Podcast Show Notes & Transcript

Summary

In this conversation, Mike and Amy continue their 3-part series Blended Retirement System focusing on the lump sum payment option at retirement.

Takeaways

• The lump sum payment option in the blended retirement system allows service members to receive a portion of their pension at retirement.
• The lump sum payment is calculated based on the present value of the pension from retirement until the age of 67.
• Taking the lump sum payment reduces the monthly pension payout until the age of 67.
• Factors to consider when deciding whether to take the lump sum payment include tax implications, discount rate, and personal financial goals.
• Consulting with a tax advisor and financial planner is recommended before making the decision.

Chapters

00:00 Introduction to the Lump Sum Payment Option

03:13 Calculating the Lump Sum and Present Value

06:29 Understanding the Present Value of the Pension

10:16 Calculating the Lump Sum Amount

19:19 Reasons to Consider Taking the Lump Sum Payment

20:17 Important Considerations and Conclusion

Links

https://militaryfinancialadvisors.org/blended-retirement-system-evaluate-the-lump-sum-option/

https://militarypay.defense.gov/Calculators/Blended-Retirement-System-Standalone-Calculator/

Operation Retirement Readiness:  BRS Part 1 

Operation Retirement Readiness:  www.operationretirementreadiness.com

Schedule a consultation with Mike: https://nextmissionfinancialplanning.com/contact/   

Schedule a consultation with Amy: https://www.instarfp.com/contact

TRANSCRIPT

Mike (00:05.213)

Hey, Amy. You know, the last couple episodes, we’ve been hitting on the blended retirement system and all the changes that have come with that. We also hit the continuation pay that’s available in the mid -career. And today, we want to dive into one of the other kind of probably lesser known options for the blended retirement system. And that’s a lump sum payment at actual point of retirement.

Amy (00:36.194)

Yeah, now sometimes people confuse continuation pay with the lump sum pension option. So as we have noted last week or last time, these are completely separate elements and decision points. Both are big decisions, but they’re different. And today we’re going to jump into the details of the lump sum option and offer tips to consider when it’s time for you to make your decision.

Mike (01:00.169)

So again, for BRS and the recap, go back a couple episodes and listen to that. But I’ll just hit on standard retirement at 20 years of service for somebody under BRS. The multiplier is now 2%. So they’re going to get 40 % of their base pay at the 20 -year point. It continues. If you do 25, you’re going to get 50%.

But that’s kind of the basics of the pension part of BRS. And so one of the options that they introduced with BRS is the ability to take a lump sum portion of that when you retire. And those options are either 25 % or 50 % of what we call the present value of what the service member would receive.

at their pension, you know, from their pension at the age of 67. So in exchange, it’s not free money. You don’t get to keep both. But in exchange for taking the lump sum, know, service members are going to receive a lower pension payout between when they take it at retirement and age 67. Then at age 67.

is going to jump to what it would have been had you not taken that piece. that’s a lot, a bunch of different numbers flying around there. So we’re going to dive in and try to explain it so that you understand exactly what this decision is and whether it makes sense for

Amy (02:47.566)

Yeah, and I think maybe a good way to start is to give an example, something tangible. So let’s say that you’re in E8 and you’re retiring with 25 years of service. For the sake of simplicity, we’re going to say that your high three is for monthly pay is $6 ,800. Okay. So 25 years, 2 % multiplier, 50%, right?

So your full annual pension for 25 years at the 25 year mark, so that’s 25 years times 2 % times the 6 ,800 monthly pay, that’s $3 ,400 per month, right? So 3 ,400 times 12 is $40 ,800. So that’s what your 12 month pension will be. I think that’s pretty intuitive. I think everybody can figure out what their pension would be. That’s the easy part.

 

It’s your high three times number of years times the 2 % multiplier. Everybody does this math. But to figure out the lump sum, we have to figure out something called the present value. Mike mentioned this, the present value of the total pension this person, so this E8, would receive from the date of their retirement until they turn age 67.

 

So, you know, we’re using 67 as the full retirement age, by the way, in the rule, it says the lump sum is actually based on full retirement age. We’re using 67 because that’s full retirement age as of right now. This could change.

 

But for right now, everybody’s full retirement age is age 67. Okay, so Mike, walk us through now. So we know that this is a E8 with 25 years of service. Let’s assume they’re gonna retire on their 44th, right on their 44th birthday. Can you just walk us through the total pension amount for the years between 44 and 67?

 

Mike (04:49.297)

So there’s a calculator for this because, again, it’s a little complex. It’s one of the things that as financial planners, you went through getting your CFP designation. That is a lot of math, but we’ll walk through the basics of it. So continuing the example, like you said, E8, let’s assume.

 

44th birthday. So between 44 and 67 for retirement age, 23 years. So that’s the gap that they’re going to receive those lower payments on if they decide to opt in. you know, basically to, we’ve got to take that money and average it across those 23 years.

