Updated: Feb. 18, 2014. President Obama signed a new bill into law that restores military retirement benefits for most military retirees and those currently serving. The new law grandfathers in military service members who were serving on or before December 31, 2013. Those who joined on or after January 1, 2014 will still receive the reduced military retirement benefits. Learn more in this article: Congress Restores Military Retirement Pay.
Updated: Jan. 14, 2014. The initial bill to cut military pay was passed by the House of Representatives in mid December 2013. The House and Senate have negotiated some changes to the bill, which have been reflected in this article. We will updated the final rulings if/when they become official.
Military organizations and lobby groups were blindsided recently when the House of Representatives passed the Bipartisan Budget Act, a bill that called for the reduction of pay raises for current servicemembers and decrease the annual Cost of Living Adjustment (COLA) for working age retirees (under age 62). One of the purposes of the Bipartisan Budget Act is to reduce the impact of the automatic budget cuts mandated by the Sequestration. Avoiding the mandated cuts will be paid for, in part, by shifting resources from working age military retirees, by reducing the annual Cost of Living Adjustment by 1% less than the current standard.
In other words, if you are a military retiree under the age of 62, you may start seeing smaller annual pay raises. This can have a huge impact over time. Let’s take a step back and look at military pensions, how the pay raises are determined, and how this may impact you.
Military Pension Benefits Overview
The military has a few different retirement plan options. The two active duty retirement plans this new bill would affect are the High-3 Retirement Plan, and the REDUX Retirement Plan.
- The High-3 Retirement Plan gives retirees a pension based on 50% of their average base pay of their three highest annual salaries when they retire after 20 years of service (plus 2.5% of base pay for each additional year served above 20 years of service). There are annual cost of living adjustments based on CPI (explained below).
- REDUX Retirement Option: Retirees who choose the REDUX plan receive a $30,000 lump sum payment at year 15, in exchange for locking in a lower annual cost of living adjustment, which is fixed at CPI-1%. (You will notice this is similar to the Bipartisan Budget Act proposal). There is an adjustment at age 62 to bring their pension up to the amount it would have been without the reduced COLA, then the COLA-1% resumes. This rarely works out to the benefit of the retiree, and in most cases, REDUX is a poor retirement option.
I haven’t yet seen word on whether or not the REDUX option will be affected by the Bipartisan Budget Act, and if so, how it will be affected. We will update this article when we learn more.
How Military Pension Pay Raises Are Currently Made
Military pensions are currently tied to the Consumer Price Index (CPI), which is a measurement of inflation in the US. The index measures over 80,000 items to determine an average inflation measurement. This rate is used to determine the overall inflation rate for many government measurements. For example, the CPI rate is used as the basis for Social Security benefits increases and VA Service-Connected Disability rates increases. The idea behind tying these payments to the Consumer Price Index is to help maintain purchasing power over time.
While this is good for the recipients, it’s a cause of contention for the bean counters in D.C. These raises are cumulative and compounding. Over time, even small changes add up to tens of billions of dollars when spread out over hundreds of thousands (or even millions) of benefits recipients. This is why the government is considering Chained CPI as an alternative to using the CPI. Diving into Chained CPI is outside of the scope of this article, but suffice it to say it isn’t something that the government put together to help pension and benefits recipients.
How Proposed Retirement Pay Cuts Will Work
The Bipartisan Budget Act calls for military retirement pay raises to continue following the CPI. However, working-age retirees under age 62 would receive 1% less than the CPI for that year. Once retirees reach age 62, they would receive a one time adjustment to bring their pension up to where it would have been had they received full COLA adjustments the entire time. Subsequent annual COLA adjustments would be at the full CPI.
Here is a quote from the summary of the Bipartisan Budget Act of 2013:
This provision modifies the annual cost-of-living adjustment for working-age military retirees by making the adjustments equal to inflation minus one percent. This provision would go into effect in December 2015. At age 62, the retired pay would be adjusted as if the COLA had been the full CPI adjustment in all previous years, and the service members would receive the full COLA from then on. Service members would never see a reduction in benefits from one year to the next and it will save approximately $6 billion over ten years.
