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A cash reserve for military retirees should cover the gap between monthly spending and retired pay, usually for 24 months, not total bills. The question tends to come up in January, when the 1099-R from DFAS and the 1099-INT from the bank both show up within a few days of each other.
A typical question sounds like this: "Retired pay handles some of my bills, so how much cash do I actually need to keep?" First Command Financial Services starts from the shortfall between spending and retired pay. Then it puts in writing when the reserve gets spent and when it gets refilled, so a bad year doesn't push a household into selling at the bottom.
By Elena Rodriguez, CFA — Portfolio Manager | Reviewed by Marcus Thompson, CFARetirees often hold cash against bills their pension already pays. Subtract net retired pay first, and the reserve can shrink by more than half.
Dana Whitfield, CFP®, Senior Financial Planner at First Command Financial Services
Interest on the reserve is taxable income, so look at it before Medicare at 65, because two years earlier decides your premium.
Marcus Reyes, CPA, Tax Director at First Command Financial Services
The same $9,000 of monthly spending produces reserves from $21,000 to $216,000, depending on how much retired pay already covers. The table sorts situations by that gap. Find your row first, then read the three options below it.
Option one covers everything: 24 months of all bills. Option two covers only the shortfall: 24 months of what spending exceeds net retired pay. Option three is thin: 6 months of that shortfall, backed by the G Fund (the TSP's Treasury-only fund). The thin option fails for anyone under 59½ who left service before the calendar year they turned 55, because G Fund withdrawals then generally carry a 10% additional tax on top of 20% withholding.
Taxes matter too. Interest from savings, CDs and money market funds is ordinary income. Treasury bill interest is federally taxed but exempt from state and local tax. Bank deposits are FDIC insured up to legal limits; money market funds are not. Taxable interest counts in modified adjusted gross income (MAGI), and the 2026 Medicare Part B premium is set by 2024 MAGI, with the first single surcharge above $109,000.
Four questions to put to a CPA or the TSP:
| If your situation is | Then hold | For Hiroshi's numbers |
|---|---|---|
| Still working, paycheck covers bills | 3–6 months of total spending | $27,000–$54,000 |
| Retired pay covers part, stocks the rest | 24 months of the gap | $3,500 × 24 = $84,000 |
| No guaranteed income yet | 24 months of total spending | $216,000 |
| Past 59½, G Fund as backstop | 6 months of the gap | $21,000 |
| Under 59½, left service before 55 | Full 24 months outside the TSP | $84,000 in bank or T-bills |
He needs 24 months of the gap between spending and net retired pay, which is $84,000 on these numbers, held in cash or Treasury bills outside the TSP. Total spending would call for $216,000, so the gap method leaves $132,000 invested.
A hypothetical household: Hiroshi, 54, a retired Navy commander, earns about $160,000 as a defense contractor program manager. He has about $900,000 in the TSP and a new 401(k), and he sold half his C Fund in the last crash. He plans to leave the job at 60, and the arithmetic looks ahead to that year.
Step 1: he expects to spend $9,000 each month. Step 2: retired pay nets about $5,500 each month after withholding, so the gap is $9,000 − $5,500 = $3,500. Step 3: $3,500 × 24 = $84,000, against $9,000 × 24 = $216,000 on total spending. Step 4: the $132,000 difference stays invested, where it can fall in value, and he could get back less than he put in.
Careful people often hold 24 months of total spending when they only needed the gap. For Hiroshi that parks an extra $132,000 in cash. If, for illustration, invested money earned 3% a year more than cash, he would give up about $3,960 a year, close to $40,000 over 10 years before compounding.
Hiroshi is single with no Survivor Benefit Plan beneficiary, so retired pay stops at his death. His adult daughter, his TSP beneficiary and his agent under a power of attorney, gets one line in the written plan: spend the $84,000 first, refill it only when stocks are within 10% of their high. First Command Financial Services writes that refill rule down because Hiroshi sold half his C Fund in the last crash, and the reserve exists to make the next sale unnecessary.
A slump longer than 2 years, a health event before Medicare at 65, a roof and a car in the same year, or a state changing how it taxes retired pay can each shorten the runway. Add known large expenses on top of the $84,000, and agree in advance that a 30-month slump is met by trimming spending, not by selling the C Fund at the bottom.
Your reserve target changes at a handful of dates, and it helps to know them in calendar order. First, the last contractor paycheck turns the gap on, so Hiroshi builds the reserve during his final 12 months of work. At age 59½, TSP withdrawals lose the 10% additional tax. At age 62, Social Security becomes available and shrinks the gap.
At age 63, his income starts setting Medicare IRMAA brackets (the income-based Part B surcharge) for age 65. At age 67 he reaches full retirement age for Social Security. At age 75, required minimum distributions begin for people born in 1960 or later. Each January, recheck the gap after the retired pay cost-of-living raise posts.
Ask him now to name you as agent under a power of attorney and to write the spending order down. A sensible order is the cash reserve first, then taxable accounts, then the TSP. Without that paper, the TSP may not talk to you, and a forced sale in a down year becomes likely.
It can count as a partial backstop while you work, but it isn't the same as cash outside the plan. Withdrawals can face plan rules, and a 10% additional tax before 59½ unless an exception applies. Many retirees keep the main reserve in a bank or Treasury bills and treat the stable value fund as a second layer.
Yes. Taxable interest is part of modified adjusted gross income, and Medicare uses that figure from two years earlier. For 2026 the first single surcharge starts above $109,000 of 2024 MAGI. Treasury bill interest counts federally too, though it is exempt from state and local tax.
Yes, for sizing purposes it usually does, because it arrives each month and isn't taxed as income by the IRS. Subtract it, along with net retired pay, from monthly spending to get your gap. One caution: if you receive concurrent payments, confirm your retired pay figure after any offset.
Treasury bills suit retirees in states with income tax, because their interest is exempt from state and local tax. Money market funds are easier to move quickly but aren't FDIC insured. Bank deposits are insured up to legal limits. Compare after-tax yield, and keep the reserve outside the TSP.
The total-spending reserve fits retirees with no guaranteed income yet. The gap reserve fits someone like Hiroshi, whose retired pay covers well over half the bills. The thin reserve fits retirees past 59½ whose pension covers nearly everything. You can run the 4-step arithmetic alone in 10 minutes; a conversation with First Command Financial Services is worth having for the refill rule, the account the reserve sits in, and how the interest touches IRMAA. The gap method also assumes retired pay keeps arriving and rising with inflation, and it doesn't cover long-term care or a large known purchase.
This article is general financial information only, not investment advice tailored to your circumstances. Investing involves risk, including loss of principal. Before making any financial decision, consult a qualified professional about your specific situation.