BRS Breakdown, Part 4: Solving the Lump Sum Option Riddle

When you retire under the Blended Retirement System (BRS), you’ll face an important decision: should you take the Lump Sum Option? This is offered as an exchange for a reduced monthly pension from the age you retire until you turn 67, which is when the Social Security administration mandates that you receive your full retirement benefit as you are considered "Full Retirement Age", or FRA. You can select either the 25% or 50% Lump Sump, and you can choose to take it in 1, 2, 3, or 4 annual payments. For example:

• 25% Lump Sum, O-5 retiring at 20 years with an average monthly "High-36" Base Pay of $10,000
  • Pension = $4,000 per month before taxes
  • 25% Option = $3,000 per month before taxes PLUS $147,600 Lump Sum
• 50% Lump Sum, same retiree
  • Pension = still $4,000 monthly, pre-tax
  • 50% Option = $2,000 monthly PLUS $295,200 Lump Sum

The military strongly cautions against taking the Lump Sum, showing how the lump sum reduces your total lifetime benefit -- because they assume you will squander the Lump Sum on personal expenses (see Figure 1 below). But is that really what will happen? What if you invest your Lump Sum? As it turns out, so long as you can invest your Lump Sum in a way that earns you higher returns than the Lump Sum Discount Rate (LSDR), which is set to be 6.33% in 2025, you can actually increase the value of your pension!

Figure 1. BRS Projections of how the Lump Sum is a Bad Deal (source: usaaef.org)

Of course Figure 1 could be right -- if you squander it on one-time personal expenses. And if you use the Lump Sum for personal reasons you'll also have to pay the "Tax Man" 12-37% of your benefit right away in Federal Income Tax. And you definitely don't want to give up lifetime income just to hand over $25,000-80,000 to the Internal Revenue Service (IRS)!. However, with the right strategy in place not only can the Lump Sum help increase your monthly income and net worth, it can also help you save on taxes.

Understanding the Lump Sum Discount Rate (LSDR)

The Lump Sum Discount Rate is essentially the interest rate the military uses to calculate the present value of your future pension payments. It's kind of like how much they would earn on that money if they kept it and paid you out over 30 years instead of giving it all to you right now. If you opt for the Lump Sum, you’re agreeing to take a "discounted" upfront payment in exchange for giving up a portion of your pension income. The LSDR for 2025 is 6.33%, meaning the government is assuming a 6.33% return on the lump sum over time. This is published every June or July for the following year, with this year's memo published HERE.

All you have to do is find an investment with returns that are higher than 6.33%, invest your Lump Sum, and watch your wealth grow faster than it would if you just took the pension. Remember, your reduced monthly payment isn't forever, and goes back to 100% when you turn 67. So you are planning for an investment that will make you bigger profits for 20-30 years. Sounds a lot like retirement investing, just like you're doing with your Thrift Savings Plan (TSP), doesn't it? And if that's the case, you already know how easy it is to invest and make more than 6.33%: the S&P 500 averages 10.8% per year over time. 

Refer again to Figure 1 that shows the No Lump Sum strategy has a lifetime value of $1,521,100 by age 67 assuming you retire in 2025 at the age of 44. According to BRS (and USAA), taking the 25% Lump Sum will reduce this value by $232,700. But if you invest your Lump Sum in the S&P 500, the $147,600 will grow to $1,750,041 at age 67! If you are massively behind on your TSP retirement savings after 20 years in the military, this can be your Golden Ticket to a multi-million dollar retirement! But there are more, and possibly better options, you should consider.

