The Military Compensation and Retirement Modernization Committee finished its report in Jan 2015 and had several recommendations that ranged from the military retirement pension to Tricare and Commissary benefits. Once the 2016 National Defense Authorization Act (NDAA) was signed in late 2015, the military retirement system is about to see some of the biggest changes in several decades. The committee final report stated:
“The Services’ retirement system should be restructured to provide retirement benefits to more than one million current Service members who would otherwise leave service without any Government-sponsored retirement savings. Doing so eases the transition of Service members to civilian life by providing them with retirement savings similar to those of their private-sector peers. This recommendation blends the recruiting benefits of a modern 401(k)-type plan, with the retention benefits of the current retirement annuity, lump sum career continuation pay, and retention bonuses paid at important career milestones in the lives of Service members. Modeling has demonstrated that such a blended system would maintain the Services’ current force profiles. It also provides additional flexibilities to the Services to adjust force profiles if desired to maintain a balanced force. It would also sustain, and may improve retention and increase lifetime earnings of retirees.”
It will take several posts to break down all of their recommendations and the underlying assumptions of the new Blended Retirement System so this discussion will start with the basic changes. According to the Military Compensation and Retirement Modernization Committee, around 83% of active duty members get out before ever even reaching retirement eligibility at 20 years so the new system has dramatic impacts for these servicemembers by allowing them to walk away with retirement benefits they never had before. Of course, the flip side of that is the traditional pension are somewhat reduced to shift some of those benefits to the non-pension holders. There are also those somewhere in the middle — they aren’t sure if they want to stay in until 20 years, but also not sure they want to get out. The purpose of this post is to help these people understand the potential tradeoffs for enrolling in the new retirement plan.
First, here are some of the basic facts about the new changes to the military retirement plan:
- Servicemembers are automatically enrolled if you join on or after 1 Jan 2018 with the member’s default contribution rate of 3%. Their TSP contributions will vest after 2 years of service and matching government contributions can go up to another 5% after that 2 years
- If on 31 Dec 2017 you will have less than 12 years of service (you joined on or after 1 Jan 2006), you may elect to enroll in the new retirement plan AND you must enroll BEFORE 31 Dec 2018.
- The new retirement pay multiplier is 2% (not 2.5% as it was under the current plan)
- 20 years of service = 40% of basic pay
- 30 years of service = 60%
- No retroactive TSP contributions will be made for new enrollees
- Contributions start the day you enroll and will continue up to 26 years of service
- If you are eligible to opt-in, you will receive DoD automatic and matching contributions the first paycheck following opt-in. There is no 60-day or 2-year waiting period as there is for new Service members under BRS starting Jan. 1, 2018.
- The government will automatically contribute 1% of the enrollee’s basic pay into the Traditional TSP every month
- The government will match up to an additional 5% of the enrollee’s TSP contributions (Note that both the government’s automatic 1% contributions and up to the 5% match are deposited into the Traditional TSP regardless if you contribute partially or solely to the Roth TSP option)
- New retirement enrollees who complete 12 years of service and sign up for an additional 4 years will receive Continuation Pay of (monthly basic pay at 12 years)*2.5 + [Secretary discretion for] (monthly basic pay at 12 years)*(# of months up to 13) — BL for an O-4 today = $17,475.50 + potential bonus up to $90,877.80 and E-7 equals $9,883.50 + potential bonus up to $51,394.20 … I would expect those bonuses to be used for career field incentives to stay
- There is also the option to take a lump sum payment from pension benefits at retirement that is beyond the scope of this post
- Congress and the DoD are still looking at tweaking various elements of this plan so stay tuned
Defined Benefit Plan vs. Defined Contribution Plan
First we need to lay down a few definitions and explain the difference between the current (and only retirement option) defined benefit plan versus the new transition to a defined benefit plan for everyone who stays in the military for 20 years and a defined contribution plan for all new servicemembers (who join after 1 Jan 2018) as well as current eligible servicemembers who decide to switch.
