Over a decade later, REDUX still sucks

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A reader e-mailed a new question on an old debate:

I have a younger relative about to reach 15 years in the Army. Currently he is an E-7 and was presented with the pension choice of taking $30,000 and a 10% haircut on the pension along with 1% less COLA down the road. Off the top of my head I told him it was a horrible choice. I’m sure you probably know all about it. Is the obvious answer for him to turn it down? It looks like such a horrible deal. I am worried that we are missing something.

The reader’s right– it’s a terrible deal, he should be worried, and unfortunately he’s not missing a thing. Career Status Bonus/REDUX is a terrible, horrible, bad awful decision for nearly all military retirees. If a lender or an insurance company tried to sell these terms to servicemembers then they’d be driven out of business. But because it’s the Department of Defense, that somehow makes it legal.

If we’ve learned anything from 15 years in the military, our first question should be: “Why is DoD being so nice to us?” The REDUX/CSB can pay off in two narrowly defined situations, which apply to a handful of military retirees. Both situations have better options. I’ll get to those situations at the end of the post– but for now, think of REDUX/CSB as a gigantic tax on those who don’t do math.

 

The history of REDUX

In the 1980s the Congress and DoD “reformed” the military retirement system to encourage longer service. Anyone who entered the military after 31 July 1986 would no longer receive the “High Three” pension. Instead, retiring at 20 years under REDUX would only offer a pension based on 40% of base pay (instead of the High Three’s 50%). Instead of annual cost of living adjustments at the rate of inflation (the Consumer Price Index), COLAs would be limited to “CPI-1%”. If the CPI was 3% that year, next year’s REDUX COLA would only be 2%.

The “encourage” part came from a higher pension multiplier for staying longer than 20 years. For every year of service after 20, retirees would be eligible for an additional 3.5 percentage points of pension multiplier. If retirees stayed to 30 years of service then they’d get 75% of their base pay, just as they had under the old High Three system.

However the REDUX COLA was still a percentage point lower than inflation. At age 62, REDUX adjusted the pension payment to what it would have been if COLA had been equal to CPI during the previous years of the retirement. But after that one-time boost, the pension COLA reverted to CPI-1%.

There’s the REDUX motivation: Stay until 30 years of service, retire in your late 40s or early 50s, and get a COLA catch-up at age 62 before inflation has really chewed into your pension. If a retiree left the military earlier than 30 years of service, REDUX was a huge pension cut. They’d also lag inflation for decades.

Initially the timing of REDUX seemed flawless. In 1991, after the Cold War and Operation DESERT STORM ended, the military started its largest drawdown since WWII. The country wanted to spend the “peace dividend”, and soon Congress was actually paying servicemembers to leave the military. The improving economy had a hand, but peace seemed to be breaking out everywhere. The mission was over and there was no longer a substantial incentive to stick around the military for 20-30 years unless you truly loved your service. The forecasts cut way back on recruiting, too. The modern force was going to be high-tech, automated, and much smaller. Cheaper, too!

Retention plummeted. It was far easier to leave after one obligation, get a civilian job in the hot Internet economy, and soon earn more retirement savings (and stock options!) than the military pension would ever deliver. The tech sector seemed to be the best way to financial independence.

DoD enthusiastically drew down: decommissioning ships and aircraft, abandoning weapons systems, disbanding entire battalions & squadrons, and closing bases. Billets were cut from commands almost as fast as the servicemembers left them, and the ranks shrank by 25%. Some senior servicemembers were forced to retire, many junior ones were denied re-enlistment or had to change specialties.

In 1994 I had 12 years of service. Only 40% of our year group had a shot at being a submarine XO, instead of the “traditional” 60-70%. The year group behind us was 35%. In 1996 I watched junior officers leave the service, buy a BMW with their separation incentive, and land a $100K/year job at an Internet startup. Which one of us was making the right decision?

By 1998, the military realized that it may have overshot the mark. Readiness was suffering, and historians were muttering darkly about how the WWII drawdown made the military unready for Korea. Think tanks were grumbling about the post-Vietnam “hollow force” era. Retention and recruiting got so bad that even the Joint Chiefs of Staff noticed. (JCS members have over 30 years of service. They’re not motivated by any pensions, let alone by REDUX.) Something had to be done.