Investment Strategies to Beat the 6.33% Discount Rate

There is a short list of ways to use the Lump Sum that will NOT make you more money. In addition to personal expenses, putting your Lump Sum in a Certificate of Deposit (CD), High Yield Savings Account (HYSA), Money Market Fund, bonds, or any of the TSP Life Cycle Funds are all terrible decisions: none will beat the 6.33% benchmark. But there are super easy and accessible ways to beat 6.33% -- and in some cases double or triple it. Here are four strategies that can help you do just that:

1. Net Worth Strategy: Invest in Index Funds

If your goal is to maximize the future or total value of your BRS Retirement Benefit, just take the Lump Sum and invest it in a low-cost S&P 500 Index Fund. As mentioned above, at 10.8% over 23 years, your $147,600 will grow to $1.75 million. That has a "present value," or in other words how much $1.75 million in the future is worth today, of $858,000. You 6x your money. But what about taxes? Even if you had to pay 24% Federal Income Tax plus 7.65% FICA tax, losing $46,715 to the IRS and leaving only $100k to invest today, you'd still end up with $1,185,000, or $581,400 in today's dollars. That's still a 4x trade-off!

The numbers will always work so long as your return is higher than the LSDR, so you don't have to be an officer to profit. Let’s say you’re retiring as an E-8 with a BRS pension benefit of $2,500 monthly, but instead opt for a 25% Lump Sum in exchange for reducing your monthly pension by $625 to $1,875. The pre-tax Lump Sum is $101,300, which taxes would reduce to about $71,000. Invest that in the S&P 500 from age 39 when you retire, and by age 55 you'll have $400,000. At age 55 your reduced military pension will have increased to $2,842. But from your $400,000 investment account you can start paying yourself $4,000 per month from age 55 to 67 without running out of money. That's almost $7,000 a month of passive income.

At 67 that pot of cash will run out -- but your pension will bump back up to the full amount of $5,000 by then, and you can start receiving $3-4,000 a month in Social Security, helping raise your income to keep up with inflation at the same standard of living. Your Lump Sum Option can buy you 12 years of early retirement!

2. Income Investing Strategy: Buy Dividend-Paying Stocks or REITs

On the other hand, maybe you just want to increase your monthly income now so you can retire early, after your 20-year military career. In this case you would invest in specific stocks and Real-Estate Investment Trusts (REITs) that pay out profits in dividends instead of higher share prices. Some examples of high dividend-paying stocks include ARCC (9.44% dividend yield) and PBR (12.92%), and two excellent REITs are STWD (9.10%) and BXMT (9.29%).

Going back again to our example of receiving $100,000 as a Lump Sum, if you invest it in a 9.2% dividend-yielding stock or REIT, you’ll generate $9,200 a year, or about $750 per month in dividend income. For the E-8 who traded in $625 in monthly pension income to get $750 in dividend income, this is a clear win! Of course high dividend-paying stocks don't typically appreciate, and in 20 years you may still only have $100,000. But in the long run, you've earned higher income and can one day still get your $100,000 back.

3. Income Investing Strategy II: Mortgage Notes, Tax Liens, and More

Dividend-paying stocks and REITs aren't the only way to generate income on investments. Admittedly this strategy is a bit advanced -- and there's no room here to explain what each one is. If you're interested in earning returns of 11%, 14%, 16%, or potentially more, start teaching yourself how to invest in mortgage notes and tax liens. Good books to start with are Real Estate Note Investing: Using Mortgage Notes to Passively and Massively Increase Your Income by Dave Van Horn or The 16 % Solution, Revised Edition: How to Get High Interest Rates in a Low-Interest World with Tax Lien Certificates by Joel Moskowitz, J.D.

4. Real Estate Strategy: Combining Income and Wealth Creation

Obviously the best strategy for your Lump Sum option is to invest it to create millions of dollars of wealth in 20 years for retirement while also replacing the income you gave up to get the Lump Sum. For this there's one clear winner: investing in rental real estate. You can generate cash flow now (rent) while building wealth for the future (property appreciation + mortgage pay-down by your tenants). Better still: rent goes up each year, generally at a faster rate than your pension (3.5% vs 2.6%), so over time your monthly income will grow even faster with real estate.

