, even under very unfavorable conditions. (In most cases, your total account balance would more than double during that time, despite you spending 4% per year.) Using this rule of thumb, these TSP balances could start producing $44,596.43 or $68,718.27, respectively, for the rest of your life. For a pilot who chose to retire under the BRS, this would be a $68K raise to the $43K he or she receives in annual pension payments, starting at age 60.
These calculations have all assumed that you never contributed more than your $19,000 and the government’s 5% match to your TSP in any given year. If you attempt to maximize your contributions in years that you deploy to the $56,000 per year limit, your eventual nest egg will be even larger.
Although the new Blended Retirement System isn’t as good a deal as the old system if you stay in the military for 20 years, it’s still pretty close. If you plan to leave Active Duty with fewer than 20 years of service, then the BRS is a great deal. Many of us join the military thinking we’re going to stay until 20, but end up changing our minds. Statistically, only a relatively small number of us make it that long. This means that you’ll probably end up very glad you get to keep your TSP money under the new BRS.
It’s likely that most of us will continue earning money after we conclude our military service and that this TSP income will only represent a portion of the money available to us in retirement. A pilot who continues his or her military service in the Guard or Reserve should also be eligible to continue contributing pay to the TSP. I cannot emphasize enough how advantageous it is to maximize your contributions each year!
We’ll look at the specifics of the Guard and Reserve retirement programs in Part 2 of this post.