In 1999 the JCS literally stood together in front of Congress and testified that REDUX was a recruiting and retention failure. The military retirement system had to be changed. The military was still struggling to “maintain peace” in Bosnia and the Persian Gulf, and the JCS evidence must have been pretty scary.

REDUX was only 13 years old in 1999 and no servicemembers had yet reached 20 years for retirement eligibility, so Congress agreed to change the system. The full High Three pension was reinstated, starting at 50% of base pay for 20 years, and with a full COLA equivalent to CPI.

However there was a compromise to salvage the REDUX dignity philosophy, and the Career Status Bonus was born. At the 15th year of service, servicemembers would be offered a choice of either High Three or REDUX. If they chose REDUX, they’d receive a “career status bonus” for taking the cheaper retirement system.

 

Issues with the Career Status Bonus

The CSB was initially set at $30K in 2000. Since then it’s lost a third of its value to inflation– it would take nearly $40K today to have the same purchasing power– but it’s still $30K. It’s also taxable, unless a REDUX retirement contract is signed while the servicemember is in a combat zone. Frankly, the types of people who want a CSB would rather take the cash and pay their taxes.

That catch-up COLA is subject to over two decades of political risk– a REDUX retiree has to have faith that no legislative changes will occur to the system before age 62. After the one-time catch-up at age 62, though, the COLA returns to its cap of 1% less than the CPI. If servicemembers retire at age 37 on 40% of their base pay (instead of a conventional “High Three” 50% pension) and give back a percentage point of their COLA for the next 25 years, then by age 62 their REDUX pension will only have 62% of the purchasing power of a High Three pension. After the catch-up adjustment, REDUX resumes losing ground on its inflation protection for the rest of the retiree’s life.

Here’s a comparison chart from “The Military Guide“. It assumes that the REDUX enlisted retiree invested (not spent) their entire after-tax REDUX bonus ($25,500) in a mutual fund yielding a realistic 3% after taxes and inflation. The invested CSB compounds for five years before both veterans start their pensions at age 38.

Graph of High Three pension vs REDUX-CSB

At retirement, the REDUX retiree starts with a lower pension ($15,576/year instead of $19,470) but an inflation-adjusted CSB value of $30,448. He starts out with more money than the High Three retiree and keeps the lead until both are 46 years old (only eight years!), when the High Three retiree’s total pension pulls ahead. The REDUX reset at age 62 slightly reduces the widening gap but by age 70 the High Three retiree has received 17% more money– nearly $100,000.

Your choice

The REDUX retirement is a tax on people who don’t do math or can’t handle deferred gratification. It looks tempting to three groups:

  1. “Whew, I can pay off all my debt.”
  2. “I can pay for college, buy a house– or get a new truck!”
  3. “I need this money to start my business.”

The first group may get out of debt, but their windfall won’t solve the root cause of the problem that created the debt: spending more than they earn. In 5-10 years they’ll be right back in debt where they started, only they’ve given up a huge chunk of pension and agreed to lose to inflation for over two decades. It makes far more sense for them to learn how to handle their spending and fight their own way out of debt.

The second group… not much anyone can do for them. Their kids can apply for scholarships, work/study, or the parents’ GI Bill. The parents are cannibalizing their retirement for their kid’s college degree, or they’re hoping that the real estate will hold its value. But the people who buy a new truck will be working for a very long time.

REDUX could pay off for the third group if their business succeeds. It’s tempting to take the seed capital, but again there are better options. The risks are crippling: the lower pension and the reduced COLA will make it even harder for the military retiree to support themselves while growing their business. In the long run it’s far cheaper to raise $30K from a personal loan or a home equity loan (or even from credit cards) and to pay it back out of a conventional military retirement. If a business plan requires $30K of startup capital then the owner could borrow from family/friends or apply for an SBA loan or even consider Kickstarter.

