Over a decade later, REDUX still sucks
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.
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.
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:
- “Whew, I can pay off all my debt.”
- “I can pay for college, buy a house– or get a new truck!”
- “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.
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