On the surface, this proposed retirement pay system is very similar to the REDUX retirement option mentioned above, minus the $30,000 Career Bonus payment (and a few other details). The REDUX option resumes cola payments at CPI-1% after pensions are adjusted as if the COLA had been the full CPI adjustment in all previous years, which is different than this system.
How Much will This Cost Retirees?
While 1% may not seem like a lot on the surface, it adds up quickly. And when you consider the effects of compound interest, the long-term results can be significant.
The Military Officer’s Association of America (MOAA) ran some numbers based on average ranks at a 20 year retirement, and they came up with the following (emphasis mine):
The cuts will have a devastating and long-lasting impact. By age 62, retirees who serve a 20 year career would lose nearly 20 percent of their retired pay.
For example, an E-7 retiring this year with 20 years of service would see an average loss of over $3,700 per year by the time he or she reaches age 62. For an O-5, the average annual loss would be over $6,200. An E-7 retiring at age 40 today would experience a loss of $83,000 in purchasing power – an O-5 would lose $124,000.
Other groups measured the loss in retirement pay around the 10% mark. Both measurements can easily be correct, depending on several important factors such as the age and rank of the retiree. Remember, it’s easy to make numbers say what you want them to say, depending on your agenda. In general, the numbers provided by the MOAA are a realistic measurement based on average age and ranks of military retirees who retiree immediately after reaching 20 years of service. Your specific situation will be dependent upon your rank and the age you retire.
Either way, a 10-20% loss of income over a lifetime is a significant loss, and one that is not easy to make up if you haven’t prepared for it.
How This Will Impact You
The decreased pensions won’t start immediately. The initial plan was to phase these changes in over a three year period and would be in full effect by the year 2016. However, it now looks like this won’t start until December 2015.
Those who retire at a younger age will see the largest impact on their bottom line. This is due to the compounding nature of how pay raises work. The longer you stick under this proposed plan, the lower your final retirement pay will be.
Those who will be the least impacted are retirees who served longer, and thus retire at a later age. For example, a retiree who serves 30 years and retires at age 50 would only see 12 years of reduced pension increases, versus 22 years of reduced pension increases for a veteran who retired at age 40.
Retirees from the Guard or Reserves may see the smallest affects from this new law, as the traditional retirement age for the Reserve Corps is age 60. However, it is possible for some Guard and Reserve members to retire early.
Exemptions to Reduced Pensions
There are some military pension recipients who may be exempt from these changes. A recent provision to the bill would exempt disabled veterans and the survivors of combat casualties from these changes (source). As of right now, I have not been able to determine the minimum disability rating to be exempt from the reduced pension, or whether the disabilities have to be combat related. Updates will follow when the information is readily available.
Other Changes in the Bipartisan Budget Act
There are several other major changes in the Bipartisan Budget Act, including giving the President the authority to lower the currently scheduled 2014 military pay raise from 1.7% to 1.0%, which President Obama has vowed to do, and a provision that would change how much federal workers contribute toward their pension plans. Currently federal workers contribute 0.8% of their pay toward their pension. The revised plan would grandfather in the current contribution rate federal employees pay, and would increase the required contribution to 1.3% for federal employees hired after January 1, 2014. There are no other changes to federal pension plans.
The Bipartisan Budget Act Hasn’t Been Passed Yet
Keep in mind this is still just a bill at this point, and it hasn’t been signed into law. The Republican led House of Representatives created this bill, and overwhelmingly passed it with a 332-94 vote. The Democratic led Senate will soon vote on this budget and will have the opportunity to pass it as written, or make changes to the bill. Then it goes to the President for approval.
Even if this passes, there is a buffer built into this change: it doesn’t go into effect until December 2015. There is an election in 2014, so there is time to make a difference by communicating with your representatives and with your votes.
Voice Your Opinion – Contact Your State Representatives: The MOAA has a system to contact President Obama and your state representatives. All you need to do is visit this page, enter your information, customize your message, and send an email to the selected individuals.