There are tremendous opportunities across America to purchase investment properties in affordable markets with solid rents. The average "starter home" in 2024 in the U.S. costs $194,000, and the average rent for these homes is $1,564. You would need about $45,000 for a 20% down payment and closing costs, which would have a typical monthly mortgage payment of $951. With a $100,000 Lump Sum you could buy two investment properties, taking on $1,900 in mortgage payments while generating $3,100 in rent. The $1,200 cash flow is almost double what you would have gotten if you skipped the Lump Sum (the $625 a month difference with the 25% Lump Sum Option). Rent would increase 3.5% annually, and so would the property. Your two $194,000 properties would each be worth about $386,000 in 20 years, and each mortgage would be down to $84,891. You could sell both properties and make a $600,000 profit.

Tax Strategies to Offset Lump Sum Income

By now you've picked up on what the real drawback of the Lump Sum Option is: taxes. Unfortunately the IRS considers your Lump Sum as "ordinary income", which means that you will have to pay tax on it like it's your paycheck: 7.65% on FICA taxes, and 12-37% in Federal Income Tax. But just because DFAS will withhold those taxes when they send your check doesn't mean you can't do something about it and get it back. And if you have the mindset to invest your Lump Sum, you will be able to offset some of the income with deductions and depreciation. Here are a few strategies that can help:

1. Purchase a Business Vehicle (GVWR over 6,000 lbs): If you run a small business or plan to start one, you can take advantage of Section 179 deductions by purchasing a vehicle with a Gross Vehicle Weight Rating (GVWR) of over 6,000 pounds. This allows you to deduct the full cost of the vehicle in the first year, reducing your taxable income significantly. Note that you can still finance the vehicle AND take the full deduction!

2. Invest in Real Estate: Purchasing rental property offers significant tax benefits. Not only can you deduct expenses such as certain closing costs, property taxes, insurance, and maintenance, but you also get the benefit of "depreciation." Depreciation is a percentage of the total value of the home and appliances and other improvements that you can deduct on your taxes, even if you don't repair or replace them this year. 

3. Invest in Capital Equipment for a Business: If you’re running a business or planning to start one, investing in capital equipment—like computers, machinery, or other assets—can also reduce your taxable income through depreciation and business expense deductions. In this way the Lump Sum can help you launch your own business or dream career, and help you all but eliminate your income tax burden.

A mentor of mine once told me that while you always take taxes into consideration when evaluating an investment, you never let taxes be the deciding factor. In real estate, that might mean that the tax breaks you get make an investment profitable -- but you still shouldn't consider it a profitable plan. In the case of the Lump Sum Option, it means that even if you can't find a way to offset the income tax through investment and business deductions, you shouldn't let paying taxes stop you from taking the money.

As we outlined earlier in the post, you can still end up way ahead in total income and wealth even if you have to give up a quarter or more of your Lump Sum in income tax. It just takes patience, but after 20 years you'll be at least 10-20% richer -- while some of you will more than double your wealth over where you would be without the Lump Sum.

Conclusion: Take the Lump Sum, But Be Smart About It

The decision to take the Lump Sum Option will be positively life-changing, and bring in possibly $100,000s more wealth for you in the 20-30 years after you leave the military and before you reach Full Retirement Age at age 67. Sure it takes some thinking and a little bit of math, but the effort will be worth it. If figuring what to do is slowing you down, or if you are intimidated from even trying, head over to the Military Wealth Coach website and sign up for a free video consultation HERE. We'll help you sort it out.

When the time comes to make your decision, here are some quick tips:

• DO: (1) Find investments that earn more than the LSDR, (2) Decide on an income or wealth (or hybrid) strategy -- then stick to it, and (3) Make a plan for taxes
• DON'T: (1) Believe the BRS infographics that show you you'll lose money taking the Lump Sum, (2) Spend it all on personal expenses, (3) Let the math, planning, or taxes intimidate you

By using these strategies, you’ll be able to turn the BRS Lump Sum Option into a powerful financial tool, rather than a potential liability. With the right tax planning and investment approach, you can take control of your financial future and set yourself up for a secure, wealthy retirement.