There’s a second hypothetical situation where CSB/REDUX would pay off: promoting to E-9 and staying for 30 years of service. However that’s incredibly difficult even when the military is expanding, let alone during a drawdown. It’s also horrendously unfair to expect a servicemember with 15 years to take the $30K and somehow blissfully expect that they’ll be willing to stay another 15 years to make up for the hit. (When I was at 15 years I could hardly wait for 20.) By the way, the “benefit” of staying until 30 years doesn’t appear until age 70, and then it’s only a few thousand bucks out of over $1M of pension payments.

However servicemembers initially stampeded for the CSB. By 2003 over 60% of Air Force enlisted had opted for REDUX, and over 40% of Navy sailors. Over 30% of Air Force officers and 20% of Marine Corps officers also elected REDUX. Years later, an Army sergeant shared his thinking behind his REDUX decision.

My advice: run away from CSB. Take the conventional High-Three retirement. If the CSB is perceived to be the solution to an “insufficient funds” problem, then there are better solutions that won’t gut your retirement.

If you’re a REDUX retiree then please share your experience in the comments below.

Still considering CSB? Post your thinking in the comments, or contact me. I’d love to help work through the calculations for your rank and years of service.

 

Related articles:
Military pension inflation protection
Effect of inflation on a REDUX military pension
Tom Philpott: REDUX Bonus: Bad Deal Gets Worse
Tom Philpott: REDUX Bonus Repeal Sought

 

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I retired in 2002 after 20 years in the Navy's submarine force. I wrote "The Military Guide to Financial Independence and Retirement" to share the stories of over 50 other financially independent servicemembers and veterans.

17 Comments
  1. […] (and their families) finally did the math and recognized that giving up years of future payments for a lump sum could be a bad deal. It all depends on how much that lump sum could earn over the years, and those future payments […]

  2. […] for a lump sum with a smaller pension. DoD already does this with the REDUX pension, and I think we’ve all learned over the last decade that REDUX has saved more money for the federal governm…. I agree that there are military retirees who are capable of investing a lump sum and earning more […]

  3. Reply
    Gilbert Abrego April 7, 2015 at 11:43 AM

    Ok I am about to hit 15 years in the Marines. I am an E6 my problem is that my current contract takes me to 1 month before 18 years. I have a small defect in my record that makes me scared I won’t get promoted. If I don’t I may not be able to reenlist so if I can’t doesn’t that make the CSB a good idea guarenteeing me a 20 year retirement?

    • Reply
      Doug Nordman April 8, 2015 at 6:03 PM

      Thanks for your question, Gilbert!

      You seem to be willing to give up a High Three pension opportunity in exchange for what might be the more realistic hope of a REDUX retirement. I can understand the attraction.

      However you still have other options, and REDUX should be last on that list. Even if you take the CSB and commit to 20 years now, there’s still no guarantee that you’ll get to retirement. The military could cancel its side of the contract, recoup the CSB (or even forgive it), and release you at 17 years 11 months.

      Here are other options to consider.

      As an E-6, your high-year tenure is 20 years. If you don’t promote to Gunny then you’ll still be eligible to continue through the end of your enlistment contract. In fact if you continue to maintain your promotion eligibility, you’ll be considered for E-7 promotion boards all the way up to retirement. (I’ve seen E-6s be selected to E-7 just a few months before retiring.) Don’t give up your chances– stay as competitive as you can until you sign your DD-214 retirement papers.

      When you reach 18 years of service, federal law protects your opportunity to reach a 20-year retirement. (https://www.law.cornell.edu/uscode/text/10/1176) This ensures that you are not involuntarily discharged when you’re nearly vested in a pension and your other retiree benefits. (Of course you’d still have to stay on active duty and serve the remaining two years.) Because of that law, your goal is to reach 18 years of service.

      The most straightforward way to reach 18 years would be to re-enlist. (As you’ve pointed out, the small defect would still be taken into account when you apply.) However you might not want to re-enlist if it obligates you to stay on active duty past 20 years.

