The Money Mustache Community
Learning, Sharing, and Teaching => Investor Alley => Topic started by: davisgang90 on May 24, 2013, 09:37:05 AM
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I'm eligible for a military pension when I retire. Some folks say this should be considered like a large government bond investment when considering your overall portfolio makeup meaning I could be more heavily invested in equities.
Others disagree and say it isn't at all like owning bonds.
I'd like to hear the group thoughts.
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A pension DB pension (pays a fixed amount per month, for life) should be used to reduce the amount that you need to save outside of it.
My wife and I are both feds, and this is what we do. The anticipated pensions amounts just get subtracted from our anticipated living expenses, and we use the remainder to forecast our needed investment amounts.
Likewise for social security, which is also just a pension plan for the masses, when you get right down to it.
I have seen some heated debates about whether or not to think of your pension as a bond-like asset, since it IS invested in government bonds. Mostly, people are upset because if they choose one of the TPS Lifecycle funds that automatically rebalance your asset allocation as you age, you end up being way too conservative if your pension is also a bond. They rebalancing formula that the TSP uses was ripped whole from academic literature for people without pensions, so it's probably not the best choice for federal employees.
The above mentioned strategy of just subtracting if off the top, though, effectively fixes the problem. It's just a harder mental hurdle to get a spouse past, because now you're talking about retiring on what look like much smaller sums.
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I am in the camp that it should offset your income needed for expense and if divided by your SWR then it is like a bond if it is a federal pension. There are other more complex factors to think about when planning if you have a pension of any kind:
-default risk, there is a big difference between private/state/local pensions and a federal pension (fortunately yours is federal).
-time, most pensions aren't qualified until you hit a certain age and tenure. This is more of an ER risk but if you are say 35 and believe you will work to the pension retirement age (lets say 55) and you plan for that expense wise what happens if at 40 you want a new job or are laid off. There goes the bulk of that forecasted pension benefit and if you haven't saved it...well you know.
-inflation, COLA is good otherwise your expense needs will rise but income will stay flat so this needs to be factored into the SWR of your invested assets.
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Thanks for the good discussion. My goal is to live mostly on my military retirement and not regularly need to touch the investments which will allow me to tolerate more risk than if I was looking for a regular draw.
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I've read arguments for/against this, and I tend to like the line of thinking.
Here is my favorite way I've heard it put.
If you have a stable pension that acts covers most or all of your expenses (and is hopefully COLA'd), you have two options with your stache:
1) Be more aggressive. You don't have a need for the money, so might as well swing for the fences and possibly hit a large amount that could be life changing, and if it doesn't pan out, no big deal, you have the pension.
2) Be more conservative. You have no need for the money due to the pension, so you don't have to swing for the fences and can just have it earning a steady, safe amount.
Which you do depends on your personality and risk tolerance levels.
If you're thinking of it as your bond allocation and then investing the rest of your stache more heavily in equities, you're likely looking at scenario 1.
But thinking of it in those terms (I have the pension so I can afford to be aggressive versus I have the pension so I can afford to be conservative) can provide a lot of clarity, IMO.
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These are some great replys. I hadn't thought of it that way.
To follow up with tooqk4u22's comment regarding ER risk. My gov pension has specific dates that skew the math. Specifically, I can only receive the pension at 55 (with penalties) or at 60 (without penalties). As a result, if I would be looking at an ER (say 45) then I need to use the majority of my investments upfront as a bridge until the pension kicks in. Unfortunately, by using the investments early, I am losing out on my biggest ally - compounding.
Any thoughts on an effective strategy? Or does it go back to the basic tenets of MMM (maximising the savings gap)? In other words, try to live as lean as possible from now until the pension kicks in (which would be like getting a large raise).
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How about the obverse-what is a pension worth as a present value (thus giving info re net worth)? Using a financial calculator, you could calculate the present value, assuming a term, payout frequency, and interest rate. It misses a COLA if there is one and underestimates any survivor benefits, but it gives a value. That present value could be added to your personal stash and you could calculate using your safe withdrawal rate. Since the pension is probably fairly secure (like fixed income), you could go, as arebelspy, says all bonds for the rest or all equities. I would regard the pension present value as fixed income/bond like though as it has legal protections, unlike an equity fund.
