How Valuable is a Military Pension?
Two recent events led to this post. First, this article about becoming a multimillionaire in the military appeared on military.com. Second, I was having a discussion with some other officers about this topic and they thought my opinion on the subject was different from what they had heard before. Because of this, we’re going to examine the value of a military pension.
How Much of a Pension Do You Get?
Let’s look at two likely scenarios for a physician. First, someone who stays in for 20 years and retires as an O-5. Second, someone who stays in for 30 years and retires as an O-6. Their pensions in today’s dollars based on this calculator would equal approximately:
20 year O-5 = $4,102.50/month or $49,230/year
30 year O-6 = $8,053.50/month or $96,642/year
Remember that your military pension payments are adjusted annually for inflation, a very valuable benefit.
How Much is This Worth?
The easiest way to answer this is to examine the pension and figure out how much money you’d need to have invested in order to pay yourself exactly the same amount of money inflation adjusted for the rest of your life. Unfortunately, this is not a simple issue.
Military.com Article “Can Military Service Make You a Millionaire?”
The aforementioned military.com article states, “The Defense Department puts the value of the monthly check of an O-6 retiring today with 30 years of service at $2.2 million…The DoD made a number of assumptions, but the idea was to put a price tag or value on the monthly military retirement check a military retiree will receive.” This article doesn’t go into the assumptions made, but let’s just take it at face value.
My MBA Finance Professor
In 2013 when I was taking my MBA, I asked my Finance professor this very question. I asked him how he would value a 21 year O-6 pension, another common circumstance for a physician. At the time this pension was approximately $53,400/year. Here is what he said:
“If you looked at this as an ‘endowment’ where one would not spend the principal, then take the annualized benefit $53,400 ($4,455 x 12) and divide by a long-term rate such as the 30 year T-Bond rate (3% in 2013) $1,782,000. In other words, if you had that $1,782,000 and put it all into 30 year T-Bonds at 3% you would get your $4,455/month. Of course, the issue is whether the 3% is a good number for the long-term. If, however, you were to look at this as an ‘annuity’ where you would spend down the principal until time of death, then you have all sorts of demographic stats issues (e.g., expected life after retirement, future interest rates, variability of the annuity investment, cost of living adjustments, etc.). In a nutshell, it can get quite complex. There are a number of websites available often through reputable firms such as Fidelity, Vanguard, etc., that you can perhaps access that have such calculations available already (instead of having to create your own model). You can plug in your what if’s and see what pops out.”
Using the 30 year T-bond (Treasury bond) rate from 3/18/16, which was 2.68%, here is the valuation with his methodology:
20 year O-5 = $49,230/2.68% = $1,836,940
30 year O-6 = $96,642/2.68% = $3,606,044
The problem with this analysis is that a regular 30 year T-bond is not inflation adjusted, so in my opinion you’d have to compare it to TIPS (Treasury Inflation Protected Securities). A recent yield on a 30 year TIPS bond is 1.12%, which would value the two pensions we’re considering at:
20 year O-5 = $49,230/1.12% = $4,395,536
30 year O-6 = $96,642/1.12% = $8,628,750
Keep in mind that the lower the Treasury bond yields go, the more valuable your pension is because you’d have to invest more money to get the same payout. Since today’s Treasury yields are at historic lows, these valuations are probably as high as they’ll ever get.
If you go to annuity websites and try to purchase an annuity for these two amounts, here is how much they would cost:
Fidelity Guaranteed Income Estimator:
For a 20 year male O-5 who is 50 years old, lives in Virginia, and wants to earn $4,103/month or $49,236/year with a 2% annual income increase (equivalent to the inflation adjustment of your military pension) the pension would cost $1,322,826.
For a 30 year male O-6 who is 60 years old, lives in Virginia, and wants to earn $8,054/month or $96,648/year with a 2% annual income increase (equivalent to the inflation adjustment of your military pension) the pension would cost $2,103,257.
The 4% Rule
The 4% rule is a commonly accepted retirement “rule” that says you can take 4% out of your retirement nest egg every year, annually adjusted for inflation, and never run out of money. In other words, for every $40,000/year of income you need in retirement, you need to have $1 million saved for retirement. Whether the 4% rule is valid in today’s low yield environment has been debated, but let’s just assume it is still valid (because I think it is).
