The military retirement system is one of the most generous pension plans to be found almost anywhere. But the days of retiring at half pay after 20 years of service may be numbered. The DoD and Congress have been investigating opportunities to cut military retirement costs. It’s a delicate balance. The government needs to trim expenses across the board (thanks to the Sequestration), but the military needs to balance cuts with retention. Slice too deep, and too many service members will leave the service before they qualify for retirement benefits, leaving the military short on experience and leadership.
The latest study, called Concepts for Modernizing Military Retirement (pdf), aims to meet that balance by offering a hybrid pension plan that combines a 401(k) style defined contribution benefit with a traditional pension. The basics work like this: all troops who serve at least 6 years will receive a contribution on their Thrift Savings Plan, a cash retention bonus will be paid at 12 years of service, and a larger lump-sum payment will be made after retiring after 20 or more years of service.
These new TSP contributions and cash payments come at a price, however. Military retirees would either receive a reduced retirement benefit multiplier, or a reduced pension while they are still working age (until around age 62).
Let’s take a look at what this may mean for future military retirees.
Hybrid Military Retirement Plan
There are three main components of the new potential retirement plan*. Here are the basics of each:
Matching Contributions in the Thrift Savings Plan: All service members would have a Thrift Savings Plan account opened on their behalf. Starting at year 2, the DoD would automatically contribute 5% of the service member’s base pay to the account, with no requirement for military members to make any contributions to receive the full 5%. Service members would be able to make their own contributions to the account if they wish. However, full ownership of the DoD contributions would not pass to the servicemember until they reach 6 years of service. A vesting period like this is a common retention tool in the civilian world.
Mid-career retention pay: The next benefit would be a lump-sum mid-career retention pay made to the servicemember around year 12. The proposal is around 2 months pay for enlisted members, and 6 months pay for officers. However, these payments would be controlled by each branch of service, so these numbers may be variable if the retention pay is used as a reenlistment incentive for undermanned or critical career fields.
Transition Pay at Retirement: There would also be a “transition pay” given upon military retirement at 20 years of service. This could be anywhere from one year of basic pay, up to three years of basic pay, depending on which option is chosen (see below for the immediate vesting, or the delayed vesting option).
There are two options currently under proposal regarding how much military retirees would receive for their military pension, and when they would receive it.
Proposal 1 – Immediate Vesting: This proposal would be similar to the current retirement system in which retirees would begin receiving full retirement checks and standard Cost of Living Adjustments for life.
Proposal 2 – Partial Payments While Still Working Age: The second proposal would enact a dual-tiered pension plan with reduced monthly payments to working age retirees, with payments beginning immediately upon separate from the military. The reduced pension would probably be around 25% of base pay. The retiree would then begin receiving full retirement pension at a more traditional retirement age of around age 62.
New Retirement Multiplier
The current military retirement multiplier is 2.5% pf pay for each year served. If you serve the minimum 20 years to qualify for military retirement benefits, you will have earned 50% of your base pay (actually, the average of your highest three years of pay for most military members still serving). Serving 30 years would earn a retiree 75% of their pay, and so on. This proposal would change the retirement multiplier, depending on which of the above options is chosen, the immediate vesting option, or the delayed vesting option.
Multiplier for Immediate Vesting: The immediate vesting option would place the multiplier at 1.75% of base pay. This would equate to a 35% benefit at 20 years of service. Serving for 30 years would net a retiree 52.5% of their pay.
Multiplier for Delayed Vesting: If the option for delayed vesting is chosen, the multiplier would likely remain at 2.5%, or possibly be reduced to 2.0%. The 2.5% multiplier would have no impact on the retiree, with the exception of the retiree receiving reduced pension payments until they reach retirement age. A 2% multiplier would pay 40% at 20 years, and 60% at 30 years (after reaching traditional retirement age).
How Much Will This Cost Retirees?
The DoD numbers show this will cost most retirees around 10% of their lifetime benefits compared to current retirement plans, depending on various factors, such as the rank and time in service of the retiree, age at retirement, market conditions for the TSP contributions, and which of the two options are chosen, the immediate or delayed vesting.
Who Wins & Who Loses Under This Proposal?
There are always pros and cons to every change. Lets take a deeper look at how this impacts military members.
Non-Retirees Benefit the Most. There are some people on the other side of the table (lawmakers and policy makers) who often quote that the military retirement system isn’t fair because fewer than 20% of service members remain on active duty long enough to qualify for a 20 year retirement. Many of the servicemembers who leave before serving 20 years walk away with nothing. This plan would change that. Anyone who serves at least 6 years would walk away with vested contributions in their Thrift Savings Plan account. The mid-career cash bonus at 12 years would also benefit many servicemembers, especially if they have the option of contributing the amount to their TSP. These Thrift Savings Plan contributions belong to the servicemember when they leave the military. This has the potential to be worth tens of thousands of dollars in the future, depending on how much the member received from the DoD, market conditions, and more importantly, whether the troops left the money in their TSP until retirement age.
Retirees See the Biggest Change. These two plans are different enough to warrant an individual response. Under the immediate vesting option, retirees would see a much reduced multiplier, substantially reducing their retirement pay. This would virtually guarantee every military retiree would have to work again after they reach military retirement. Currently, many retirees are able to plan in advance and may be able to retiree for good on a military pension. The added TSP contributions would make up for some of the pension shortfall, but this moves the responsibility to the servicemember, and would require them to leave their funds in the TSP until they are able to withdraw it (currently age 59½).
The delayed vesting option would cap military pensions at 25% until the retiree reaches a traditional retirement age (age 62), at which point they would receive their full pension. The delayed vesting option has either the same multiplier, or a slightly reduced multiplier. The primary difference is a larger cash payout for the career transition bonus paid out when the servicemember retires. How the servicemember uses the transition pay would have a large impact on how the numbers work out in the long run.
Does the government win? Either of these plans would save the government money in the long run, but they wouldn’t bring immediate cash savings. The Pentagon would grandfather in all current servicemembers to their current retirement plan, and the DoD would have to begin making large lump sum payments in the mean time to all servicemembers who meet the benchmarks for cash payments. The real savings by the Pentagon wouldn’t be seen for a few decades at least. After that, the savings would grow.
Will The DoD Move Toward a Hybrid Retirement Plan?
About two years ago, the Defense Business Board proposed some radical changes to the retirement system that would move almost the entire military retirement system to a 401(k)-like retirement plan. The plan would eventually shift 100% the responsibility for retirement from the government to the troops. The proposal was wildly unpopular, and the DoD feared the military would have a hard time meeting retention goals. This new proposal is somewhere in the middle.
One thing is clear: changes are coming to the military retirement system. It’s not really a question of if. It’s a question of when, and to what degree the changes will take place. We have already seen the previous proposal to shift all of the retirement to a 401(k) type plan. And this year we have seen Congress pass a law to reduce Cost of Living Adjustments for working age retirees. That law was repealed almost in its entirety shortly after it was passed. The law was changed to grandfather in all servicemembers who were in the military prior to 2014. Those who entered the service in 2014 or later will still have a reduced military pension.
The writing is on the wall. Changes will happen. It’s just a matter of the government finding a happy medium that will work for the lawmakers and lobbyists, and that won’t hurt retention too much.
The good news is the DoD has stated current servicemembers would be grandfathered into their current retirement plan. Hopefully this will be the case, and any changes that happen in the future will happen when servicemembers join the military under the assumption of the new rules.
* To be clear, the Pentagon is not calling this a proposal or recommendation at this time, simply an option the military could choose in the future.
Image credit: General Frank Grass.