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How about the obverse-what is a pension worth as a present value (thus giving info re net worth)
I've had similar thoughts, but the problem with this approach is that the pension is not accessible in the same way that the rest of your investments are. Since you can only draw it down during the later part of your life, you're inevitably going to upset your desired asset allocation as you approach pension eligibility age.
The secondary (and I think lesser) problem is that for ER types, a pension that you can't collect for 30 more years but that is based off of today's salary has a very small NPV. 30 years of inflation plus thirty years of compounding are both working against you, in that case.
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I'm eligible for a military pension when I retire. Some folks say this should be considered like a large government bond investment when considering your overall portfolio makeup meaning I could be more heavily invested in equities.
I'd like to hear the group thoughts.
I'm going to go with Milevsky:
http://the-military-guide.com/2010/12/30/tailor-your-investments-to-your-military-pay-and-your-pension/
And here's a three-part post on investing once you're confident that you're getting a military pension:
http://the-military-guide.com/2011/03/24/asset-allocation-considerations-for-a-military-pension-part-3-of-3/
(parts 1 & 2 are linked at the bottom of that post)
How about the obverse-what is a pension worth as a present value (thus giving info re net worth)? Using a financial calculator, you could calculate the present value, assuming a term, payout frequency, and interest rate. It misses a COLA if there is one and underestimates any survivor benefits, but it gives a value. That present value could be added to your personal stash and you could calculate using your safe withdrawal rate. Since the pension is probably fairly secure (like fixed income), you could go, as arebelspy, says all bonds for the rest or all equities. I would regard the pension present value as fixed income/bond like though as it has legal protections, unlike an equity fund.
Here's a couple different ways to view your pension, including the COLA:
http://the-military-guide.com/2011/03/17/present-value-estimate-of-a-military-pension/
I'm retired on an active-duty O-4 pension, and we have a rental property that's finally flowing a little cash. These two income streams cover the majority of our spending, and if we had to we could cut back our lifestyle to survive on "only" my pension. After more than a decade of retirement (including two recessions) I don't see any cutbacks in our future.
The rest of our investments are >90% equities and ~8% cash. The cash covers two years of expenses (beyond my pension & our rental income) because that's how long most bear markets have hammered equities. Our safety factor is our ability to cut our spending, so I disregard cjottawa's concern about SWR failures. In fact, the main reason for an annuity is to hedge the risk of SWR failure. Once you've hedged that risk you can be more aggressive with the remaining assets. By "aggressive" I mean Berkshire Hathaway stock, a small-cap value ETF (IJS), a dividend ETF (DVY), and an international dividend ETF (EFV). Lots of equities, yes, but not exactly crazy.
One could claim that you have no reason to take risks with money that you don't need. You could also claim that you should shoot for the moon with money that you don't need. I can appreciate both sides of the debate, but my inclination has been to use the excess to explore different types of investments. Over the last decade I've run the gamut of investing styles, yet every year I trade less and return to value/index investing. Everything else is either too much research work or too much tracking labor. I've even learned how to do angel investing and selling put/call options specifically so that I don't get tempted to try either of them when I'm 82 years old. Both of those areas seem to be doing satisfactorily so far (no bankruptcies and only one exercise) but they're also both more work than I care to keep up with. I'm looking at peer-to-peer lending with a skeptical/cynical eye, but that's a couple of blog posts for another time.
One could claim that end-of-life medical expenses will cause the SWR to fail. However military retirees have Tricare and Tricare For Life, so medical expenses are "likely" to remain under control. Military retirees can also purchase cheap(er) long-term care insurance through the federal program, although personally I'd wait until the big insurers figure out what they're doing with their new hybrid products. But either way military retirees are also hedged against healthcare expenses, which gives them even more justification for a high-equity investment portfolio.
Between 2007-09, our investment portfolio (~92%/8% equities/cash) declined over 50% from its stupid-high peak to its Great Recession pit. (Today it's recovered and returning to that 2007 high.) Ironically for that period, our equities moved pretty much in black-swan lockstep both going up and coming down (and going up again). I was looking for any excuse to rebalance by selling one equity to buy another, but they never got far enough out of balance to hit a limit. In fact they fell so fast that our cash percentage was rising by comparison. In retrospect I wish I'd had the guts to plunk a bunch of cash into the market in early 2009, but I think we all recognize how we felt about that idea back in early 2009. During the roller-coaster ride the only trading we did was tax-loss swapping along with selling a few call options. By the time we reached the end of our two-year cash stash, our equities had recovered enough to sell some gains to replenish the stash.
