Author Topic: Windfall/Bonus preplanning  (Read 4651 times)

gliderpilot567

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Windfall/Bonus preplanning
« on: November 12, 2015, 10:40:32 AM »
Situation. Active duty military, 10 years in. Next year, I plan to sign the pilot bonus, which is $225k: I can elect to take half up front and the rest evenly over the next 8 years; or, I can elect to take 25k/year for 9 years. After running some scenarios I am almost certain that the half up front lump sum is the better choice so that I can start more money compounding sooner, even if I pay more taxes initially. So that is not really my question, although feel free to chime in if you have thoughts on it. My question, if you read on, is how best to allocate the money to investments.

We are planning to be debt free except for the house by early next summer (about $30k in debts remaining - 20k in student loans at mostly 7%, and 10k left on a car note at 3%). We have one over-leveraged rental property that we'll be in a position to sell and just about break even, so I'm planning to rid us of that encumbrance as well.

The 112.5k bonus, if I accept it, is expected in Sep/Oct of 2016. After that, there will be a $14k bonus paid every year on the anniversary, through 2024. Accepting the bonus commits me to active service through 2025, at which point I'll get the mil pension and we should be close to FIRE if we do this right.

My taxable income is $88k (and will be next year). This is not including the tax-free housing allowance, which happens to almost exactly cover our mortgage payment (not utilities; those come out of regular expenses). We plan to continue to live in houses for which we pay at or below the housing allowance, so for the most part that part of the equation is a wash for now.

I expect at least one more promotion during my career, and the standard 1-1.3%ish annual military pay raise. By 2025 my taxable income should be around $102k in 2015 dollars based on the current pay tables. This will yield a pension of about $50k in 2015 dollars, depending on what the average of my final 3 years is. Add the pension (which is inflation protected) to 4% of whatever we can invest by then and we will be in good shape to FIRE or at worst begin a PT bridge career. I will be 42 and she will be 44.

Currently, my wife works and makes about $43k, but we will be relocating at the end of June so she'll only work half a year. It will be a short one-year assignment, to school, so she doesn't plan to work after that for the rest of 2016.

This means that we're expecting a 2016 income of $109k, plus the $112k half-bonus for a total of $221k gross. Again, this does not include $18k in housing allowance and about $3k subsistence allowance, neither of which are taxable. There will be various relocation allowances and travel vouchers and such, but those mostly wash out.

We have 4 kids under age 17. Planning to continue to file taxes as married/joint.

So after all that, my question is: what do we do in the rest of 2015, and then what do we do in 2016, to best exploit this windfall? I will have about $7-8k cash on hand at the end of 2015, which is currently planned to pay off student loans, but we can redirect it into an investment if it makes more sense. Right now there is only about $2.5k in my TSP and a few hundred in her 401(k), due to our facepunchy past, so we want to build those up ASAP.

I will max out my TSP and her 401(k), to begin with. Where does money go next? Looking to maximize our stash at the end of 2025, while minimizing our tax liability next year.

Expenses, if needed for anyone's math, are around 36k/year. This does not include the house. Yes I know, not very mustachian, we are busting our butts to mustachify our lifestyle. Great progress since last year when we were 130k in the red and spending like consumer suckas.

Thanks for reading! Looking forward to the discussion.
« Last Edit: November 12, 2015, 11:45:39 AM by gliderpilot567 »

humbleMouse

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Re: Windfall/Bonus preplanning
« Reply #1 on: November 12, 2015, 10:50:09 AM »
Question out of curiosity - what is a pilot bonus?  How does one get a $250k bonus in the military?  This is the first time I have heard of anything like this.

gliderpilot567

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Re: Windfall/Bonus preplanning
« Reply #2 on: November 12, 2015, 11:45:21 AM »
It's a bribe the USAF offers fighter pilots, because so many of them are jumping ship to the airlines. It has been in place in some form or another since the mid 90s.

Background info, to become a pilot in the USAF, you go through a year of training which then commits you to ten more years of active duty service. This puts most pilots at the 11-12 year point in their careers once they serve out their commitment. This also just happens to be the point in an officer's career where most have families and are getting tired of the moves and BS, and the 20-year retirement is just a shade too far away. Combine that with the booming airline industry these days, and the result is that the USAF bleeds seasoned pilots that are right at the point in their careers that they are needed for staff and eventually command billets. Hence the bribe.

There are two forms of bonus - the 225k (I typo'd in the original post, its 225 not 250) which commits you to 9 more years of service (which puts almost everyone right at 20); or a smaller, 125k bonus which commits you to 5 more years. The smaller one doesn't make sense to me because if you stay in 16 years, you might as well finish out 20 and get the pension.

This pilot bonus is NOT related to the 30k "REDUX" scam which is a bad-deal incentive available to all military members. Accepting the bonus has no effect on the 20 year mil pension.

