Investments

How To Get Rich In The Military

By David Krug David Krug is the CEO & President of Bankovia. He's a lifelong expat who has lived in the Philippines, Mexico, Thailand, and Colombia. When he's not reading about cryptocurrencies, he's researching the latest personal finance software. 10 minute read

Military personnel are accustomed to overcoming obstacles. Combat tours, deployments, and transfers are all common sources of stress. You won’t get much practical experience in handling money while working.

A third of active-duty military personnel had been late on at least one monthly payment in the previous 12 months, according to 2019 data from the National Foundation for Credit Counseling. Since 2014, that number has more than doubled, which is cause for concern because it suggests a growing trend.

To most service members, investment is something they should put off until they have paid off their debt and built up a financial cushion. To start saving for retirement and perhaps generating a passive income stream via investments, one must first get out from under any debts other than the mortgage.

A military pay might not be enough to retire comfortably, but it does provide access to a number of investing and savings opportunities that are unavailable to the general population. By putting them to good use, you may secure your financial future and perhaps even retire early.

Military Pension

For veterans with 20 years or more in the military, the military pension system is their most valuable financial resource. At 20 years of service, the member receives a yearly income equal to 50% of their base pay; after that, the annual income increases by 2.5% for each consecutive year of service.

Plus, the retiree receives a yearly cost-of-living boost related to the consumer price index (CPI) (CPI). Retired military members not only receive a generous pension, but also lifetime medical coverage at a reasonable cost, and additional perks like base access and exchange shopping privileges.

Despite these perks, the pension doesn’t always yield as much cash as military families would prefer. Service personnel, fortunately, receive additional perks once they retire.

Thrift Savings Scheme

Despite its potential, the Thrift Savings Plan (TSP) offered by the United States government is rarely used. Although all active-duty troops are automatically enrolled, far too few actually contribute and reap the benefits.

The new Blended Retirement System was introduced by the Department of Defense in 2018, and it mixes the traditional military pension with a defined contribution plan similar to a 401(k).

The Thrift Savings Plan (TSP) is a retirement investing account available to U.S. military personnel that is easy to use, inexpensive, and tax-sheltered. In this way, they may take advantage of the power of compounding by investing money that isn’t subject to taxes right away in the stock market and other investment options.

Tax Benefits

The money you put into a TSP, like 401(k) contributions, is exempt from federal income tax. A profit equivalent to your tax rate is generated instantly.

If your usual income tax rate is 25% and you donate $10,000 to your TSP account, you will keep the full $10,000. Over the decades leading up to retirement, that sun will rise thanks to compound interest.

However, members are subject to income tax on the total amount they withdraw after they reach retirement age.

However, contributors who earn tax-free pay while serving in a conflict zone can access their contributions tax-free in retirement. That’s a great perk that’s hard to get by elsewhere.

There is also a Roth TSP available to service personnel, which inverts the tax benefits. With a Roth 401(k) or TSP, you’ll have to pay taxes while you earn the money, but withdrawals in retirement will be tax-free.

Contribution Limits

There are similar restrictions placed on contributions to TSPs as there are to 401(k)s and 403(b)s for retirement savings.

Service members under the age of 50 can make a contribution of up to $19,500 in 2020 and $20,500 in 2021. For those above the age of 50, the maximum yearly contribution is increased by $6.500, up to $25,000.

This graduated contribution cap allows workers who are getting close to retirement age to sock away more money during their last years of employment.

Matching Contributions

Members of the armed forces are eligible for the government’s substantial matching contribution program.

The government begins contributing one percent of military salaries beginning 60 days following registration. This is yours regardless of whether or not you make any contributions to your TSP account.

Additionally, the government will match up to 4% of your donations. There is a dollar-for-dollar match on the first three percent of salary that you put in. The military will match 50 cents on the dollar for each additional 2 percent you put in.

Accordingly, if you put in 4% of your pay, you’ll earn a matching 3.5%. If you put in 5%, the most you’ll get back in matching funds is 4%. When added to the standard 1% payment, this means that service members can contribute up to 5% per year.