In early 2009, I decided to look at our investment portfolio as part of an overall asset allocation that included our pension and our rental income. I chose to view the pension as I bonds and the rental income as a CD (although you could make a case for it being a bond). When our equity investments were compared to those bond/cash assets, our actual asset allocation was mostly bonds. At the 2007 peak it was 10% equities, 85% bonds, and 5% cash. At the 2009 pit it was about 5% equities, 90% bonds, and 5% cash. In other words, our 50% drop in the value of our investment portfolio was barely a 5% blip in the overall view of our lifetime income (or "net worth" or "human capital").
Our investment portfolio is probably going to hover around the current peak for a while, but we have no plans to change anything. Our asset allocation is well within its bands, and we'll rebalance if necessary. If the market rises or drops 10% either way then I might sell a few more put/call options, but there's no reason to get greedy. If the portfolio continues to rise then we'll probably stay the course. We may boost our charity donations but I don't see us expanding our lifestyle. From now on we're going to get more comfortable by viewing the volatility as part of the big picture, not just the periscope view inside our investment portfolio.
Besides, I only have enough rack storage for four surfboards and wax is cheap...
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Nords,
Thanks for your detailed response. I think I'm aligned with your way of thinking on the pension. I just made 06 so will have a fairly generous pension in a few years.
My wife and I are still trying to figure out retirement locations and plan a big trip out west next summer to see more of the country.
One added challenge we have to consider is our 15 year old son who has autism. He will most likely live with us for the rest of our lives and we need to consider possible employment opportunities for him. The good news is I am fairly certain he will continue to be covered by Tricare and I may even be able to pass on Survivor Benefit Plan on to him (we are still reviewing special needs trusts, SSI and such).
Thanks again to all for the great discussion.
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My wife and I are still trying to figure out retirement locations and plan a big trip out west next summer to see more of the country.
That's a tough one. Even the generic books & forums have a hard time with figuring out a retirement location, let alone the military-oriented media. We locked on to our retirement location at my seventh year of active duty so I don't have any personal experience to share, either.
If there's one retirement-location theme that I've noticed across the last 15 years, it'd be "plans change". Diehard RVers decide to settle down or to change their travel schedule. Boaters come ashore (or buy a bigger boat). Expats decide to move back to the home country. People get tired of their ideal climates or their dream house or neighborhood/traffic growth. A fantasy home becomes an operating/maintenance nightmare. Proximity to relatives becomes critical (either close by or as far away as possible). Kids graduate from the great school system that was so important when the parents bought the home. Parents become grandparents and think about moving closer to the grandkids. An elderly parent needs more help than you can deliver from three time zones away. These factors are even more prevalent for Hawaii residents.
Servicemembers are susceptible to treating retirement as "just another transfer", but the reality is that you don't have to pick a new lifetime location. You may actually get restless in your "retirement" locale after 24-36 months (depending on your service's relocation budget). You don't have to move everyone & everything within a week of travel time or before 30 days of leave is used up.
About the only constructive suggestion I have for the first year of retirement is: rent. You might even be able to get your final household goods shipment to be extended up to 18 months.
While you're searching for your ideal retirement spot, think of it as "temporary"... maybe 5-10 years. That'll take some of the pressure off the decision. You might make three or four more of those retirement location decisions during your lifetime.
One added challenge we have to consider is our 15 year old son who has autism. He will most likely live with us for the rest of our lives and we need to consider possible employment opportunities for him. The good news is I am fairly certain he will continue to be covered by Tricare and I may even be able to pass on Survivor Benefit Plan on to him (we are still reviewing special needs trusts, SSI and such).
You might already know this about SBP, but I believe he qualifies as a family member with an "insurable interest".
This post has a 50-slide PowerPoint presentation on SBP, and that phrase comes up at slide 23:
http://the-military-guide.com/2011/04/13/more-sbp-details/
You'd need to consult with a SBP specialist (not just the TAP seminar leader) and perhaps a trust lawyer. I don't think that any other form of civilian life insurance would even come close to SBP.
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Thanks Nords, Great post as usual.