Military finances

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To assist in the education of U.S. military personnel on financial topics, this article departs from the wiki's policy of neutrality. Please see forum discussion: Military Investing

U.S. military personnel have a number of financial and investing situations that are specific to military service. Military finances highlights some of these topics.

General military issues

  • Military members move frequently.

These moves make home ownership problematic for military members. Before committing to home ownership, carefully consider the following:

  • Landlording can be a difficult second job especially if one is an absentee landlord.
  • Contrary to popular belief, housing values do not always go up, [1] and transaction costs are huge when you buy and sell. [2]
  • It is likely that you won’t want to go back to your starter house/townhome/condo when you get out of the service, and the burdens of being an absentee landlord will continue.

Give very serious consideration to just renting your entire career, carefully saving up a down payment for your dream house when you get out. Obviously this doesn’t apply to everyone, but it does apply to far more people than usually realize it.

  • Basic Allowance for Housing (BAH)

The Basic Allowance for Housing (BAH) is calculated based on your rank, where you are stationed, and whether you have any dependents registered in DEERS [3]. But there is no requirement that BAH has to be spent exclusively on housing costs. Feel free to spend less and save the difference. BAH is not taxed.[4]

  • Basic Allowance for Subsistence (BAS)

The Basic Allowance for Subsistence (BAS) is calculated based on whether you are an officer or enlisted. Active duty service members who are not issued a meal card are entitled to BAS. There is no requirement that BAS has to be spent exclusively on food. BAS is not taxed.[4]

  • Cost of Living Allowance (COLA)

Cost of Living Allowance (COLA) is available to service members stationed overseas to compensate for the difference in value between the US dollar and the local currency. However, items purchased on-post overseas are still bought in US dollars. There is no requirement for you to spend this on the local economy, so feel free to save/invest this. COLA is not taxed.

  • Military members have low tax burdens.

Most military members have an effective federal tax rate well below 5%, and many are negative. Allowances are tax-free. Basic pay is tax-free when one is deployed. Even re-enlistment bonuses can be tax-free if taken while deployed. In general, with these low tax rates, choose a Roth account (pay tax now instead of later) instead of a tax-deferred account (pay tax later instead of now.) The TSP (Thrift Savings Plan) offers a Roth option, and military will normally have low enough income to contribute to a Roth IRA. Additionally, your personal property (such as your car) is considered to be located in your home state for tax purposes. This can be beneficial to service members stationed in a state that taxes personal property (such as Virginia).

  • If you aren’t a resident of a state with no income tax...

If you aren’t a resident of a state with no income tax, examine carefully the advantages of establishing residency in one of these states. (Seven states have no state income tax: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. Two others, New Hampshire and Tennessee, tax only dividend and interest income) [5]. Michigan exempts military pay from its income tax. Note that if one is stationed in Alaska, the permanent fund dividend distributed to state residents is an additional benefit. [6][7]

  • Military members have very secure, very regular income.

Take advantage of this to make your investments automatic. Set-up automatic withdrawals into your retirement accounts to take advantage of compounding returns. In addition, secure income usually requires a smaller emergency fund than the typical person requires. Three months worth of expenses held in an emergency fund should be adequate..

  • Take advantage of educational opportunities available in and through the military

For example, one smart strategy for young military enlistees (age 17) is to go to college while on active duty, transition midway through their careers into an officer field (for example med tech to nurse ), “retire” and at age 37 begin a new career with health benefits for life and a lifetime pension. The new GI bill has many advantageous features. Learn the benefits and take advantage of them. [8]

  • Be cautious when dealing with car dealers.

One does not need to buy luxury vehicles. Unscrupulous car dealers around bases will try to induce you to buy expensive cars. [9] An expensive car can lead one into a debt cycle that will take half a career to climb out of, if one can ever get out at all. Take advantage of free legal services and have your local legal office review the purchase agreement before you sign.

  • Avoid the payday loan shops.

Avoid the payday loan shops that are common at the entrances to the base. Never take a loan from a payday or title loan company. Interest charges are excessively high. Prudent debt management requires one to keep debt under control. Note that a bad credit score will affect one’s security clearance and career.

  • Take advantage of TRICARE health insurance, even after retirement.

There is no better deal in health insurance, and military members can cover all of their dependents cheaply. Military retirees can and should retain coverage, and can select from several plans.[10]

Military specific investments

  • Financial literacy

Personal finance is much more than understanding your investments. It involves items such as managing day-to-day expenses, insurance, and taking care of your family in times of need. Planning a course through this maze is an essential first step. Where do you start? Retired Marine Mark Hensen has created a PowerPoint presentation that will walk you through the basics. Download his free presentation here (Personal Financial Management Basics for U.S. Military).

  • The TSP is the military “401K”.

It is the lowest cost 401K in the country. In investing, costs matter. Vanguard is the low-cost leader in the investment field due to their unique structure. Their investing fees are 1/10th that of most of their competitors, and 1/2 to 1/4 that of Vanguard's Admiral shares. It is a great place to invest, with traditional and Roth options both available. You can currently put up to $17,500 of tax-deferred contributions, or $52,000 of total contributions (including tax-free combat pay) per year into the TSP. [11] There are several different index funds in it. These include:

  • The C fund: an S&P 500 index fund.
  • The S fund: an extended market index fund (all the US stocks that aren’ t big enough to be in the S&P 500 index.)
  • The I fund: a very inexpensive Developed Markets International Index fund (think Europe and Japan). It doesn’t contain any emerging market stocks (like Latin America, Russia, Brazil, China) .
  • The F fund: a total bond market index fund, holding basically all the bonds sold in the US.
  • The G fund: a very special fixed income account. It pays you a bond rate of return, yet with zero risk of loss. [12] Although its expected return is lower than other funds, it is much higher than other similar risk-free investments. As such, many Bogleheads with TSP access use the G fund as their primary bond investment.
  • L funds: target retirement funds which provide a reasonable mix of the other funds with no additional costs for the diversification. Be sure to check the prospectus and find the asset allocation mix you’re comfortable with.