There are a variety of other bonuses and incentives available to various career fields, all designed to promote retention.

humbleMouse

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Re: Windfall/Bonus preplanning
« Reply #3 on: November 12, 2015, 12:06:05 PM »
Interesting, thanks for the response.  One more question I would have is why pilots would choose the airline industry over air force - I have heard that pilots in the airline industry make peanuts for wages. 

As far as your original question - I am no expert on tax law but one thing that sticks out is the student loans @7%.  I would use whatever money you have laying around to pay those off asap.  7% is a brutal interest rate. 


Exflyboy

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Re: Windfall/Bonus preplanning
« Reply #4 on: November 12, 2015, 12:20:33 PM »
Interesting, thanks for the response.  One more question I would have is why pilots would choose the airline industry over air force - I have heard that pilots in the airline industry make peanuts for wages. 

As far as your original question - I am no expert on tax law but one thing that sticks out is the student loans @7%.  I would use whatever money you have laying around to pay those off asap.  7% is a brutal interest rate.

They make peanuts if you start with 250 hours "experience" and the basic ratings.. this sticks you in the right seat of a regional jet where you make peanuts for 10 years. The co pilot in the Buffalo New York crash in 2006 apparently was paid $16,000 in the year prior to the crash!

If however you can get to the majors the salary is much more lucrative, much more likely as an ex USAF pilot with a few thousand high performance hours

I looked into this as a possible Post FIRE gig.. I have an instrument rating and about 1200 hours in high performance .. So only needed a couple of ratings and I be an airline pilot right?.. Hahah yeah right!. No way was that kind of experience was going to land me a proper airline job.

Besides all those Part 121 and 135 rules... sounded too much like a real job for my liking..:)

gliderpilot567

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Re: Windfall/Bonus preplanning
« Reply #5 on: November 12, 2015, 12:22:26 PM »
Yup... those student loans are going away ASAP. The car note is a lesser interest rate, but being a much shorter term loan means it eats a lot of income each month. Either way, both of those are in my near-range sights, and I want both gone well before the bonus comes our way. We paid off $100k of other debts over the past 12 months through various mustachification strategies, so we're in the debt payoff home stretch now.

As for why pilots would choose airlines over the USAF - it depends, and is different for every person. Most who do so, end up leaving active duty but joining the Guard or Reserve - so they still get to fly their jet fighters, while working an airline day job. The beauty of that is both careers can be part time and flexible scheduled, allowing more time for happy life. It is true that starting wages in the airline industry are a pittance, but the sooner you get in the more seniority you build, and starting after a 10-year stint in the military gives 10 more years of seniority as opposed to waiting until the 20th year. It really depends on each individual's preferences, financial situation, etc. Also, pilots in the USAF don't always fly. I've been lucky enough to be in a cockpit for the past 10 years, but I'm looking at a year of school and at least two years of non-flying staff before I can get back in a jet. The second half of a USAF pilot's career is more desk time and less cockpit time. Some guys can't stomach this (it was a hard pill for me to swallow, but the knowledge that I could be financially independent at the end was great motivation).

So yes, I am mostly interested in the tax implications with what to do with all that extra money, plus how best to invest it seeing that it will be essentially the beginning of our investments and we'll have $112k (plus everything else we save next year, having no debt payments) to put into an empty portfolio.

Catbert

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Re: Windfall/Bonus preplanning
« Reply #6 on: November 12, 2015, 12:51:10 PM »
I agree with your decision to take as much as possible of the bonus up front.  That will put you in a unique tax situation for one year.  Visit a tax professional and/or spend some quality time with TurboTax to see how it will play out and what your option are.  I expect that you will lose some deductions with the surge income (e.g., ability to deduct SL interest, child care, loses on rental real estate).  Capital gains taxes have a surcharge IIRC above 250K MAGI (or is it 200K).  I don't know exactly how this will affect you since I don't have SLs, children or >200K income.  You may be able to shift some deductions either into or out of 2016 depending on when they will be most valuable.

Definitely max out TSP, IRA and 401k possibilities.  If you wife will only work 6 months in 2016 then double up on her 401k contributions to get the max.  If there is time this year to up contributions (TSP/401k) even for a pay period or two then do it.   

RelaxedGal

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Re: Windfall/Bonus preplanning
« Reply #7 on: November 12, 2015, 01:29:10 PM »
Definitely max out TSP, IRA and 401k possibilities.  If you wife will only work 6 months in 2016 then double up on her 401k contributions to get the max.  If there is time this year to up contributions (TSP/401k) even for a pay period or two then do it.
Or maybe not the IRA - income limit is $183,000 - $193,000

ShoulderThingThatGoesUp

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Re: Windfall/Bonus preplanning
« Reply #8 on: November 12, 2015, 04:13:40 PM »
You can also contribute $14,000 per child to a 529 per year, I think. So in your case that's $56,000 off the top that doesn't need to be taxed.

gliderpilot567

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Re: Windfall/Bonus preplanning
« Reply #9 on: November 12, 2015, 04:37:03 PM »
You can also contribute $14,000 per child to a 529 per year, I think. So in your case that's $56,000 off the top that doesn't need to be taxed.