      Another option would be signing an extension on your current contract. Here are some reasons you might consider incurring additional service:
      – to be eligible to transfer your GI Bill benefits to your spouse or kids
      – to receive tuition assistance for college classes
      – to qualify for advanced technical or leadership training schools
      – to comply with a minimum tour length at a new duty station (at least two years)
      – to comply with the minimum area tour to be relocated at a new duty station (2-3 years)
      You might qualify for other Marine Corp programs that would require you to sign an extension.

      So for example, if your next set of PCS orders begins after your 15-year point, then you could also sign an extension on your current enlistment contract to have three years of service remaining at your new location. The extension qualifies you for the next tour of duty, but it also gets you past the 18-year mark.

      Even a one-month extension (for any reason) would take you past 18 years and give you the protection of serving to 20.

      REDUX is not a guarantee that you’ll serve to 20 years, but it does guarantee that you’ll give up a lot of the High Three pension that you’ll be able to earn through other means. In your situation, I’d look at signing an extension. While you’re pursuing that option, continue to give your best performance so that you can mitigate the small defect in your record and maximize your promotion chances.

  4. Reply
    David W. January 21, 2015 at 9:10 AM

    Hi Doug,
    I found your article very informing. The decision is upon me and the “Debt Problem” is looming large over my wife and I. I find the REDUX calculator quite unclear. If you would allow me to make some assumptions, could you paint a clear picture for me on what I would be losing if I take the REDUX/CSB (based on these assumptions)? Of course, if you are willing to give me a fair shake based on my assumptions, you can feel free to follow that up with your opinion too!

    Assumptions:
    1. This REDUX/CSB clears our debt slate completely.
    2. My wife and I, due to being smarter now than we were 8 years ago (thank you Dave Ramsey), DO NOT fall back into debt, and we live a debt free life thereafter.
    3. I retire from AD as a W-4 with 30 years.

    Thank you in advance!

    • Reply
      golfsmygame May 17, 2015 at 1:52 AM

      After months of researching articles and running calculators to determine if taking the bonus is viable, I developed an excel calculator. Would like some feedback on the calculator Doug.

      Most articles on the web I’ve seen out there on the web to build up a straw man that simple isn’t accurate. Earning only 3% on your investment in my humble opinion just isn’t accurate. The TSP C fund today has a 10% rate of return for the life of the fund. Also, I have never read an article that mentions the tax saving of investing in a Roth type investments. You can put $18K in the TSP Roth this year and also $5.5K in a traditional Roth investment.

      For the investor the whole point behind taking the money in advance is to invest and not touch the money until you quit working. Your investment will earn more money in the long run even if you earn a meager 7-8%.

      https://www.dropbox.com/s/kyszdi3jvwrfqm2/Redux%20Comparison%20Calculator.xlsx?dl=0

      • Reply
        Doug Nordman May 17, 2015 at 8:17 PM

        I get a lot of spreadsheets from readers. They’re very detailed with great formatting, and most of the readers have better spreadsheet skills than me, but here’s the thing: they’re poorly documented. It’s very hard to dig out a list of assumptions and to follow the programmer’s logic chain.

        First, I recommend that you crowdsource your feedback by posting that Dropbox spreadsheet to MrMoneyMustache.com or Early-Retirement.org. It’ll attract a larger crowd there than as a comment on this blog post.

        Next, help your readers understand your assumptions. For example, how’d you determine the value of cell H39? Are you starting with $24K (after DFAS withholds 20% of the CSB for taxes) and compounding that at 10% for five years? As another example, it’s difficult to tell whether the factor “Estimated average interest rate on investment” in J18 is 7% before inflation, or 7% after inflation. The funds are probably in a Roth IRA or a Roth TSP so taxes might not be an issue, as long as that 20% withholding is enough to pay the taxes. Maybe it should be 25% withholding. Or maybe only part of the CSB could be contributed to the Roth accounts.

        We could endlessly debate the projections of the TSP C fund’s future returns or military pay growth or inflation. 10% APY compounding is not as credible as annual historical returns or Monte Carlo. The key, however, is to apply the same projections to all three factors: the CSB after-tax lump sum, its smaller REDUX pension, and the High-Three pension.