Investopedia.com defines a defined benefit plan as “An employer-sponsored retirement plan where employee benefits are sorted out based on a formula using factors such as salary history and duration of employment.” This is the standard 2.5% of basic pay per year rule to calculate retirement pay at 20 years or beyond which we are all familiar with. Most traditional pensions, including military retirement pay, are a defined benefit plan. However, unlike most traditional companies defined benefit plans that depend upon market returns and the continued viability of the company, the military defined benefit plan depends upon the continued ability of the federal government to tax and otherwise raise money to cover its obligations. While there is a good debate about the ability of our government to continually run the kind of large deficits as we have seen in the past, the fact remains that the federal government pension remains the safest and most reliable pension available. Add in the power of inflation (COLA) adjustments and the value of a military pension only increases. Of course, only 17% of servicemembers ever get to retirement so what about the rest of the force?
After many years of considering a change, the DoD decided in 2012 to push ahead with modifying the retirement system and created the Military Compensation and Retirement Modernization Committee. This committee held hearings for nearly 18 months and solicited direct feedback from over 100,000 servicemembers, veterans, and families as well as hearing testimony from many veteran’s groups and military organizations. In addition, they added numerous surveys, which some of you may have participated in, and public Congressional hearings. All of this generated large media attention and publicity from all corners. There were several key findings identified. First, the committee identified the inherent “unfairness” of the current cliff vesting at 20 years. The hearings and surveys also revealed much of what the civilian workforce has realized with the increasing numbers of Millennials entering the workforce – namely that workers and servicemembers want more portable and flexible retirement benefits. While servicemembers have had access to the Thrift Savings Plan (TSP) since 2002, they have not had automatic government or matching contributions like federal civil-service members have. Servicemembers indicated they preferred the ability to leave active duty with more in their retirement accounts than the all-or-nothing plan.
Investopedia.com defines a defined contribution plan as “A retirement plan in which a certain amount or percentage of money is set aside each year by a company for the benefit of the employee. This is usually a special kind of savings account specifically for retirement, the TSP in this case for servicemembers. Most current retirement plans, such as 401(k) plans, are defined contribution plans. The employee owns the balance of the account (with vesting restrictions) and can transfer it with them between jobs or roll it over into their personal Individual Retirement Account (IRA) which is a subject for a future post.
There are some commentators who have strongly critiqued the new retirement system as a way for the government to decrease its financial obligations to retirees by saving billions of dollars a year by funding pensions at 40% instead of 50%. While the DoD has to pay the one-time costs of matching funds into servicemembers’ TSP accounts, they are relieved of the Congressional requirement to pre-fund the pension amount as required by current law. DoD’s accountants also know that not all servicemembers will take advantage of the matching contributions which means that DoD can (sadly) reap cost savings there as well.
Future posts will dive into the complex calculations and case studies modeling given certain scenarios of ranks, time-in-service, and projected rates of return and inflation, but my initial calculations have clearly demonstrated a few things.
- If you are 100% sure that you will stay in the military until at least 20 years, then you should stay on the current retirement system due to the combination of no catch-up contributions, compounding effect of automatic inflation adjustment at a 50% vs. 40% pension, and the uncertainties of market returns.
- If you are planning to get out of the military and you joined the military after 1 Jan 2006, then the new plan allows you to have some retirement benefits provided you contribute at least 5% of your basic pay to get the full government match.
- If you are somewhere in the middle where you might want to get out at some point, then you need to check back soon as we continue to walk through some case studies that illustrate the tradeoffs you will face.
Some people have asked me my opinion on the new retirement plan and I believe the new retirement plan to overall be a better option than the current plan that benefits the 17% who make it to 20 years. Servicemembers will need to be diligent and disciplined to always earn the full DoD match once they are eligible because otherwise they are “leaving free money” on the table.