financial planning

Throwback Thursday Classic Post – How Valuable is a Military Pension?

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(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.

Annuity Websites

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.

Unquantified Value

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 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.

Throwback Thursday Classic Post – Moonlighting in the Navy

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It’s August and a whole new crop of recent residency graduates can now moonlight for the first time in their Naval careers, so here is a video and blog post that discusses some of the basics of moonlighting.

Should You Moonlight?

I think the answer to this question depends on a lot of things. First, do you envision yourself working clinically when you leave the Navy? For most physicians, the answer to this question is yes, and depending on your specialty you may need to moonlight to maintain your clinical skills. We don’t always get exposed to the full scope of our specialty in the Navy. My wife is a pediatrician, and when she was on active duty I thought she had a full scope pediatric practice and did not need to moonlight to maintain her skills. As an emergency physician, though, it is rare to get exposed to the full breadth of emergency medicine in a Navy emergency department. You have to make an honest assessment of your specialty, the breadth of your Naval practice, and whether you need to moonlight to maintain your skills.

In addition, you need to figure out your motivation for moonlighting. A common motivation is to earn extra money, and that is a fine motivation, but you never want to make decisions that make you dependent on the money. You may deploy, your CO could take away your moonlighting privileges, or you could PCS somewhere where you can’t moonlight. You don’t want to be the bankrupt doctor because you bought a house you can’t afford without moonlighting.

The Navy’s Moonlighting Rules

In order to moonlight you have to get permission from your command. It is a privilege, not a right, and you can lose this privilege if you fail a PFA, don’t stay up-to-date on your training/readiness requirements, or don’t produce academically when required.

If you are going to moonlight somewhere outside of a 2 hour drive, you need to take leave. If you are flying anywhere, no matter the distance, you need to take leave. You can’t moonlight more than 16 hours/week and you need to have 6 hours of time off between clinical periods for your moonlighting job and your Naval duties. You’ll need to complete an annual attestation that says you are aware of these policies and compliant with them. If your specialty makes complying with these guidelines hard, you can ask for a waiver from your command.

Where Should You Moonlight?

If you moonlight locally you don’t need to take leave. If you can find a clinical setting you think you’d like after your time in the Navy is complete, you can even start working toward partnership.

If you work locum tenens, you can travel and sometimes chase “the big money.” If you work enough, the locum companies will cover all of your expenses, DEA, state licenses, travel, hotel, expenses, and malpractice insurance. Because you are likely traveling to a location more than a 2 hour drive away, you’ll need to take leave.

Basic Financial Planning for Moonlighters

Moonlighting allows you to put more money in tax advantaged retirement accounts. If you’re a non-moonlighter, you’d be limited to putting $19,000/year in the TSP and $6,000/year in your IRA (based on 2019 limits). If you moonlight and get paid on a 1099 as an independent contractor, you can fund a SEP IRA or solo 401k up to $56,000/year. It is rare that you’ll hit this maximum because you can’t moonlight enough to earn the amount required to do it, but you will be able to put more away than a non-moonlighter. A SEP IRA is easier to set up than a solo 401k, but a Solo 401k allows more money to be contributed at an equivalent salary. Plus, a SEP IRA messes up your backdoor Roth IRA contribution. For a great discussion on these two options, go to this article, but the bottom line is you’ll likely want to set up a Solo 401k and not use a SEP IRA:

http://whitecoatinvestor.com/sep-ira-vs-solo-401k/

Finally, moonlighters often want to incorporate because they think it provides malpractice protection, but that is a myth. Although there may be some tax advantages to incorporating, it doesn’t protect you from professional liability or malpractice.

Contract Pitfalls

If you are going to sign a contract, you are going to need to get some professional help. You should hire a healthcare or contract attorney to review any contract you are considering. You could also consider using a company that specializes in reviewing physician contracts like Contract Diagnostics. There are many issues you need to understand, including:

  • Due process or termination clauses – For what reasons can they terminate you? Are you entitled to a hearing with the medical staff before your privileges are removed or restricted?
  • Tail coverage – Does your malpractice insurance require tail coverage? If so, who is paying for it? Tail coverage is malpractice insurance that covers you after you stop working for that employer, and it can be VERY EXPENSIVE so you will want to know who is paying for it.
  • TRICARE or VA eligible patients – You can’t bill these patients as they are already entitled to your services.  This is spelled out very well in the moonlighting paperwork you will file with your command, but make sure your employer understands this.

