Military pensions and Social Security benefits are both calculated using complex formulas. However, for Social Security purposes, military retirement income is calculated like any other income. This means you pay payroll tax on it as if you are an employee.
Military Retirement Pay--Final Pay
Retirement pay for those who joined the military prior to September 8, 1980, is calculated by multiplying the number of military service years military by 2.5 percent, then multiplying that percentage by their last month's service. So, if someone earned $5,000 in their last month after serving from 1975 to 2010, their monthly retirement pay would be $4,375 (2.5 percent x 35 years = 87.5 percent x $5,000).
Military Retirement Pay--High 36
The High 36 plan applies to people who joined the military between September 8, 1980 and August 1, 1986. Rather than calculate from the last month's pay, the percentage is multiplied by the average of the final 36 months. If someone who joined the Army in 1985 made $4,000 per month in 2003, 2004, and 2005, excepting December 2005 when they got a promotion and pay increase to $5,000 a month, their pension will be 50 percent (20 years x 2.5) of $4,027 a month, or $2,013 a month.
Military Retirement Pay--Career Status Bonus
Anyone who joined the military after 1986 can choose between the High 36 and the Career Status Bonus (CSB) program. Under the CSB program, retirees can choose between their last 36 months or their highest 36 months. Someone who joined in 1988, earned $5,000 a month in 2003 and 2004, then was promoted to a position paying $6,000 a month in 2005, and was then demoted in 2006 back to $5,000 a month can choose to use 2005 in his retirement calculations in 2010.
What's more, the CSB program rewards service past 20 years. Every year is calculated at 2.5 percent up to 20 years. Then, every year after that is calculated at 3.5 percent. If our retiree chooses the CSB program, which gives him an average of $5,333 from which to calculate retirement pay, for his first 20 years of service he receives 50 percent of his pay (2.5 x 20). For the following 2 years, he receives 7 percent (3.5 x 2). His retirement is 57 percent of $5,333, or $3,040 a month.
Social Security is calculated by determining a contributor's average wage over her entire working life, up to age 65. At 65, you will receive Social Security payments based on your retired income, in addition to continuing to receive retirement income.
Changes to Social Security Payments
Earning income after retirement affects your Social Security payments. As of 2010, you lose $1 from every $3 you earn over the annual earnings limit, which was $37,680 in 2010. Our CSB program retiree above is collecting $3,040 a month, or $36,480 a year--below the earnings threshold. His Social Security payments are unaffected. However, someone receiving $5,000 a month in military retirement benefits collects $60,000 a year, $23,520 over the earnings limit: $23,520 / 3=$7,840. His annual Social Security benefits are reduced by $7,840.