New Military Retirement Plan – Proposed Benefits Changes

The Senate Armed Services Committee recently passed the FY 2016 National Defense Authorization Act, which features several major proposals, including military retirement reform, personnel reform, and headquarters and management reform. One of the primary goals of the 2016 NDAA is to find areas where the government can cut back and save money. This will come in many shapes and sizes, including reducing troop numbers, retiring old weapon systems, reducing the acquisitions of new weapon systems, and much more.

Perhaps one of the biggest proposed changes would happen to the military retirement system, which has seen few changes in the last 70 years. This new plan is proposed to go into effect on January 1, 2018. But don’t worry – current servicemembers and retirees are grandfathered into the current system, though current servicemembers would be given the option to change to the new retirement system if they wish.

New Military Retirement Plan

We’ll give a brief overview of the current system, then highlight the proposed changes and how they might impact current or future military retirees. Note: the focus of this article is entirely on the defined benefit, or pension, of military retirement benefits. The recent proposal didn’t include any major changes to other military retirement benefits, such as health care.

Current Retirement System

The current military retirement system is a “cliff-vesting” retirement plan, which basically means it’s all or nothing. Once you reach the required 20 years of service, you qualify for the entire retirement plan. Failing to reach the required 20 years of service nets servicemembers zero retirement benefits (with the exception of early retirees and medical retirees, which is out of the scope of this article).

Here is a basic overview of the current retirement pension plans available today:

  • High Pay
  • High-3 (average of highest three years of pay)
  • REDUX (reduced multiplier in exchange for a Career Status Bonus of $30,000 cash at the 15 year mark).

These three systems all reward retirees with an immediate pension once they reach 20 full years of service. The High Pay and High-3 Systems give retirees a pension based on 2.5% of their base pay for each year they served on active duty. Under this plan a 20-year retirement pension is worth 50% of the member’s base pay. There is also a Cost of Living Adjustment (COLA) each year based on the Consumer Price Index (CPI).

The REDUX pension plan is slightly different. Retirees who choose this plan receive a $30,000 cash bonus at their 15 year mark, in exchange for receiving a retirement multiple based on 2.0% of their base pay for each year served. Under this plan a 20-year retirement pension is worth 40% of the member’s base pay. In addition, the annual COLA pay raise is based on CPI – 1. So if the CPI is 2.0%, REDUX retirees would only receive a 1% COLA increase. In general, REDUX is not a good deal for military members.

Here is a more in-depth analysis of active duty retirement benefits, including a podcast.

Need for Change

There are several reasons given for the proposed change. The annual fixed cost to the government is certainly a concern, as it is growing every year with more retirees and COLA increases. But there is also a desire to make the military retirement system closer to what people might find in the civilian sector (except very few civilian companies offer pension plans these days). Many civilian employees have portable retirement plans they can take with them when they leave their job, often in the form of a 401k or similar retirement plan.

Very Few Military Members Receive any Retirement Benefits: Only about 17% of military members remain on active duty long enough to serve the full 20 years required to earn a military pension. That means roughly 83%, or about 5 out of every 6 servicemembers, don’t receive any long term retirement benefit from their military service. Servicemembers do have access to the Thrift Savings Plan, however, they can only contribute funds from their own pay and bonuses. The military does not currently make matching contributions like many civilian companies offer.

Solution: The government is proposing a plan that would offer service members a 401k-style retirement plan (using the TSP) in conjunction with a pension plan that vests at 20 years. Members would be free to take their TSP account and matching contributions with them when they leave the military. This would come at the expense of a lower multiplier for the pension. However, the total retirement benefit under the new plan may actually exceed the current plan for some retirees.

Let’s look at the proposed plan.

Proposed Retirement Plan

The new military retirement plan, as proposed, is a blended retirement plan that utilizes the Thrift Savings Plan, a Career Continuation Bonus, and a pension. This plan is the same plan that was proposed in the 2015 Military Compensation Modernization Recommendations.

Officials estimate that at least 75% of active duty servicemembers will receive some form of retirement benefit under the new plan, as opposed to the roughly 17% who receive benefits under the current plan. The difference comes from the Thrift Savings Plan contributions made by the government, which would start after the servicemember has completed 2 years of service. Under this plan, the only servicemembers who wouldn’t receive some benefits would be those who serve fewer than 2 years.

