(Enjoy this always relevant re-post.)
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:
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.
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 underappreciated 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.