I believe that 529 contributions are not tax deductible; it's the earnings/distributions that are tax free. Still we will most likely put some of the money into those.

gliderpilot567

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Re: Windfall/Bonus preplanning
« Reply #10 on: November 12, 2015, 04:44:43 PM »
Only next year will have this surge income. The next nine will be more normal, 113 to 125k, plus anything my wife makes if she works and any side hustles I can come up with time for. So we'll be eligible again to contribute to a Roth.

Unfortunately the bonus isn't coming until Sep/Oct, so I can't apply any of it to 2015 Roth contributions; however, we should have enough savings that I may be able to put some in before we file taxes. What about traditional IRA, can I load those up and then convert to Roth the following year?

Nords

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Re: Windfall/Bonus preplanning
« Reply #11 on: November 14, 2015, 05:49:24 AM »

Glider, I'm not a fan of long military obligations or bonus bribes.  (I speak with considerable experience in both areas.)  However if you're feeling challenged & fulfilled and you think you'd do it anyway then you might as well take the money.

I'd have a "Plan B" for that hardship unaccompanied tour to Korea... or a health surprise that flunks a flight physical... or whatever other hot-fill billet the assignment officer wants to put you in.  Because once you take the money, you're their honey.

You're absolutely right to pay off debt, ditch the rental property, and max out the contributions to your TSP, spouse's 401(k), and both IRAs.  In the unlikely event that you need to tap those accounts before age 59.5 there are plenty of penalty-free ways to do so.  I doubt you'll need to do so.

Since you're effectively signing a 10-year employment contract with minimal possibility of layoffs, you could choose to be much more aggressive with your asset allocation.  If you (and your spouse) feel that you can tolerate the stock-market volatility (or at least ignore your account balances) then you could invest in a 100%-equity portfolio of passive index funds with low expense ratios.  That'd be the TSP's I & S funds (since other funds of those types tend to have higher expense ratios) and a collection of Vanguard or Fidelity equity index funds (domestic or global).  But you have to sleep comfortably at night, too, so pick an asset allocation which you can set in autopilot and stay the course.

I don't know the details of your bonus contract, but can you still sign your GI Bill benefits over to your spouse and/or kids?

A few garbles on the info here:
Definitely max out TSP, IRA and 401k possibilities.  If you wife will only work 6 months in 2016 then double up on her 401k contributions to get the max.  If there is time this year to up contributions (TSP/401k) even for a pay period or two then do it.
Or maybe not the IRA - income limit is $183,000 - $193,000.
IRS Pub 590 lists those limits for a Roth IRA.  However even above those income limits, you can make a non-deductible contribution to a traditional IRA and then immediately convert it to a Roth IRA for the same effective result.

Of course if you're contributing to a traditional IRA then you might want to wait on the conversion until your income drops due to military retirement or quitting a job.  Do the conversion (a little each year) when your income-tax bracket is lower. 

Roth IRA conversions are a perpetual debate in many other threads here, but the main point is that you should contribute to an IRA every year no matter whether it's a Roth IRA or a traditional IRA.  After the annual deadline, the opportunity is forever lost.

You can also contribute $14,000 per child to a 529 per year, I think. So in your case that's $56,000 off the top that doesn't need to be taxed.
The gifting limit to from anyone to anyone else is currently $14K/year per person per recipient.  That's just an administrative limit for the giver, above which you'd have to report the transaction for eventual assessment against estate-tax laws.  The recipient doesn't have to pay any tax on a gift and doesn't have to report it as income.

Gifting kids via UTMA/UGMA is considered risky because the money is theirs at the age of maturity (generally 18 years).  You gotta know your kid and you'd want to develop their money-management skills before they get to high school.  Maybe even before they're teens.

I'll admit that there are good reasons to gift money to kids.  But you gotta know your kid and make sure that they have the money-management skills before they start lighting $100 bills on fire.

You can contribute much more per year to a 529 account, and that's not considered gifting.  It's also less risky because they don't "own" the money at maturity and you can change the account's beneficiary.  There may be state tax benefits to contributing to a 529, but paying for college is much more complicated than just 529 contributions.  If you can transfer GI Bill benefits to a kid then I'd hesitate to fund a 529 account.

rockstache

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Re: Windfall/Bonus preplanning
« Reply #12 on: November 14, 2015, 09:11:24 AM »
I have some experience with these types of bonuses too. One question popped into my head while reading is: is there any possibility that you could be deployed to a tax free zone in the future? Because that would change my thinking in how/when I accepted the money.