Here is an overview of how the plan would work:

  • Thrift Savings Plan Contributions: Servicemembers would automatically be enrolled in the TSP and would begin receiving matching contributions up to 5% of their pay once they have completed two years of service (starting at 2 years, 1 day of service).
  • Continuation Pay Bonus: Military members would receive a Career bonus upon reenlisting for 4 years at their 12-year mark. This would equal 2.5x their monthly base pay. This does not take into account other reenlistment bonuses which may be in effect. The servicemember would be able to take the payment in a lump sum, or as annual payments during their reenlistment. Like all reenlistment bonuses, the Continuation Pay would be subject to being recouped if the servicemember failed to finish their enlistment (with limited exceptions).
  • Defined Benefit Changes (Changes to the Pension): The current pension is what most people think about when they think about the retirement system. The new plan would use a 2.0% multiplier instead of a 2.5% multiplier, making a 20-year pension worth 40% of base pay instead of the current 50%.
  • Control Over How & When Retirement Pay is Received: Retirees would be able to choose one of three methods for receiving their retirement benefits. They could (1) take an immediate monthly annuity (the pension plan as we know it today), (2) take a lump sum payment with a smaller monthly annuity, or (3) take a larger lump sum with no immediate monthly annuity, but they would be eligible to receive the full annuity they would have been eligible to receive, once they reach Social Security age. For the latter two options, retirees would be eligible to choose to take either 50% or 100% of the discounted present value of their pension that would be due to them before they are eligible for Social Security benefits.

The last section is the biggest curve ball in the plan. It adds flexibility, but also complexity when determining how much the retirement benefits are worth, and this complexity may end up hurting some retirees who end up making a poor decision based on their situation. On the flip side, having the option of taking a lump sum payment up front could help some retirees during their transition into the civilian sector.

Pros and Cons of Proposed Plan

There is a lot to like here, and a lot to be skeptical about. In general, I’m not a fan when military benefits get reduced. Primarily because each reduction makes it easier to repeat in the future. But this proposal has a lot of merit, particularly when it comes to helping the entire military population, not just the 1 in 6 who stay in long enough to retire. I don’t want to take anything away from anyone who served the full 20 years – I have a lot of respect for all of you!

But there are many who served for 12, 14, 16, or 18 years, and just couldn’t complete the full 20. They are sent on their way with whatever they have in savings and whatever they were able to put into their TSP or their own investments. This proposal would give members a greater incentive to save in their TSP, since the matching funds would equate to receiving free money. The Continuation Pay Bonus would also be an incentive to remain in the service and would be a nice bonus for those who were already planning on staying in the military.

Finally, the reduced pension isn’t a catastrophic reduction. Yes, 40% of your base pay is a lot less than 50%. But if the servicemember is able to contribute to their TSP account and receive the full 5% matching contributions, then they should have been saving at least a total of 9% of their base pay into their TSP throughout the majority of their career (I’m assuming the matching TSP contributions would be the same as the Civil Service FERS plan, which is explained in this TSP contribution limit article). Depending on how the markets perform, the compounding effects of time may help erase the gap between the two pension plans.

Of course, that’s the big “what if?” isn’t it? We all know many people won’t save the full amount, even if they receive matching contributions, and we have no way of knowing what the markets will return. There is also a big difference between having a fixed pension for life and having some money in the bank that needs to be managed and withdrawn as needed (it’s more complicated due to the tax implications, need to balance a portfolio, etc.).

Who Wins, and Who Loses?

At the end of the day, the big winners would be the military members who serve a few years, but don’t make it until retirement. They will have the opportunity to save some money for retirement and take it with them when they leave. And since that is the majority of the military population, there will be a lot of winners. The government is also a winner, at least, in some ways. They will save money on their fixed pension expenses, but much of those savings will be redirected to other servicemembers through the TSP and Continuation Pay Bonuses. Some retirees may also end up as winners, depending on how their investments do and how they take their pension payments.

The losers? I hate to use that term here, because everyone in the current system is grandfathered in. So the only people who will be affected are those who haven’t joined yet, or those who elect to transfer into this system. I don’t want to discount our future servicemembers, because they will carry on the traditions and defense of our nation. But they will join the military with that plan in place, so they aren’t losing out – they will be receiving what they signed up to receive.

The biggest question mark around this new plan surrounds the variable nature of the benefit. Trading a fixed monthly payment for a lower fixed payment and some money in your Thrift Savings Plan is a risky proposition because we can’t predict future returns. This it’s impossible to accurately calculate the future value of this plan compared to the current plan. But that is a problem faced by the vast majority of the population, and certainly not unique to military members.

Overall, this is a reasonable proposal, and one that very well could be passed into law in the near future. If it does, then we will likely see some major changes when it rolls out on January 1, 2018.

What do you think about this proposal?