If you plan to retire from the military or the Federal government, you will receive a pension. And, your pension will adjust for inflation (mostly). But if you're considering a career change for any number of reasons, how can you determine what you're leaving on the table if you depart without receiving a pension?
Should you stay or go?
If you are relatively new in your career as a military service member or Federal employee, some private sector jobs may seem much more appealing with higher salaries. Or, you might just be frustrated by the constraints of your work. Or tired of leaving your family. Or any number of other really good reasons to seek a career change.
Deciding whether to leave a job for lifestyle or satisfaction reasons are valid and you should do your research and get a lot of advice from others who have traveled that road. This article won't cover how to evaluate those types of reasons. But, if your main reason for considering a career change to the private sector is money, this article is for you.
Looking for greener pastures?
It’s true. In some sectors, you can absolutely earn more in the private sector than in the government. However, you’ll be giving up quite a few benefits that are rarely available in the private sector. It’s difficult to place a value on generous leave (vacation) policies and the relative job security of the military/ Federal government. Besides, maybe the private sector job vacation policy is that you get to take whatever time off you want as long as your work is done. And maybe, your private sector job is in a company that your family owns (99.9% job security).
However, what we know with a high degree of certainty, is that there is a very small chance a private sector job offers a pension. Most private sector companies have done away with pension plans (according to the Bureau of Labor Statistics only about 15% of private sector employees have access to a pension). Instead, the company may offer a 401k. If there is a 401k, they may offer a matching contribution. Or, there might be a profit sharing plan or, perhaps, some kind of equity compensation plan.
In any case, you will be expected to bear the majority of the burden of funding your retirement.
Maybe. Maybe Not.
So how much would you need to save in your 401k (or profit sharing/ equity compensation plan) in order to have access to an income stream that would mirror a military or Federal pension?
Let’s walk through a very simple example to get an idea.
Let’s pretend you are a military officer and that if you stay until 20 years of service you will be an O-5. Using today's dollars, your pension at retirement will be roughly $5,272/ month (based on 2023 pay charts). Let’s pretend you would be retiring around age 43 and that you will live until about age 82. We will assume that your pension will inflate at roughly 2% per year to keep up with inflation (sort of). We’ll ignore any survivor benefit options.
In order to calculate what your pension is worth today, we need to decide how you would invest the funds if you were handed a lump sum so that we can estimate something called a “discount rate”. The discount rate is essentially the answer to the question: what rate of return would I need to ensure I could take $5,272 (adjusted for inflation over time) from my portfolio each month from age 43 until about age 82 without running out of money.
If you are a very conservative investor, your discount rate might be around 4-5% (roughly the average 30 year treasury bond yield). If you are a little more aggressive and can tolerate the risk associated with a moderately allocated portfolio (60% equity/ 40% bonds), your discount rate might be closer to 6-7%.
If you would invest a lump sum conservatively we would use a discount rate of, let’s say 4%, and your pension would be worth around $1.6 million.
If you would invest in a moderate portfolio of stocks and bonds we would use a discount rate of let’s say 6% and your pension would be worth around $1.2 million. Your pension is worth less if you plan to be a moderate investor because you are assuming you can grow your money by 6% per year instead of 4% per year. Therefore, you would need less money to fund the $5,272 monthly withdrawal because your market returns are expected to be higher.
But keep in mind that if you invest in the market you are subject to the volatility of the market. A pension removes market risk.
And keep in mind that your pension lasts for as long as you live. In our example we assumed you would live until about age 82. But if you live beyond age 82, your retirement savings would be exhausted and you would have nothing left. Your pension protects you from longevity risk.
So in addition to your pension being worth at least $1.2 million, the pension provides the added security of providing a steady income stream regardless of market returns AND you can't outlive your pension. These are incredibly valuable characteristics of your pension.
Opportunity Cost?
So what does this mean if you’re 30 years old and trying to decide whether to stay with the government or leave? It means that if you still want to retire at age 43 and be able to take $5,272 (adjusted for inflation) from your portfolio from age 43 to about age 82, you will need to figure out how to get your investment balances to at least $1.2 million dollars by the time you’re age 43. Or you will have to retire later. Or you will have to retire on less money.
If you're 30 years old and want to retire in 13 years you have to accumulate at least $1.2M in order to achieve the lifestyle you could have on an O-5 pension. You'll have to save even more if you're nervous about losing money in the market (you are more conservative) or if you believe that your life expectancy is beyond 82 (and it probably is!).
Clearly, this is a very simple illustration. If you are considering this decision, you need to consider reasonable assumptions for your specific situation to determine the true value of your pension.
There are very good reasons to leave the military or Federal service before retirement - family considerations; stress; purpose; etc. But, if money is your number one reason for considering a change, be sure you understand the value you are leaving on the table - the opportunity cost - if you walk away from your military or Federal pension.
Some Notes:
Pension calculators vary. Assumptions matter. This is a very simple example. You should either seek advice or make your own calculations with reasonable assumptions for your specific situation.
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