 

And that’s where again the math gets a little more difficult because you’re also dealing with inflation and things like that and the cola to the pension so But Amy, can you tell us what you know, the the present value really

 

Amy (06:00.0)

Yeah, so present value. let’s think about it like this. So Mike, if I said that I was going to give you a thousand dollars today or I’m going to give you a thousand dollars in five years, you’d pick that you want the money now, right? Because when you have the money now, it’s more valuable to you. You can use it the way you want. You can invest it. You can grow it. And maybe it’s worth more than a thousand dollars in five years. Now, your pension is very similar, right? So your pension is made up of a series of

 

those future cash flows. So we have to figure out what the value of those cash flows, those future cash flows would be in today’s dollars. In order to do that, there’s something called a discount rate and the DOD sets the discount rate each year. And essentially what happens is that future cash flow, so that future $40 ,800 is,

 

discounted back into today’s dollars and that’s the present value. Like I said, this is used, this is updated by DOD each year, calculated on June 1st and then it goes into effect the following January 1st. The current rate for 2024 is 6 .26%. Another way to think about this is if you took the lump sum from your pension,

 

You’re borrowing money from your future self at 6 .26%. So, you know, if you think about that, you know, we have mortgages, we have credit cards, things like that. You’re borrowing money from your future self at an interest rate of 6 .26%. So Mike, can you talk a little bit more about, you know, what that means, this idea of borrowing from your future self?

 

Mike (07:51.753)

Sure. So, you know, if you’re going to go out and get a loan and, you know, that’s your interest rate, 6 .26 % on the money that you’re paying back. You know, one way to think about it is could you, you know, borrow that money, invest it, make a higher return than that 6 .26 %? Because if you could, you’re probably going to be better off. You know, then it makes sense to borrow the money. If you know, you think you

 

then you may not want to borrow that money. you know, little context on pensions. Your pension is basically guaranteed, you know, so you know that that’s the discount rate and the 6 .26 % is what you’re going to get. So.

 

You know, that’s that’s really the gamble you’re taking is is that going to be higher or lower kind of in the future? And it really probably more comes down to what are you going to do with the money? But we’ll kind of get into that a little more. But again, you know, if you take the lump sum. You may or may not, you know, get six point six percent, you know, as of right now.

 

for that money that you’re borrowing. And so that’s kind of the gamble you’re taking.

 

Amy (09:21.026)

Yeah, and it’s, I mean, this is a complex financial concept. Financial planners have to learn this stuff. takes all of us a while to understand it. So, you know, stick with us. Let’s get back to the example. So there’s a number of present value calculators that you can use. You plug in the discount rate, you plug in the annual cash flows that you’re discounting, and it’ll give you the answer, okay? Now we have to keep in mind that pensions are also

 

for inflation so the the cola factor that Mike mentioned. So you know if we just use a spreadsheet and we calculate the present value of this E8’s pension from retirement so from age 44 to age 67 it’s about seven hundred and forty four thousand dollars okay. So your option for the lump sum is you can either take 50 % lump sum or you can take 25 % lump sum.

 

50 % for this person in this example is about 372 ,000, 25 % is about 186 ,000. So if this person shows, for example, 25 % lump sum, he or she would receive 186 ,000 about 60 days after retirement.

 

or he or she could choose to receive that lump sum over four years to reduce the tax impact because it could be, you know, the lump sum payout is considered all taxable income when received. So that would be a big tax bill. So this is what you would get. This is what this person would receive. Mike, tell us what they’re giving up in order to get that 25 % lump sum.

 

Mike (10:56.265)

Sure, so if the person takes the 25%, again, their payments reduced from their pension until they hit age 67. At age 67, it’s going to jump back up to what it would have been had they not taken it. If they take the… And so for our example, they were going to be getting about $3 ,400 per month. And so they would lose a quarter of that.

 

I’m to do the math in my head, it’s somewhere. We’ll do the 50 % one because that’s easier. But and so for the 50%, if they take that amount that Amy talked about, their pension is going to be reduced from that $3 ,400 to $1 ,700 per month. But they’ll have that big lump sum of money that they can they can use. So again, you know, big.

 

upfront number may be tempting, but you’re talking about reduced payments over 23 years based on being 44 when you’re retiring. so, you know, it’s really a personal decision of whether, you know, what are your needs for the money? It can definitely make sense, even if even if you’re not going to earn that much.

 

you need that money to buy a house or, you do something else, it might make

 

Amy (12:32.62)

Yeah, I mean, there’s there’s a lot that goes into this some things to keep in mind as you consider this decision. We mentioned it earlier.

 

All of the income is taxable in the year you receive it. So whether you take a lump sum all in one year or you spread it out, it’s taxable all in that year. So it’s possible that you’re going to be giving up 25, 30, 35 % or even more to the IRS. If your state where you’re retiring and you’re becoming a resident is it taxes pensions, then you might also give up money to the state.

