The 1% bump

Starting small, starting early

Early in my military career, I was introduced to the Thrift Savings Plan (TSP). Fundamentally very similar to a 401(k) plan, the TSP is the military’s version of a tax-deferred savings plan to help save for retirement. It seemed like a great idea. But, like many new to the military, my income was too low to save for retirement (or so I thought). I foolishly believed I needed every penny of my pay to support me and my young bride. Even if I could afford a few dollars a month, I doubted it would make much of a difference in the long run. Sadly, this naive mentality prevented me from saving even small amounts early. As I know now, and as you will see here, I left a lot of money on the table.

Make the match

Before we continue, if your company offers matching contributions to your TSP or 401(k), you should seriously consider contributing enough to get the greatest match. This is free money. All circumstances are different, so reach out to find out how maximizing your company match could benefit you.

The 1% bump method

Once I felt like my income could support retirement savings, I began contributing 10% of my base pay to the TSP. I was relieved to start, but I knew I should find ways to save even more. As I thought about this, I realized that my contributions would grow automatically due to frequent pay adjustments. These adjustments came in three forms: annual adjustments, time-in-service increases, and promotions. The good news was, even at 10%, my contributions would increase over time due to these increases. Mission accomplished.

However, I wasn’t sure this would be enough. I then thought of raising my contribution percentage with each regular adjustment. Annual adjustment = 1% increase. Time-in-service adjustment = 1% increase. Promotion = 1% increase. I called these increases “bumps” and, as I shared this idea with others, I nicknamed each one. They are:

1. A-bump: Annual bump. Each year, the military pay charts are adjusted to account for inflation. These adjustments range in amount but have always been greater than 1% since 1973. In additional to the annual increase, allowances for housing and food can increase from year to year, further increasing the annual change.

2. T-bump: Time-in-service bump. In addition to the annual increase, soldiers receive biennial raises to compensate for their time-in-service. This is meant to retain servicemembers and allow for increased costs of growing families, etc.

3. P-bump: Promotion bump. Of course, as a servicemember grows through their military career, promotions will occur. These promotions come with pay increases to compensate for increased responsibility.

I decided to give it a shot. 10% withholding to start followed by a 1% increase with each annual increase, each two-year increase, and each promotion.

A funny thing happened

I maintained my strategy for 3-4 years before I noticed something interesting. While my contributions to my TSP were growing substantially, my take-home pay was also increasing. I’m not sure exactly what I expected, but I remember thinking most or all of my pay increases would be eaten up by my 1% bumps. However, quite the opposite was happening. Each year, along with each two-year adjustment and promotion, I saw my take-home paycheck grow significantly. How was this possible?

I suspected most of this phenomenon could be attributed to the fact that I was allocating all of my contributions to pre-tax TSP. This is the traditional way to contribute to TSP or 401(k) plans. All contributions are made before taxes, so they are tax-free going in (and will be taxed when I withdraw them). For instance, if you contributed $100/mo to a traditional 401(k) or TSP plan, your take-home pay would not decrease by $100/mo. If your tax withholding was calculated for the 22% tax bracket, your take-home pay would decrease by about $78. Since that $100 is going into the plan tax-deferred, there is no need to withhold taxes from it. For me, I was receiving a nice tax break on my contributions. So, I figured the regular increases in my take-home pay were a result of those tax benefits.

To test this theory, I began allocating my bumps to the Roth option instead. The Roth TSP, as with Roth 401(k), doesn’t enjoy the same tax-free benefits up front (instead they are tax-free coming out). In keeping with our example, if you contributed $100 to a Roth 401(k) or TSP, your paycheck would decrease by $100. There is no tax benefit on the front end. So for every bump going forward, I would taxed on the full amount instead of receiving a tax break. Still, I found my paychecks growing consistently. I was amazed yet again.

Note:

I should mention that military pay is a little unique. TSP contributions are based on base pay which amounts to 50-75% of a servicemember’s total compensation. The remainder of pay is from housing and food allowances which are not considered for TSP contributions. So, even though I was increasing my contributions by 1% with each bump, I was really only increasing them by 0.5%-0.75% of my total pay.