        When I used my assumptions to create this graph:
        http://the-military-guide.com/wp-content/uploads/2011/03/graph-of-high-three-pension-vs-redux.pdf from this post:
        http://the-military-guide.com/2011/03/14/effect-of-inflation-on-a-redux-military-pension/
        I varied the parameters to see what combinations of returns, inflation, or military pay would make a significant difference. In nearly every case, the larger High-Three pension and its higher COLA overtook the CSB’s head start in less than a couple of decades. In almost all cases, REDUX just can’t keep up.

        Let me emphasize that point: the CSB doesn’t grow fast enough to stay ahead of the annual percentage point reduction in the pension COLA.

        Let me know what part of that PDF graph you feel may be a strawman.

        That post was written before the Roth TSP existed, though, so perhaps the Roth TSP affords an edge. However if a servicemember had the room to put their entire CSB into a Roth TSP and Roth IRA(s), that assumes they had been putting very little income into those accounts. It’s probably more realistic to assume that the servicemember (and possibly a spouse) had to put most of the CSB into taxable accounts because they’d already been contributing to their Roths.

        The one time that CSB/REDUX was a better deal was for the E-9 who served for 30 years. I’ll let the readers decide who’s confident at 15 years of service that they’ll make E-9 and stay for 30. I wouldn’t hoist that burden, let alone suggest that anyone else tackle it.

    • Reply
      Doug Nordman February 8, 2015 at 6:51 PM

      Thanks, David, great question!

      #3 is the weak link in your assumptions. First, you’re forecasting that you’ll even want to stay for 30 years of service. When you joined the military 15 years ago, did you plan to sign a contract for 15 years or did you take it one commitment at a time? I feel it’s tremendously unfair of the CSB/REDUX creators to sucker a servicemember into thinking that they’ll want to stay to 30. By the way, the choice of staying to 30 might be pulled out of your hands by a family crisis or your health.

      Second, you have no guarantee that you’ll be able to stay to 30. You may reach 20 years of service and be retired by the military due to downsizing or sequestration or some other unforeseen circumstance. Federal law says that if you reach 18 years of active duty then you’re guaranteed to be able to stay until 20, but you are not guaranteed any service past 20.

      Third, you might not make W-4 rank. Despite your performance, your service might drastically curtail promotions in your specialty or downsize your entire community.

      Even if you make W-4>30, you’re giving up 1% of your COLA every year until age 62. In 2013 when Congress passed the “COLA-1%” law (which has since been overturned) the smallest estimate of the lost dollars was $80K at an E-7 pension. I don’t remember the number for W-4s but O-5s were well over $100K. If you retire at age 48 and give up 1% of your COLA for another 14 years, then at a minimum you’re taking a $30K loan today and paying at least another $50K of interest on it.

      It’s almost the equivalent of taking out a payday loan to get rid of your other debts.

      I think that your assumption #2 is the most powerful action you can take now. Once you go through the Financial Peace University curriculum (or whatever techniques you choose) then you’ll track your spending and develop your budget. You’ll spend your money on the things that you truly value, and you’ll have cash left over nearly every month. In addition you can sell excess possessions, tackle side-hustle projects during off-duty time, or even talk to your chain of command about a second job. In other words there are plenty of ways to cut the spending (and to generate the funds) to pay off your debt without sacrificing years of retirement benefits.

      I personally know a dozen financial bloggers who have paid off more than $30K of debt in a few years with their Ramsey skills. Even in their darkest debt days, they would never have taken a $30K loan with such a long-term payback.

      I have two other suggestions. One would be to read the MrMoneyMustache.com forums and post a “case study” review of your debt with your income & expenses. The posters on the forum will help you spot areas where you could spend less (and pay off debt). Second, you could visit your service’s relief society for a spreadsheet analysis of your income & expenses. They do it all the time and they’ll be able to suggest many ways to cut spending and boost income.

      Please let us know what you decide to do!

