Updated: Feb. 18, 2014. President Obama signed a new bill into law that restores military retirement benefits for most military retirees and many of those who are currently serving. Those who joined on or after Jan. 1, 2014 will still receive the reduced military retirement benefits included in the Bipartisan Budget Act, detailed below. Service members who are serving on or before Dec. 31, however, are exempt from this new law. 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 negotiated some changes to the bill, which are reflected in this article. We will update the final rulings if and 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 service members and decreased the annual cost of living adjustment for 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 COLA by 1%, compared to 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 how military pensions are calculated, how the pay raises are determined and how this may impact you.
What Pension Benefits the Military Offers
The military has a few retirement plan options. The two active-duty retirement plans this new bill could affect are the High-3 Retirement Plan and the REDUX Retirement Plan.
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. We will update this article when we learn more.
- High-3 Retirement Plan: This plan gives retirees a pension based on 50% of the 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. There are annual cost of living adjustments based on consumer price index.
- 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 COLA, 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 the 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. In most cases, REDUX is a poor retirement option.
How Military Pension Pay Raises Are Currently Made
Military pensions are currently tied to the CPI, which is a measurement of inflation in the U.S. 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 Department of Veterans Affairs service-connected disability rate increases.
The idea behind tying these payments to the CPI 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 DC. 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 the scope of this article, but let’s just 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 pensions up to where they would have been if they had received full COLA adjustments the entire time. Subsequent annual COLA adjustments would be at the full CPI.
Here is a quote from a 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 [retiree would have their] pay. . . 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 10 years.”
On the surface, this proposed retirement pay system is similar to the REDUX retirement option mentioned above, minus the $30,000 career bonus payment. 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 from this system.
How Much This Will Cost Retirees
While 1% may not seem like a lot, it adds up quickly. When you consider the effects of compound interest, the long-term results can be significant.
The Military Officers Association of America ran some numbers based on average ranks at a 20-year retirement.
It came up with the following:
The cuts will have a devastating and long-lasting impact. By age 62, retirees who serve a 20-year career would lose nearly 20% 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 at 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 retire immediately after reaching 20 years of service. Your specific situation will be dependent on your rank and the age at which you retire.
Either way, a 10-20% loss of income over a lifetime is a significant loss that is not easy to make up if you haven’t prepared for it.
The decreased pensions won’t start immediately. The initial plan was to phase these changes in over a three-year period, so they would be in full effect by the year 2016. However, it now looks like this phase-in won’t start until December 2015.
How This Will Impact Younger Retirees
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 are 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 retired 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. In contrast, thee would be 22 years of reduced pension increases for a veteran who retired at age 40.
Retirees from the Guard or Reserves may see the smallest effects 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.
How Exemptions Affect the Reduced Pensions
Some military pension recipients may be exempt from these changes. A recent provision to the bill would exempt veterans with disabilities and survivors of combat casualties from these changes. I have not been able to determine what the minimum disability rating is to be exempt from the reduced pension or whether the disabilities have to be from combat. Updates will follow when the information is available.
Other Changes to 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 vowed to do.
There is also a provision that would change how much federal workers contribute to their pension plans. Currently, federal workers contribute 0.8% of their pay toward their pensions. The revised plan would retain the current contribution rate federal employees pay and would increase the required contribution to 1.3% for federal employees hired after Jan. 1, 2014. There are no other changes to federal pension plans.
The Bipartisan Budget Act Hasn’t Been Passed Yet
This is still just a bill at this point. It hasn’t been signed into law. The Republican-led House of Representatives created this bill and passed it overwhelmingly with a 332-94 vote. The Democrat-led Senate will soon vote on this budget and have the opportunity to pass it as written or make changes to the bill. Then it will go 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.