How Does Military Retirement Pay Affect VA Loan Qualification?

Military retirement pay counts as qualifying income, and it is treated as primary income where it is reasonable to conclude the payments will continue.

Three things are worth understanding before applying: 

• How retirement pay behaves in each of the two calculations lenders run
• What happens when a disability offset has changed the amount
• Why taxable and nontaxable income are handled differently in the math

Retirement Pay Counts as Full Income

According to the Va’s guaranty regulation, income cannot be discounted because it is derived from an annuity, pension, or other retirement benefit. The amount of any pension will be used as primary income if it is reasonable to conclude the income will continue in the foreseeable future.

The regulation's two-year history requirement applies to employment, not pensions. It is triggered when a borrower has been with their current employer for less than two years. 

The Two Calculations Your Income Has to Pass

Ordinarily a borrower must meet both standards:

• Debt-to-income ratio
• Residual income

Failing one does not automatically disqualify an application.

Debt-to-Income Ratio

DTI is figured by comparing anticipated housing expenses plus long-term obligations against gross monthly income. The standard is 41% or less.

Above that figure, a loan may still be approved with written justification from the underwriter's supervisor. If the ratio exceeds 41% and residual income exceeds the guideline by at least 20%, no second-level review or statement of justification is required. The regulation lists military benefits among acceptable compensating factors.

Note that this calculation runs on gross income. Retired pay arrives after deductions, and a Retiree Account Statement will show items such as Survivor Benefit Plan costs and federal income tax withholding subtracted from the gross figure. 

Residual Income

The second calculation measures the dollars remaining each month after housing, debts, and taxes. VA publishes minimums that vary by region and household size.

A Reduction That Names Retirees

For applications involving an active-duty servicemember or a military retiree, the residual income figures are reduced by a minimum of 5 percent where there is clear indication the borrower or spouse will continue to receive benefits from the use of facilities on a nearby military base.

Retirees appear in that provision alongside active-duty members, which is worth knowing if you live near an installation.

Where Retirement Pay Gets Complicated

Retiring Recently and Starting a Civilian Job

The regulation notes that applications from Veterans who retired after 20 years of active duty require special attention, because retirement income alone may not be sufficient for the loan amount sought, and many such applicants have been in new jobs for a very short time.

Two provisions follow that work in the applicant's favor.

If your new civilian job draws on the skills you used in uniform, that service experience can count toward your work history. 

The regulation's own example is an aircraft mechanic who retires and goes to work as an auto mechanic or machinist. The skills carry over, so the income counts. Its counterexample is a former Air Force pilot a few months into selling insurance on commission. Nothing transfers, there is no track record, and the income does not count.

If retirement pay alone gets you close to qualifying and you only need modest employment income to bridge the gap, the regulation says doubt should be resolved in your favor.

If Your Retirement Pay Is Smaller Than You Expect

If you draw both retired pay and VA disability compensation, your retired pay may have been cut. DFAS calls this the VA waiver: the law makes you give up retired pay dollar for dollar against whatever disability compensation you receive. Two payments, but not two full payments.

Plenty of retirees get the full amount of both anyway. That is Concurrent Retirement and Disability Pay, and you generally qualify if your disability is rated 50 percent or higher and you are entitled to both payments that month. If you were medically retired under Chapter 61, different rules apply and it is worth asking about them specifically.

There is also Combat-Related Special Compensation, a separate program you have to apply for through your branch. You can receive CRDP or CRSC, not both.

Taxable Versus Nontaxable Income

Retired pay is taxable. DFAS issues a 1099-R each year and withholds federal income tax from retirement payments.

That matters because of how the regulation treats nontaxable income. Verified nontaxable income may be adjusted upward, or "grossed up," once it is established the income is likely to continue and remain untaxed. The regulation lists disability retirement payments among the qualifying types and directs that care be taken to confirm the income is in fact tax-exempt.

Two limits apply. The adjustment may be used only for the debt-to-income ratio, and only actual income may be used to calculate residual income. Because ordinary retired pay is taxable, it is not grossed up.

The Funding Fee Exemption

Among the groups exempt from the VA funding fee are Veterans entitled to receive VA disability compensation who chose to receive military retirement pay in lieu of compensation before loan closing. The full list appears on VA's refinance page and in VA's loan fee guidance, and it also covers Veterans rated eligible for compensation through a pre-discharge claim and those entitled to compensation who are not receiving it because they are on active duty.

Confirm your status before closing. If a funding fee was paid and an exemption applies, VA states a refund may be available through your servicer or a Regional Loan Center.

What Has to Be Verified

The regulation is direct: income that is not verified, or cannot be verified, cannot be considered when analyzing the loan.

For retirees, the Retiree Account Statement is the natural starting point. DFAS describes it as a two-page document summarizing pay, benefits, and deductions at a given point in time, issued monthly through myPay with an additional statement each December. Your lender will specify what else the file requires.

The Bottom Line

Retirement pay is treated as full, primary income, and the rules around it are more accommodating than many retirees expect. Three provisions are worth raising by name: the residual income reduction that names military retirees, the allowance for short job tenure where military skills transfer, and the funding fee exemption that turns on which payment you elected to receive. Read more about VA loans

FAQs

Does retirement pay count as much as a regular paycheck? 

It counts as primary income where continuation is reasonably established. The regulation prohibits discounting income solely because it comes from a pension or retirement benefit.

Do I have to be retired for two years before it counts? 

The two-year history requirement in the regulation is written about employment with a present employer, not about pension income.

Can I combine retirement pay with income from a new civilian job? 

Yes. Where military duties relate closely to the new position, the regulation allows that experience to support using the employment income despite short tenure.

Why is my retirement pay lower than my award letter says? 

Most likely the VA waiver. Retired pay is reduced dollar for dollar by VA disability compensation unless you qualify for concurrent receipt, which generally requires a disability rated at 50 percent or higher.

Am I exempt from the funding fee if I take retirement pay instead of compensation?

Possibly. Veterans entitled to disability compensation who receive retirement pay in lieu of it are among the exempt groups.