 

So before you speak before you take the lump sum you really should speak with a tax advisor Make sure you understand exactly the impact that’s gonna have on your overall situation It’s not enough to just assume that you can multiply your income But what by whatever bracket you think you’ll be in there certain taxes that you may not be paying at a lower income level So once you get to a higher income level these other taxes might kick in

 

Also, another, you know, sort of consideration is if you’re considering taking the lump sum is to keep in mind the behavioral aspect of receiving this lump sum of money. You have to, especially if you’re doing it for specific purpose, you have to remain disciplined in spite of receiving a lump sum of money. So you feel wealthy, you feel like you can spend money. It’s very difficult for the average human being to pull that off.

 

So there’s just a couple of the factors. Mike, having said this, there’s still reasons that there might be a, you know, it might be a good idea to take a lump sum for some people. Mike, why don’t you keep talking about good reasons people might take the lump sum.

 

Mike (14:15.145)

Sure, I’ve threw out a couple, like I said, even if that 6 .26 % isn’t, you’re like, oh, I’m going to earn 8%. So I’m just going to save this money and do that. Maybe you’ve got high interest debt. Maybe you got credit card debt that’s costing you a lot of money. Or some other issue where you’ve had to run up a bunch of debt.

 

It could make sense paying off that high interest debt with something that is quote unquote 6 .26%. It could make sense and maybe it’s only a portion and you save or invest rest. So at that point, could make sense. The other thing is maybe you want to start a business or a franchise business that there’s some upfront

 

that if you had this money that you could use to do that, that would potentially be a good use of that money. Even if you’ve done your 20, 25 years, if you’ve been a diligent saver and it looks like, my retirement is on track,

 

You could take that money and maybe you want to take a sabbatical. Maybe you want to, you know, travel for a year. That could be a great source of funds to do that. You’re not running up more debt while you’re gone. And, you know, yes, you’re going to have lower payments over that time. most most people after retirement, you know, even if they take some time off, the money’s there in that second career. And you can go in and get that job.

 

And the other nice thing is, yes, you’ve taken that initial tax hit. But now, if you’re earning significant amounts of money after in your second career, you don’t have all that pension income on top of it. So it could actually lower your tax. It’s almost like putting it into a tax deferred piece, although you have paid the taxes upfront.

 

Mike (16:38.729)

that you’re generating less income over those years between retirement and 67. That if you’ve got that second career coming online that you’re making hundreds of thousands of dollars, it might even make sense even if you’re going to quote unquote, the money on the sabbatical or travel or whatever else you might do.

 

There’s just some of my thoughts on why it might make sense. Again, very personal decision. Encourage you to really run the numbers and see what you’re giving up and what the impact is going to be to your long -term financial success. So definitely recommend you talk to somebody about that before you make that decision.

 

Amy (17:33.036)

Yeah, and I mean, you those are all good reasons to consider it. You know, but make sure you also are keeping in mind some other, you know, if you have a bunch of debt, some of it’s student loan debt, what are the forgiveness options that might be on the table for you?

 

Are there debt consolidation plans? Have you stopped taking on new debt? Because if your idea is that you’re going to pay off all your debt with this big lump sum, but you haven’t addressed the cause of what’s creating the debt, you now are reducing your income stream because you’re retiring, and then you’re going to reduce it some more.

 

but you definitely have not fixed the problem with the debt. So you’re gonna be right back where you started. So there is a lot that goes into this decision. So I think the key takeaway here is before you take the lump sum, make sure you fully understand the cost of taking the lump sum. Make sure you understand what you’re giving up. The tax costs, the discount rate, meaning the amount of money or the amount of interest, if you will, that you’re kind of borrowing money for yourself at.

 

And, know, whatever is motivating you to consider this option, paying down bills, making an investment, taking some time off, you know, determine whether or not there’s another better way to achieve your goal without taking the lump sum. And that might mean that, you know, you need to run calculators. you need, you need fancy spreadsheets. You need to talk with a professional.

 

Just make sure that this is an irrevocable decision. Once you say yes and you want the lump sum, you’re in it. So it’s a big deal. Take everything into consideration and do a good analysis before you make the decision.

 

Mike (19:17.129)

Yeah, I’ll throw one more out there that I kind of hit on. But a house down payment could be used for that with mortgage rates at 7%, 8 % right now. Although they’ve been slowly drifting down a little bit. That could reduce your mortgage payments over the next 30 years. So again, of different nuances to consider.

 

And kind of just to wrap it up on some of the technicalities, you need to request this at least 90 days before retirement. And that’ll be the decision to take it or not. And then PFAS typically pays it 60 days after retirement. So again, look at those dates. And again, that will feed back into the tax calculations of.

 

depending on when you retire, when your official retirement date is, when this would actually pay out, you you’ll want to really consider that for if you’re taking a single lump sum. And then the other option is you can get it divided over four years to minimize the tax impact. So again, more math to do to understand this. And then finally,

Doesn’t impact the ability to get into the survivor benefit program. So no worries there. Amy, anything I missed?

Amy (20:53.9)

No, I think that about covers it. We’re going to put some other resources in the show notes. So we mentioned some calculators. We’re also going to include a blog written by one of our colleagues over at Military Financial Advisors Association that helps walk you through this in an article if you take information in better that way. Other than that, I think we covered it, Mike. It’ll be, I appreciate your time today and look forward to talking to you next week.