If you divide the annual military pension by 4% it would give you the size of the nest egg you’d need to withdraw that amount:
20 year O-5 = $49,230/4% = $1,230,750
30 year O-6 = $96,642/4% = $2,416,050
Keep in mind that your government pension is guaranteed by the federal government but the assets used in the typical application of the 4% rule, like your retirement accounts and other assets, are not, making your pension a much safer bet that is probably worth more than the numbers above.
There is some value in the military pension that people tend to underestimate. First, it is guaranteed by the US government, which makes it “risk free”. The only option discussed above that would offer this same value is the valuation comparing the pension to Treasuries. Even an annuity from an insurance company is not risk free because insurance companies do go out of business. (I will admit, though, that this is a rare event, and you could diversity by purchasing annuities from multiple companies, so an annuity can be pretty close to “risk free”.)
Second, you can’t screw it up. Investors are their own worst enemy. They buy high, sell low, trade too frequently, don’t save enough, over estimate how high their returns will be, pay excessive investment fees, and other errors that can very easily screw up your well planned retirement. You can not screw up your military pension.
Third, some states don’t tax a military pension. You can find that info here on-line or here in PDF form.
Fourth, and this benefit is HUGE for me. I see my military pension as equivalent to a massive pile of TIPS. This allows me to take much more risk with the remainder of my investment portfolio and net worth. How much risk? Overall my asset allocation is 90% in stocks, which is a lot more risk than most people would recommend at my age of 40. Because of my pension, though, I don’t think I’m taking too much risk.
The Bottom Line
As you can see, a military pension is risk free, inflation adjusted, and can be quite valuable. Can you make more money as a civilian, save well, and accumulate even more than this? Yes, but this is all determined by your civilian salary, discipline as an investor, and rate of return on your investments, which no one knows since they can’t predict the future. A military pension is a very valuable and underappreciate financial asset that is probably worth somewhere between $1,200,000 and $2,500,000, depending on how long you stay in and what rank you achieve. If you try to match the risk with Treasury bonds at today’s rates, it is worth a lot more.
9 thoughts on “How Valuable is a Military Pension?”
March 20, 2016 at 10:06
Absolutely fantastic! The money the government invested in buying your MBA is paying back the entire Navy community. Thank you Joel for another great post!
October 9, 2016 at 12:50
[…] security insures against that, but so does your military pension, which regular readers know I highly value. Although the BRS has a pension as well, it is reduced, shifting more of this risk to […]
January 1, 2017 at 18:22
[…] How Valuable is a Military Pension? […]
November 12, 2017 at 12:21
[…] It depends on your age, gender, and health, but assuming a 50-year-old healthy male, you could purchase that annuity for about $2.5 Million. Yes, you read that right. That’s a pretty valuable pension, no? [PoF: This is consistent with a thorough analysis done here at Navy Medical Corps Career Blog in 2016, which valued a pension at somewhere in the range of $1.2 to $2.5 Million] […]
March 18, 2018 at 09:47
If I have 15 years in and sign an MSP agreement as well as transfer my post 9/11 G.I. benefit, will these obligations run concurrently? It’s a 4 year obligation right? Will that prevent me from signing an MSP?
March 18, 2018 at 11:09
Yes, the GI Bill transfer obligation and any medical special pays (MSP – now Retention Bonus or RB) are concurrent. Frankly, the GI Bill transfer doesn’t actually obligate you. You can still get out if you want (unlike when you take a RB). You just lose the transferability and your kids/spouse don’t have the GI Bill.
March 18, 2018 at 11:27
Thanks. I take it you need to have a spouse/kid in order to initiate the transfer?
Better get married soon.
March 18, 2018 at 11:28
Yes, looks like you have some homework…
December 15, 2018 at 15:03
Retired medical corps 0-6 here, wife is a retired nurse corps O-5, I had 34 years for pay purposes when I retired(medical school years counted for pay in my day), so I received 85% of my pay when I retired. My wife and I are retired with pension and social security income of over $250K a year. My medical school classmates are afraid to retire, worried about running out of money. The grass isn’t necessarily greener in the civilian world of medicine, especially in the primary care specialties. Do the math before walking away from the military at the 12-15 year breakpoints, ask yourself, “how much would I need to put away a year, in the working years I have left, to return me that much money (lost pension benefits),” you will find it’s is very hard to do.