You can exchange funds within the TSP with no transaction fees, commission costs, or taxes. [13] When you leave the service, it is prudent to not take all your money out of the TSP. Subsequent jobs will likely have 401K plans that won’t be as good as the TSP and, as long as you keep some money in the TSP, you can always rollover subsequent 401(k) plan assets back into it in later years.

  • A military pension is better than most pensions.
Consider remaining in the service for the required 20 years to get this pension. A military pension is special for two reasons. First, active duty retired pay starts when one retires, rather than when one turns 65. (Reserve retired pay generally starts at age 60.) A pension beginning in your 40s is a whole lot more valuable than one that begins in your 60s. Second, it includes health benefits. This is such a significant cost to most early retirees that many end up having to work until they qualify for Medicare primarily due to the cost of health care.
Example: How much is the pension and health benefits worth? Well, let’s say you retire as an E-7 after 20 years. That would pay you about $2100 per month, or about $25,000 a year, indexed to inflation. An inflation indexed annuity that pays out $25K a year would currently cost you about $450,000. Add in health care costs for 40-50 years and you can probably safely double that amount. An officer that retires at O-5 would have a pension equivalent to an annuity costing $800K, plus health care benefits. Your regular, secure income combined with this pension allows you to take a great deal of investment risk with your TSP and Roth IRAs.
  • Savings Deposit Program (SDP)

The Savings Deposit Program (SDP) is a program that allows one to put in up to $10K while deployed. It pays 10% per year, guaranteed, and continues to pay for 3 months after one comes home. Take advantage if you can. Given special deployment bonuses, lower expenses, and tax-free income, it should be easy to do. You can also defer tax-exempt money into the TSP, but you should only consider doing this if you are already maxing out the SDP AND Roth IRAs for the year. Even then, you may be better off putting that money toward a mortgage, a downpayment, or even a taxable investing account. Be sure to max out your tax-deferred TSP contribution (at least until the Roth TSP becomes available) before or after you deploy, assuming you’re not gone the whole year.

  • Look into USAA for your insurance needs.

The company has an acknowledged reputation for providing good service and good pricing. [14] Their banking and investments aren’t bad either, although most Bogleheads prefer Vanguard for investments. USAA also offers a car-buying service that includes both new and used cars, and which can provide you some assurance in getting a reasonable deal.

  • If one needs a good cash rewards credit card, consider opening an account at PenFed.

It only costs $5 (which one technically gets back when the account is closed).

  • Be sure to shop on base to enjoy tax-free savings.

Be sure to shop on base to enjoy tax-free savings at the commissary and the BX/PX/Navy exchange. That adds up over time. Remember the laws of economics don’t actually apply at the BX so sometimes you find things ridiculously cheap and sometimes they cost way more than they would elsewhere, so be sure to shop around. Also be sure to ask for a military discount everywhere you go. You’ll be surprised how often you get one. The fewer the number of military people in the area the more likely you are to get a significant discount.

  • Stay away from anything that says “First Command” on it.[15]

Stay away from anyone who encourages you to invest in something because it is better than the TSP. People who cater to military members are not usually looking out for you, even if they’re former military.

See also

References

  1. The rise and fall of residential real estate prices are exemplified by the Case-Shiller Home Price Indices, see Home Prices Continue to Show Seasonal Strength According to the S&P/Case-Shiller Home Price Indices, press release, September 27, 2011.
  2. See What Are The Real Costs of Selling a Home; and State by State Closing Costs, from Bankrate.com
  3. The Defense Enrollment Eligibility Reporting System
  4. 4.0 4.1 See if you can take advantage of the IRS's Savers Credit; check this forum post for details. IRS Publication 3, Armed Forces' Tax Guide will help with taxes.
  5. See FTA State Tax Comparisons, click State Individual Tax Rates for pdf. file for the current year.
  6. See Permanent Fund Dividend Division, Military Information and Permanent Fund Dividend Division, FAQs
  7. Table 1 (page 10) in Individual Income Tax Provisions in the States, from the Wisconsin Legislative Fiscal Bureau, contains a state-by-state list of active duty military pay provisions (Tax Year 2011). July 2012.
  8. See United States Department of Veterans Affairs Post 9/11 GI Bill and especially these forum posts: Military Investing.
  9. See Car Buying Tips For Our Friends in the Military, from CarBuyingTips.com
  10. See TRICARE Publications
  11. See TSP Contribution Limits.
  12. The G Fund interest rate calculation is based on the weighted average yield of all outstanding Treasury notes and bonds with 4 or more years to maturity. As a result, participants who invest in the G Fund are rewarded with a long-term rate on what is essentially a short-term security. TSP G Fundsheet
  13. TSP limits interfund transfers between funds to two per month. After two monthly transfers, only transfers into the G Fund are permitted. See Thrift Savings Plans Information Sheets
  14. USAA, from Wikipedia
  15. See Trapped! Financial Scams Are Targeting Military Families and First Command to Pay $12 Million to Settle SEC and NASD Charges Involving Misleading Sales of Investments to Members of the Military, from the SEC

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