Retirement Merges to Buy
The end of a military career is bittersweet. On the one hand, you’ve earned a place in history as one of the few willing, able, and talented enough to defend freedom. One the other, you know you’ll miss both the camaraderie as you enjoy life without so much spinal compression. Of course, there are more than a few other considerations that you need to sort through before hanging up your speed jeans for the last time, but this article should give you a few things to mission plan against as you ponder retirement.
The Month You Retire Matters
There is a “glitch in the matrix” that produces “pay inversions” such that retirees in some months will ultimately receive more throughout retirement than others. Specifically, those who retire earlier and with less total service (by a few months) can receive more than those who retire later with more time in service. These pay inversions stem from the way that DFAS calculates cost of living adjustments (COLA). This article is an excellent read on the details, but the gist is that COLA is highly sensitive to the month and quarter that you retire. Retiring at the end of a fiscal quarter, not in September, and preferably in March form the guide posts for your best chance at enhanced retirement earnings through COLA management.
Shaping this merge will be tough for many. The fact is that September is a very common month to retire for those PCS’g on the summer cycle. You’re done with command or your assignment, using up terminal leave over the summer, and if you’re an O-6, it’s probably the latest retirement that the Colonel’s Group would give you when you dropped papers a year earlier. Anguishing about the choice to retire is tough, but if you have time flexibility, choosing your retirement month could have six-figure consequences during life 2.0.
Before you scoff the weight of this issue, consider that in your first year of retirement, your retired pay receives a pro-rated amount of COLA. In 2022, the year with the highest inflation most of us have seen in our working lifetimes, here’s the COLA you would have received:
- Retire before 1 January 2022: 8.7%
- Retire between 1 January to 31 March 2022: 7.0%
- Retire between 1 April 2022 and 30 June 2022: 4.4%
- Retire between 1 July 2022 and 30 September 2022: 1.2%
- Retire between 1 October 2022 and 31 December 2022: 0.0%
You read that right. If you retired in 2022 with inflation running amok, you had a great chance to miss on much of an active duty COLA and a retired pay COLA.
Selling Back Leave
Most of us start our enroute descent to retirement with a sizeable chunk of leave. It’s good dry powder and gives you options as you transition. As you probably recall, you can “sell back” your leave or use it as terminal leave, but which is better?
When you sell back leave, you’ll get paid your basic pay for each day. An O-5 with 20 years retiring in 2023 could get a check for over $20,000 before taxes by working to the last day and selling 60 days. While you only get your basic pay (no BAH, BAH, flight pay, etc.) you’re still getting those pays for working the last two months. Selling back leave can make financial sense.
Conversely, if you plan to start a new job, making about what you made on active duty, starting to work on terminal leave could pad your account with two-plus months of extra pay including allowances and incentives. But don’t forget about the taxes…
April 15th is Coming
Taxation in the year of military retirement often produces some serious face in palm time. Assuming you retire partway through the year and start a new job, you’ll have some financial tail winds: double pay from time on terminal leave, (handsome?) salary from your new job, and your military pension all funneling into your checking account.
Come tax time, you’re likely to hit some headwinds too. Our 20-year O-5 retiree brings home about $126K of annual taxable income. If s/he is the breadwinner, the family is probably in the 22% tax bracket. It’s not hard to trip the (2023) threshold into the 24% bracket (about $190K) when you add up:
- Taxable military pay earned in during working months of your final year
- Fully taxable civilian pay from new job, overlapped during 2+ months of terminal leave
- Fully taxable military pension received post military retirement
In addition to the possible tax-bracket bump, you’ll notice that more of your pay is subject to the social security tax—up to $160,200 in 2023, and all of your (non-active duty allowance) pay is subject to the 1.45% Medicare tax. If you’re an O-6+, you’ll find it easy to trip into the bonus round paying an additional .9% Medicare tax on income above $250K.
You’ll want to be diligent filling out that W-4 form for your new job, and then potentially adjust it in your first full year out of active duty. You can also have additional money withheld from your pension to cover potential taxes. Remember that you’re not immune to State Income Taxes anymore either. Super fun…
A Forever Home
One of the great benefits of retirement is the option to plant roots. It finally makes sense to own a home (if it didn’t prior) since you don’t have to move every 2-3 years. There are at least two retirement-related decisions you’ll face when deciding about a “forever home.”
The days of easy loan underwriting are gone for now. Lenders will fine-tooth comb your income and will even verify your expected military income if you buy your house while still on active duty. It may be harder (or impossible) to get a loan or refinance if you haven’t started your new job yet, so nailing down your mortgage early can help.
There’s a penalty for locking down your mortgage/re-fi early though. Years of flying fast jets has likely left you with more than a few Code-2’s that the VA will compensate you for. The problem is that your VA rating may not come until well after you need to lock down housing. You should care because disabled veterans are eligible to have their VA funding fee waived, saving thousands of dollars in a purchase or refinance. You can apply to have the fee refunded, but you had to be eligible for VA compensation at the time of closing. That may not be the case if you buy your home/re-fi prior to the VA process.
Juggling loan approval, new job starting dates, the VA evaluation process, and your loan date will feel like advanced calculus, but it could save you thousands.
Fifty Percent Usually Isn’t
We usually think of retired pay as (at least) 50% of basic pay. That is the math, but lots of things nibble at it. DFAS will withhold income tax (but not the additional .9% Medicare tax that your retired pay could force). You’ll likely need to pay for retiree vision and dental insurance (Tricare doesn’t cover those) and that’s easily $100-$200 per month out of your pension. Finally, if you elect to take the Survivor Benefit Plan (SBP), you’ll pay 6.5% of your pension for that, so another $300+. Remember that the SBP provides only 55% of your retired pay, so effectively about 25% of your active basic pay to your surviving spouse (or children).
The SBP decision is complex. You have to make an SBP election prior to your effective retirement date (and your spouse has to approve the choice not to take it). If you don’t take it—you can’t change your mind after retirement, so this decision is worth serious contemplation and calculation. If you do take the SBP, you get one window to opt back out between months 24-36 of retirement. After that, you’ll pay 6.5% (which goes up with inflation/COLA) for the full 30-year period of SBP payments (you also have to be over age 70, but 30 years is the main hurdle for most retirees).
Remember that if you pass away and your spouse/children actually receive the pay, they’ll be taxed on it since your premiums were pre-tax.
Finally, as you may have heard, Congress has authorized and SBP Open Season in 2023 during which retirees can opt back into or out of SBP. While there is no guarantee of future Open Seasons, Congress has averaged about one Open Season per decade in the past 30 years.
Cleared to Rejoin
Your retirement is a great valediction after a career defending freedom, but it has seemingly endless financial complexity. You can twist the odds in your favor by planning ahead. Choosing a retirement month to optimize COLA can add tens or hundreds of thousands to your net worth.
Terminal leave simultaneous with a new job can really stack the Benjamin’s in that last year but beware the tax man—he hits hard on higher earners! Factor your potential VA rating into your forever home purchase, but if your new job situation might be fluid, don’t forget that lenders care about your ability to pay.
Finally, while joining the “check-a-month club” can be pretty sweet, it’s unlikely to feel like 50% of what you were making after it hits your account. Make sure your new budget and tax planning factor in the realities of your pension. You’ve more than earned your retirement, planning early can help you smooth out the financial turbulence so you can enjoy it.
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