Want to become a millionaire in 20 years? Hang in there for military retirement.

July 3, 2011

Finance

The military has a pension system that can’t be beat. For those of us who hang in there for 20 years, you receive an immediate annuity upon retirement. But exactly how much would you need to have saved in order to pay yourself an equivalent retirement amount? In order to find that out, we need to determine the present value of a graduated annuity, which is what a military pension is. It grows with inflation so that your buying power isn’t eroded as time passes. To calculate the present value, a few factors have to be defined and a few assumptions have to be made.

Let’s assume that I decide to retire after 20 years and I make it to the rank of Lieutenant Colonel. According to the military retirement calculator, an O-5 retiring at 20 years in 2011 would receive $45,358 (PMT1) before taxes. Further, let’s assume that if I retire at 44, I will live until age 90. This gives me 46 years (N) in retirement. I expect the inflation rate (g) to be approximately 3%. Finally, I would expect an equivalent lump sum to return approximately 7% per year (i) in the stock market if it was invested. Using all this information, I plug it into the following equation:

PVGA=Pmt1/(i-g) [1-((1+g)/(1+i))N]

= 45,358/(.07-.03)[1-(1.03/1.07)46]

=$937,409

As you can see, the present value is just shy of $1 million before taxes. Although only a small percentage of the military stay in for 20 years, I think this is a consideration that shouldn’t be taken lightly for obvious reasons.

2 Comments on “Want to become a millionaire in 20 years? Hang in there for military retirement.”

  1. JDH Says:

    Did you consider the opportunity cost in terms of pay forgone by staying in the military as opposed to civilian employment?

    Reply

  2. raymondtung Says:

    That was actually going to be the subject of my next post. Calculating the additional amount your civilian job needs to pay you to make up for that discrepancy.

    Reply

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