Low Expenses

The low costs of participating in the TSP are another perk for investors. The TSP’s approximate expenditure ratio of 0.015 percent is among the lowest of any major retirement savings program.

Your money will go further because of the low expense ratio than it would in a managed mutual fund, where the fee ratio might be 1.5% or higher.

Members may retain more of their savings in the market thanks to low cost ratios and less payments to high-priced mutual fund managers. In particular, this is helpful since the TSP provides access to target-date funds that gradually reduce risk as retirement approaches.

When acquired outside of a TSP, these sorts of funds typically have significantly higher expense ratios.

Investment Options

You may tailor your TSP investing strategy to your risk tolerance and time before retirement. Individuals can increase their portfolio diversification by purchasing shares in one or more funds.

  • G Fund. The TSP’s default investment fund, the G Fund, holds government assets that have historically low volatility and conservative returns. If you don’t specify which fund you want your TSP money to go into, it will be allocated to the G Fund.
  • Four Funds: F, C, S, and I. Bonds, large-cap stocks, small-cap stocks, and international corporations are all represented by the F, C, S, and I Funds, which are all index investments. BlackRock Mutual Funds oversee these investments, which aim to mimic the performance of several open-market index funds.
  • L Fund. The L Fund is a relatively new investment option that operates like a target-date fund, allowing participants to select a retirement projection that comes as near as possible to that date. The fund will invest more conservatively the closer you go to retirement, based on how much time you still have until you can draw on the money.

Withdrawal Rules

Withdrawals made after age 59 1/2 are treated the same as withdrawals made from a 401(k) account, i.e., as regular income subject to the usual rates of taxation. For those who cash out their retirement funds before turning 59 and a half, a 10% penalty is assessed on top of the ordinary income tax rate.

Withdrawals can be delayed until the member reaches age 72 if they believe they won’t need their retirement income until then. The exact date is April 1 of the year after their 72nd birthday.

Thereafter, account holders are obligated to begin taking yearly distributions known as RMDs in order to gradually reduce the account balance. After that time, you’ll face severe fines from the IRS if you don’t start taking withdrawals.

TSP Loans

While serving in the military, you can borrow money from your TSP in the event of an emergency and then pay it back over the course of one to fifteen years. Customers have access to two distinct loan options, both of which can be used for either general or specific purposes.

The former has an adaptable one-to-five-year payback schedule and may be used for anything. The latter type of loan allows for a maximum payback time of 15 years and can only be used for a primary dwelling. You’ll need to provide proof of the planned use in order to get a loan for a

It’s important to keep in mind that there’s an opportunity cost associated with borrowing money in addition to the interest you’ll have to pay back. You forego the interest, dividends, or other profits that would have accumulated on the borrowed funds during that time.

Also, if you pay the interest on your loan using after-tax money, you’ll have the pleasure of paying income taxes twice on those funds when you take them in retirement.

Traditional IRA

In addition to a Thrift Savings Plan, military personnel who are interested in lowering their taxable income but want additional investment possibilities can create a standard IRA. In the same way that you can create a Roth IRA with almost any brokerage and invest the money anyway you choose, you can do the same with a regular IRA.

Tax Benefits

Taxes on regular IRA contributions are postponed in the same way they are on TSP contributions. That has the potential to enhance the total amount you can provide. If you pay 25% in taxes on your income, then a $5,000 donation might end up costing you only $3,750.

Contribution Caps

With both Roth and standard IRAs, the contribution caps are the same. If you’re under the age of 50, you may put in up to $6,000; if you’re 50 or over, you can put in up to $7,000.
Both you and your spouse need to be gainfully employed in order to fund a conventional IRA, but you can do so regardless of your income level. However, in order to receive the maximum tax deduction, your annual income must be below $66,000 if you’re single or $105,000 if you’re married filing jointly.
There is a phasing down of the deduction for people with incomes between $66,000 and $76,000 ($105,000 and $125,000 for joint filers), and those with incomes over those thresholds cannot deduct any payments.
Warning: Federal law forbids contributing more than the restrictions stated above to one or more IRAs, so keep that in mind if you’re thinking of investing in both a Roth and a standard IRA. You can’t put more than $7,000 into your IRAs in a given year (or $7,000 if you’re over 50).

