Grow and Thrive - Beginning Phase 3
In Phase 1 on your path to financial independence, it was crisis mode - stop hemorrhaging money now! Moving on to Phase 2, the goal was to stabilize the situation - set a strong foundation for future growth. Now, in Phase 3, we’ve built that foundation, and the focus now becomes truly building your wealth - not just to survive, but to truly thrive. Specifically, now that you've 1) paid off your consumer loan and credit card debt; and, 2) established a healthy emergency fund, we'll reallocate your Excess Income to support this growth.
BUT, this is no get-rich-quick scheme. Rather, as you move forward and embrace this plan, you will slowly - but surely - reach financial independence. And that’s what it’s all about, not the money itself, but the freedom that money provides you to pursue your purpose. When you have doubts or frustrations - and we all do - find inspiration in that reason you initially set for deciding to take control of your financial life.
Congratulations on reaching this point!
The Three Pillars of Military Retirement
In the post-Blended Retirement System (BRS) world, the military has three pillars to its retirement model: the traditional TSP, Roth TSP, and defined benefit pension. Making the most of these three will put you in outstanding financial position as you transition out of your military career.
Broadly speaking, the three work together like this: when you retire after 20 years, you’ll immediately begin to receive your pension payments - a nice check dumped into your bank account every month. Then, at age 59 ½, you get a nice little bump and can begin withdrawing money from both your traditional (need to pay income tax) and Roth TSPs (don’t need to pay income tax), money that’s been growing with that magical thing called compound interest, since the day you first opened your TSP! Details below.
***Note: Due to personal reasons, I chose to separate from the service after nine years and did not use the pension portion of military retirement in my own financial journey, but this doesn’t change how awesome an opportunity this is, which is why I emphasize pension benefits here.***
The Traditional/Roth TSP Combination Plan
In Phase 1, you enrolled in the traditional TSP to gain the 5% government match. This means you’re already getting two awesome benefits. First, the 5% of your base pay that you contribute is not included in your current tax bill, so you save cash every year when it comes to tax time. Second, that 5% that you contribute is automatically doubled, as the government matches up to 5% and deposits it directly into your traditional TSP. Continue to take advantage of this your entire military career, and you’ll have a nice little retirement nest egg established.
Now that you’ve reached Phase 3 and are in a much better position financially, it’s time to start contributing to your Roth IRA, an absolutely incredible retirement savings tool. While I won’t cover all of the tax-specific details here, a Roth TSP works like this: every dollar you contribute to this account is taxed on your current tax return, and then, it grows tax free. As a result, when you turn 59 ½, you can begin withdrawing your initial contributions plus all compound interest growth of those earnings TAX FREE! Here are a couple examples to show how awesome this is:
Scenario 1
Situation: At age 30, you contribute $2,000 to your Roth TSP then completely forget about that money until age 59 ½, never contributing another dollar.
Years to grow: 29 ½ (age 59 ½ [withdrawal age] minus age 30 [current age])
Assumption: 7% interest growth (normal planning factor for a stock-based portfolio)
Your money at age 59 ½: ~$14,700*
Scenario 2
Situation: Same as above, but after your initial $2,000 contribution you contribute $2,000 more per year until you retire from the military at age 40, then forget about it until age 59 ½.
Years to grow: same
Assumption: same
Your money at age 59 ½: ~$125,300!*
*Want to play around with these numbers? Here’s a good compound interest calculator.
Bottom line - the more you contribute and the earlier you start, the more you’ll have in retirement.
Next Steps and Reallocating Your Excess Income
Because each service does it a little differently, confirm with your admin/personnel office how to open a Roth IRA - then do it! Now that you’re already contributing 5% of your base pay to your traditional TSP to receive the 5%, government match, I recommend contributing each additional percentage to your Roth TSP. So, every time you get either a time-in-service raise or promotion, add a percentage or two to your Roth TSP contribution. In 2019 you’re allowed to contribute up to $19,000 to your entire TSP (traditional and Roth combined) - while this is certainly a lot of money, work towards this goal!
So how much should you initially contribute? Here's where that Excess Income comes into play. Now that you've finished putting together your healthy emergency fund and paying down consumer/credit debt, you have that extra money floating around each month. Use this as your initial Roth TSP contribution! Example: let's say you're an E-6 with 10+ years of service, current base pay is $3,656.23/month. Next, say your Excess Income (identified in your budget) is $200/month. To find out the percentage you should start contributing to your Roth TSP, divide Excess Income by base pay and multiply it by 100: ($200 / $3,656.23) x 100 = ~5.5%. This now becomes the beginning contribution percentage when you open your Roth TSP. And, as stated above, treat every raise you receive as an excuse to increase this by a percentage point or two. You've now successfully reallocated your Excess Income from paying down debt to building your wealth!
So how much should you initially contribute? Here's where that Excess Income comes into play. Now that you've finished putting together your healthy emergency fund and paying down consumer/credit debt, you have that extra money floating around each month. Use this as your initial Roth TSP contribution! Example: let's say you're an E-6 with 10+ years of service, current base pay is $3,656.23/month. Next, say your Excess Income (identified in your budget) is $200/month. To find out the percentage you should start contributing to your Roth TSP, divide Excess Income by base pay and multiply it by 100: ($200 / $3,656.23) x 100 = ~5.5%. This now becomes the beginning contribution percentage when you open your Roth TSP. And, as stated above, treat every raise you receive as an excuse to increase this by a percentage point or two. You've now successfully reallocated your Excess Income from paying down debt to building your wealth!
Note: When you begin withdrawing money from your TSP at age 59 ½, the money will be proportionally drawn from both your traditional and Roth. So, if you have 70% in your Roth and 30% in your traditional, 70% of each withdrawal you make will be tax-free, and you’ll need to pay income tax on the 30% from your traditional account.
An Endangered Species - The Pension
In the civilian job world, no-kidding pensions (aka “defined benefit plans”) get rarer and rarer every day. Instead, most employers have transitioned to the civilian equivalent of a TSP, known as a 401(k) or “defined contribution plan.” And, the ability to find a pension after only 20 years, almost impossible! With that said, while the payout in the BRS-version of the pension is lower than the legacy military retirement system, getting 40% of your high-three base pay after 20 years is unbelievable! (full details here). While a 20-year career in the military is absolutely not for everyone (as I said above, myself included), it can be an incredible way to establish your financial health if you love what you do.
Conclusion
You’re going to get out of the BRS what you put into it. By this point in time, you’ve already established a solid financial foundation after completing Phase 1 and Phase 2. Now, take advantage of all three pillars of military retirement - traditional TSP & match, Roth TSP, and the BRS pension - and you’ll be on cruise control to financial independence.
Questions? Thoughts? Recommendations for another topic? Let us know in the comments!
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