    • Reply
      Gerard February 8, 2015 at 7:27 AM

      The question I have pertains to an AGR (Active Guard Reserve). Given that a member was in their late 50s when they retire (56 1/2) TAFMs of 20years but pay date of35 years. Is the redux in their favor

      • Reply
        Doug Nordman February 8, 2015 at 7:15 PM

        Thanks for your question, Gerard!

        We’ll have to confirm some details before we can work on the numbers. And first, any Guard/Reserve members wanting the Career Status Bonus would have to be on active duty at the 15-year point.

        As I pointed out to David in his comment, it’s a risky assumption that the member would be able to continue on duty (active or drilling) until their late 50s. The CSB has been $30K since the program was enacted in 1999, so 15+ years of inflation have whittled it down to a much smaller amount in today’s dollars. Another issue in both the officer and enlisted ranks is the amount of pay. In general, the REDUX “gap” is the least for E-9s and O-6s (as well as flag/general officers) because of their pay raises later in their careers. However nobody at 15 years of service could confidently predict being promoted to those ranks.

        In general, the $30K is not worth the money. You’re giving up much more in terms of pension and COLA than you’re receiving, even if you immediately invest the CSB (what’s left after taxes) and allow it to compound until age 62 (the REDUX “catch up” adjustment to your pension).

        If you’re interested in calculating the precise numbers (and on active duty at the 15-year point), then please send me an e-mail with your dates of service (active duty and drilling) and your point count.

  5. Reply
    Ray K April 15, 2014 at 4:47 PM

    What happens if you take REDUX but then retire from the Reserves (if that can be done)?

    • Reply
      Doug Nordman April 16, 2014 at 8:20 AM

      Good question, Ray!

      To do that, you’d have to sign up for REDUX (and the Career Status Bonus) at 15 years of service. Then you’d have to leave active duty before reaching 20 years of service. So after taking the bonus you have a window of up to five years where you might decide to leave active duty for the Reserves.

      However to get the CSB you had to sign a commitment to stay on active duty to retirement eligibility. I suspect that the service personnel branch would require you to repay your CSB before they’d approve your resignation, so the Reserve pension would be the usual Reserve High Three pension calculation.

      I don’t think that the federal law for REDUX/CSB even addresses the possibility of a Reserve REDUX pension. I’ve never seen any mention of it in the DoD financial management regulation for calculating a pension, either.

      The number of servicemembers taking REDUX is very small– I doubt that any of them have later tried to transfer to the Reserves.

  6. Reply
    Bob@bob.mail March 19, 2014 at 11:46 PM

    If you buy an investment home, as your business, The redux is the smarter move! I can buy a rent ready house for 32k, rent it out threw a property manager while i am still in the service for $600, and by the time I am out of the army it will have already paid me back the 30 I spend from the redux, and I can buy a 2nd rental home with that money. The redux for an e-7 is 437 a month. The rent from 1 house is 550 AFTER the managment fees. Plus it pays for itself while i am in. Due the math, if your smart, it is a good deal!!

    • Reply
      Doug Nordman March 21, 2014 at 7:04 AM

      Thanks for your comment, Bob.

      It’s easy to get distracted by a discussion of whether there are other attractive investments for the $30K. The point to focus on is whether it’s worth giving up a lifetime income stream to have $30K today. The answer to that question is “Maybe it was in 1999, but not after 15 years of inflation.”

      Prospective landlords would have to compare the rental property’s income stream (and resale value) to the cost of giving up all those future pension dollars and COLAs. It might be a better return to save up $30K for a rental property from your paycheck rather than sacrificing decades of future pension income.

  7. […] nearly two decades away, and there’s plenty of time to solve it. (It took 13 years to fix the original 1986 REDUX retirement system.) I think that Congress can eventually be persuaded to respond to public opinion (and declining […]

  8. Reply
    Reader Challenge Roundup: Readers Choice and the Next [BIG!] Challenge | Mocco May 20, 2013 at 10:02 PM

    […] Over a Decade Later, REDUX Still Sucks [PILLAR POST] by Doug from The Military Guide […]

  9. […] Over a Decade Later, REDUX Still Sucks [PILLAR POST] by Doug from The Military Guide […]

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