Withdrawal Procedures

Withdrawals made before age 59 1/2 will be subject to a 10% early withdrawal penalty in addition to standard income tax. Both your contributions and any gains you take out before the plan’s maturity date are subject to taxes and penalties from the Internal Revenue Service.

Consequently, if you think you might use some or all of your contributions before retirement, a Roth IRA is the better choice. Additionally, once you reach the age of 72, you are obligated to start withdrawing money from your conventional IRA or face severe penalties.

Investment Choices

A conventional IRA can be opened at any investment-handling financial institution, just as a Roth IRA. That gives you a range of investment opportunities only limited by your imagination.

Target-date funds, mutual funds, ETFs, stocks, bonds, and options are all viable investment possibilities. You may invest however you like, whenever you like, and in whatever way best suits your personality and goals.

Real Estate

Only a small fraction of a balanced portfolio should be invested in paper assets. To diversify your portfolio, real estate should not be overlooked. There are far too many positives associated with real estate to overlook. These include tax benefits, inflation protection, passive income, and the potential to leverage other people’s money.

Direct Property Investment

Direct property purchase is one viable choice. Once you’ve settled in at your next permanent change of station (PCS), you might want to consider turning your new primary abode into an investment property. As an alternative, you may invest in a rental property from the ground up with Roofstock.

There are unique factors to consider when deciding whether to purchase or rent a home if you are in the military.

Flipping houses is an alternative investment method to buying and holding. Even if you pay someone else to do the modifications, the amount of time and effort required makes this feel more like a side business than a serious investment.

REITs

There are several types of REITs, or real estate investment trusts. Publicly traded real estate investment trusts (REITs) can be purchased with either a taxable brokerage account or an individual retirement plan (IRA). SEC rules require them to distribute 90% of annual profits to shareholders as dividends, and they must comply or face stiff penalties. That usually indicates a high dividend yield but limited growth prospects.

You should only acquire private REITs from the issuer themselves. To investors’ advantage and detriment, they are not subject to the same level of SEC regulation.

However, this gives the fund’s management a great deal of leeway to increase the fund’s assets rapidly. Several private REITs that I invested in, such as Fundrise and Streitwise, have done well for me.

The methods through which individual REITs acquire and manage real estate properties also differ. Mortgage REITs provide loans secured by real estate, whereas equity REITs hold the assets outright.

Finally, each REIT specializes in a certain sector of the real estate market. Many investors focus on residential real estate, while others favor commercial, industrial, or even undeveloped property.

Other Indirect Real Estate Investing Opportunities

Admit it. Most people wouldn’t want the hassles landlords have to deal with. However, real estate investment trusts (REITs) aren’t the only vehicle for investing in real estate without taking title.

It’s a good idea to look at alternatives to direct real estate investments, such as private notes, real estate crowdfunding websites like Groundfloor, private equity firms, and real estate syndications. Keep in mind that most real estate syndications and private equity funds will only accept accredited investors.

You may put money into real estate ETFs through your 401(k), IRA, or brokerage account. Investment funds that focus on certain sectors of the real estate market include homebuilder ETFs, hotel ETFs, and others.

Bottom Line

Those serving in the armed forces who are interested in making wise investments for their retirement should first and foremost look into the federal Thrift Savings Plan. When compared to the majority of investments open to the general public, its cheap price structure helps you to save a ton of money on management fees and other costs.

However, military personnel who wish to further diversify their retirement portfolio may create a Roth or regular Individual Retirement Account. You can put your money into any one of these vehicles, or into a mixture of them. All of these things contribute to your retirement riches and security in addition to your military pension.

Members of the armed forces have access to a wide variety of investment opportunities, not limited to tax-deferred retirement accounts, such as taxable brokerage accounts, real estate investments, and college savings accounts. Ultimately, your long-term goals, your tax bracket, your outlook on future taxes, your desire for investing flexibility, and your ability to contribute will determine which accounts you utilize.

Maximize your savings rate to amass money as quickly as possible and leave yourself in a far better financial situation tomorrow than you are in today.

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