The data

Even considering the adjustments listed above, I was excited to dig deeper into this effect. I opened a fresh spreadsheet and started entering my previous years’ pay and contributions. Sure enough, the data supported what I was experiencing. Ignoring taxes, each year my after-TSP contributions net pay kept increasing. My lifestyle was growing and my TSP was growing more rapidly each year. While I was still surprised by the effect, I was comforted that I wasn’t missing something important.

While I was proud of my new habit, I recalled my early years when I thought I couldn’t afford to save for retirement. The truth is, I very much could afford it (and should have), but I didn’t understand the value of a small contribution. The flaw in my thinking was that I needed to invest at least 10% or it wasn’t worth it. Looking back to 2003, had I started with even 1% of my meager pay, it would have only amounted to $15.03 a month. A small amount indeed, but how much of a difference would it have made?

Meet MSG Saver

My experience aside, I wanted to know how a typical E-8 retiring in 2024 with 26 years in service would have benefited from this system. Below is a chart outlining the career and retirement savings for our fictional example, MSG Saver. MSG Saver enlisted in 1998 as an E-1 and progressed through a 26 year career, eventually retiring as an E-8. The difference between MSG Saver and me is, MSG Saver started his savings at 1% and used the bump method described above. With each year, time-in-service adjustment, and promotion, MSG Saver bumped his TSP savings by 1%.

This chart contains historically accurate data pulled from military pay charts and returns of the Dow Jones (S-fund) from 1998.

What am I looking at here?

Before we dive into the explanation of the chart, I want to draw your attention to two numbers. First, look in the lower right corner. That number, $828,048.06, is the ending account balance for MSG Saver after using this method. Now contrast that large number with a number at the top under “Contributions and Take Home,” below “Contribution.” That number, $111.13, represents MSG Saver’s first year of savings. Yes, the entire year. That works out to $9.26 a month!

NOTE: Remember, MSG Saver’s final number is his balance at the end of his military career, not his actual retirement. TSP rules mirror 401(k) rules in that MSG Saver won’t be able to touch this account until he turns 59 & 1/2. Since most E-1 enlistees are high school graduates, our fictional saver is likely only 44 years old at the end of his military career. If his balance grows by 8%, his nest egg will be $2,626,708.48 by the time he can take withdrawals. All from $9.26/mo to start!

Next, I want to draw your attention to the entire column under the header “Take Home.” These numbers represent MSG Saver’s net pay after TSP contributions. Yes, this isn’t his actual take-home pay (taxes and other deductions will be paid), but most deductions are proportional to this net (or gross) pay. So, for our example, we are ignoring those adjustments and simply using the net pay after contributions.

Now quickly scan that column. Notice anything? As expected, and as I experienced myself, this number keeps increasing. Admittedly sometimes very small (2011-2014, reflecting a series of years with low annual pay raises of 1% to 1.7%) and one outlying year with a small decrease (2014-2015, reflecting a small 1% pay increase for the military). This down year also coincided with MSG Saver experiencing three 1% bumps in the same year.

Now look at MSG Saver’s contribution column. This is where the magic happens. While his take-home pay is increasing steadily, his contributions to his TSP are exploding exponentially. The beauty of this is, he can still grow his lifestyle. It will be slower than other servicemembers, but still growing. This method allows him to both increase his spending while increasing his savings rate at the same time.

One more note: MSG Saver would have run into a problem in 2016. Due to his aggressive saving habits, his contribution in 2016 would have been capped by the end of the year. The annual 401(k)/TSP contribution limit in 2016 was $18,000. Beginning that year, MSG Saver would need to seek other forms of savings to keep his method going, such as IRAs. Eventually he would exceed both his TSP and IRA limits in 2020, forcing him to turn to brokerage accounts or similar.

Yes, this applies to You

This method works well for the military. But, it also applies to anyone whose income grows during their working years. Regular pay increases, raises, bonuses, switching jobs, and other pay adjustments can be given this same treatment. Curious about calculating a similar approach for your situation? Reach out to see how the bump method could help you exponentially grow your savings without ruining your current lifestyle.