TomTX

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Re: Windfall/Bonus preplanning
« Reply #13 on: November 14, 2015, 11:28:29 AM »
Start stuffing money now. Beg or borrow if you have to, get stashed what you can in 2015.

Don't forget, you can contribute to your 2015 IRAs up until April 15, 2016 - just designate it that way on the paperwork.

gliderpilot567

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Re: Windfall/Bonus preplanning
« Reply #14 on: November 14, 2015, 10:51:37 PM »
Hey Nords, I read your book! Thanks for the reply too.

The pilot bonus does not affect the pension, the GI bill benefits, or anything else. It literally is just a set of golden handcuffs, nothing more. There is rumor of the current CSAF trying to change it from 25k/year to 35k/year, but remains to be seen if/when that will happen given today's budgetary situations.

There is a possibility of deploying to a tax free zone in the next couple years, but this bonus is excluded from the deployment tax protections (otherwise it would be well worth it for me to volunteer to be downrange when the lump sum hits).

I do intend to switch over my post-9/11 GI bill to my kids... it will incur a 4 year commitment for me, but if I do that and also sign the bonus then those years will run concurrently. If that means I should not fund a 529, then I will do some more research...

And then the big question... whether to take the devil's money at all... believe me this has been a nightly subject of discussion between me and my wife over the last two years. I've gone back and forth many, many times, but as I have gathered more information and spent many long days and nights thinking critically about it all, I've begun to lean more and more toward staying in and finishing out 20. Many, many factors under consideration - family, health, career, stress, time, money - and I haven't signed anything yet but it's looking increasingly likely that I will decide to. So check back in a year and I will let you know!!


Nords

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Re: Windfall/Bonus preplanning
« Reply #15 on: November 15, 2015, 01:16:39 AM »

Hey Nords, I read your book! Thanks for the reply too.
Happy to help!

The pilot bonus does not affect the pension, the GI bill benefits, or anything else. It literally is just a set of golden handcuffs, nothing more. There is rumor of the current CSAF trying to change it from 25k/year to 35k/year, but remains to be seen if/when that will happen given today's budgetary situations.

And then the big question... whether to take the devil's money at all... believe me this has been a nightly subject of discussion between me and my wife over the last two years. I've gone back and forth many, many times, but as I have gathered more information and spent many long days and nights thinking critically about it all, I've begun to lean more and more toward staying in and finishing out 20. Many, many factors under consideration - family, health, career, stress, time, money - and I haven't signed anything yet but it's looking increasingly likely that I will decide to. So check back in a year and I will let you know!!
The AF seems to be training aviators to go for 10+ years, and your service has the highest officer retirement rate of all the services (well over 30%).  So if you're being rewarded to do something you'd willingly do anyway, then you should sign the contract.

Another key is signing from a position of financial strength.  If you were taking this obligation to pay off six figures of debt, then a few years from now you'd be a very unhappy hostage.  Our daughter's Navy surface nuclear community has such poor retention that in 2019 she'll have the option to sign up for another $50K-$60K of bonus money... per year.  Hopefully by then she'll have a solid financial base and be ready to make her decision on other factors. 

But I'd never advise anyone in the other services to sign up for a decade.  Not even the Coast Guard, let alone infantry or special forces.  And frankly even for the nukes, a five-year contract is nearly three tours during which a lot of bad assignments can happen.

I do intend to switch over my post-9/11 GI bill to my kids... it will incur a 4 year commitment for me, but if I do that and also sign the bonus then those years will run concurrently. If that means I should not fund a 529, then I will do some more research...
That's a perpetual debate.  The good news is that you have lots of choices.

For example, if your spouse was going to earn enough from a MBA funded by the GI Bill to pay for all your kids' college educations, then she should use the benefit for her own benefit because some day her earnings could eventually be an even bigger benefit for your kids.

Another debate is how much of your kids' college educations you want to subsidize.  You could tell them that the first two years of community college are on you, and then they could use one year of your GI Bill for their third year at State U, and then the rest is their challenge. 

A third debate is whether you should "lock away" money in a 529 account that could have paid for a trade certification or to start their own business.  But with four kids it's highly likely that one of them will attend college, and your only challenge will be figuring out a "fair" way to parcel out the funds.  For example, a friend's oldest son is at USNA studying to become a Marine like Dad.  SInce son #1 is getting a "free" education, their second son has announced his intention to go to Stanford.  He thinks he's going to get to use the entire 529 account, too, which may turn out to be a premature assumption.

Whatever decision you choose, please keep us posted!  I get the question a lot, and your experience will surely help the people behind you.