Here are the Powerpoint slides for the video podcast below:

Moonlighting

How Much Is Your Military Pay Really Worth?

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Financial posts are some of the most popular on this site, so I figured I would share a great article that summarizes a lot of the financial benefits of being active duty:

How Much is Your Military Pay Really Worth?

Guest Post: Supplemental Disability Insurance for Active Duty Physicians

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(EDITOR’S NOTE: While we have great benefits in the military, one area where our benefits fall short is disability insurance.  If we were to be disabled on active duty, our disability pay would not reflect our physician bonuses and higher income.  For years I struggled to find supplemental disability insurance.  I used the American Medical Association plan because they’d give me up to $2500/month of additional coverage and it was all I could find.  That was until I contacted Andy Borgia at DI4MDs.com.  He was able to get me the amount of coverage I needed when many, many other people couldn’t.  For some reason many disability insurers don’t want to cover active duty.  Below is a post from Andy about supplemental disability insurance.)

May is disability insurance awareness month and also the time of the year a number of physicians transition into new positions due to the completion of most training programs July 1st. As a result, it is an excellent time to examine protecting the most valuable asset any physician has, their ability to practice and earn an income. Whether you are a military physician with a number of years left to serve, soon to be exiting the military or currently in a residency/fellowship program, it would be prudent make certain you are adequately protected in the event you become disabled and unable to practice due to a sickness or accident. Statistics, which can be found all over the internet, including our site, indicate approximately 1 in 3 people will be disabled during their working career, which can be the cause of financial ruin. Disability insurance for physicians is universally recommended.

Being active duty military, you may think you are already adequately protected. This is far from accurate since military disability benefits only cover base pay and do not include incentive, special or bonus pay, allowances or private earned income. These extra forms of income usually provide the majority of a military physician’s pay and should and can be protected. If you are about to leave the military, the day after you are discharged, any military disability coverage will cease and you will be completely unprotected. Establishing an individual disability insurance policy can take up to 4 months, since medical records must be obtained so to be adequately protected requires advanced planning.

To make certain you and your family are protected, establish an individual disability insurance
policy. The individual policy contractual provisions should protect you in your chosen medical specialty for the entire benefit period, provide both total and partial disability benefits, allow for an increase in coverage upon completion of duty without additional medical requirements, and be noncancelable and guaranteed renewable (policy cannot be cancelled, premiums changed, coverage altered by the insurance company). Residents and fellows may be eligible for discounted polices if established prior to completion of training and should be taken advantage of.

Contact an experienced insurance agent that represents a number of companies and is familiar with contractual provisions and underwriting procedures, it does make a difference, to explore your
options. Please visit our website www.DI4MDS.com to obtain our Military Physician Disability Insurance Guide. This will provide an educational first step.

For a complementary personal disability insurance consultation please contact me directly (Andy G Borgia CLU, andyb@di4mds.com, 888-934-4637).

Old vs New Retirement System Explained

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I already discussed the value of a military pension, but this article from the Military Officers Association of America does an excellent job of explaining the old and new systems, so I wanted to reblog it for anyone who’s interested to read:

The New Service Retirement Program

How Valuable is a Military Pension?

Posted on Updated on

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.

Annuity Websites

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.

Unquantified Value

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.

Have Student Loans? Check This Out

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Although personal finance is a hobby of mine, I’m nowhere near an expert when it comes to student loans because I never had them.  That said, I know there are a lot of Navy physicians who do have them and might want to refinance.  Anyone who does have loans should check out the White Coat Investor because it is probably the best resource on the web for information on dealing with student loans (and other financial topics).  Here is his latest post:

What Should I Do With My Student Loans?