Beware Of Huge Flaws In The Military Blended Retirement System

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History still repeats itself, but we’re still not learning from it. Now we have the Military Blended Retirement System on the horizon…

The existing military retirement system has been in place since the end of the last millennium when REDUX ended and the High Three pension was signed into law. The REDUX system was modified to offer a lump-sum Career Status Bonus of $30K in exchange for the reduced pension.

Only a few people remember why this 1999 change was implemented: REDUX was one of the factors killing retention. Back then the Cold War had ended and the wars in Afghanistan and Iraq were “over”.

The World Wide Web had been added to the Internet, and the economy was booming. The peace dividend was finally paying off and the federal budget was actually running a surplus! The military had just finished the biggest drawdown since WWII (over 25% of the force).

Recommended: Should You Choose The Military’s New Blended Retirement System?

In the mid-1990s thousands of servicemembers were being paid to leave active duty, and not enough people were willing to stick around past 20.

Retention was so dire that the chiefs of all four services jointly testified to Congress: the drawdown was over and we’d cut too deep.

The marginal performers and the short-timers were long gone but now the lifers were leaving as soon as they finished their service obligations. The Internet was making everyone else rich!

Nobody wanted to settle for a measly 40% pension at 20 years (let alone stick around for a 75% pension at 30) when they could jump into a New Economy career.

Today those Baby Boomer and Generation X attitudes seems pretty silly to Millennials. But when you’re living through history and you don’t know how it turns out, its movies can have a surprise ending.

A Video Explanation

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REDUX and the Career Status Bonus

The Career Status Bonus seemed like a great deal when it started in 1999. After 15 years of service, you could get $30K (before taxes), just for sticking around to 20!

Servicemembers had lots of great plans: paying off debt, or starting a business, or making a down payment on a “forever” home. A few were even buying hot tech stocks on sale and planning to grow their investments faster than the parts of the pension & COLA they’d given up. I’m pretty sure that a few other plans turned into new pickup trucks too.

Nearly 17 years later, the CSB is still $30K. Meanwhile, inflation has cut the CSB’s buying power down to $20,988 (before taxes) and the original pension-cutting provisions are still in effect.

People realize that a 40% pension at 20 years is a lot smaller than it sounds, and years of reduced COLAs took a huge toll on its spending power. The CSB calculators make optimistic assumptions about future investment returns— just over 7% APY before taxes– which have proven to be difficult for typical investors to achieve.

Servicemembers (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 depend on the assumed average returns of the lump sum. In technical terms, the net present value of a lump sum payment depends on its estimated future value and the discount rate.

Now a new generation is being asked to make the same decision.


Lump-sum math and the discount rate

Military's Blended Retirement System

The pension lump-sum details

Once again, the amount of a lump-sum payment depends on how big everyone expects it to grow in the future.

For example, a pension of just $100/day ($3000/month) could be paid out for a military retiree’s remaining life expectancy of 35 years. That’s $1.26M in today’s dollars because the pension is adjusted for inflation.

However, nobody knows how long an individual retiree will live. A lot more Americans are surviving to their older years (lower mortality) and longevity has been rising slowly during the last century. A handful of today’s military retirees are over 100 years old, and that number is bigger today than it was a decade ago.

Nobody truly knows how much DoD has to set aside today to pay that pension. If inflation is low and investment returns are high then it’s easy to fund a long retirement with a relatively small amount of money. That works out to a high discount rate because a small amount of money grows to a much larger final value. However, if inflation spikes or future investment returns are lower then we’re going to need a lot more to pay for retirement. That works out to a small discount rate because a large sum of money grows very slowly to a slightly larger final value.

Over the last two decades, American businesses and state/municipal governments have learned some harsh lessons about pension accounting. Accountants and actuaries have refined their statistical models of retirement, and pension accounting is much tighter than its previous 75 years.

Many municipal pension funds (and some airline pensions) have assumed that inflation will stay low (for decades) and investment returns will be high (forever). They decided to use high discount rates and only set aside a small amount in the pension fund.

When their employees retired and the payments started rolling out, it turned out that those estimates were wildly optimistic and the pensions were horribly underfunded. Cities and companies have frozen retirement plans, raising contributions to their pension funds, and even declaring bankruptcy– all because accountants finally have decent tools to analyze their predictions.

When everyone applied these new tools to their pension funds, they finally had to face up to realistic financial obligations and use much lower discount rates.

Ironically, DoD pension funds are in great shape today because Congress forced similar accounting changes on the military over 30 years ago. DoD has to set aside funding every year for expected pension expenses, and those funds are invested in special-purpose Treasury securities which pay a very low (but very safe) rate of return.

In today’s pension math, DoD has to use a very low discount rate and has to set aside a large sum of money to pay for a military retirement.


DoD’s lump-sum pension payouts and their discount rate

One of the features of the new blended military retirement system is an optional lump-sum payment. Retirees could give up some of their pension (until age 67) in exchange for an immediate lump-sum payment at retirement. The specific amounts of this lump sum would depend on the retiree’s age and the size of their pension, but once again the discount rate is the critical factor.

Nobody knows exactly how this lump sum will be calculated. The new retirement law allows a lump sum to be paid but it doesn’t specify the calculation or the amount. DoD will be able to set their discount rates by their own policies under the Congressional legislation, and the lump-sum choice is up to the retiree.

However, the lump sum is already looking like a bad deal. The American Academy of Actuaries is concerned about DoD’s potential accounting for the lump-sum payouts. The Academy’s decades of experience has shown that an appropriate discount rate for today’s economic forecasts is roughly 2%-4%. (That’s a low discount rate.) However, when DoD was analyzing the value of a military pension, they were using a discount rate of 8%-12%. That’s a high discount rate for any corporation, and for DoD it’s stratospheric.

This means that once again retirees will be tempted by what appears to be a huge sum of money, but which will only eviscerate their pensions until they reach age 67. We’ll hear stories about paying off student loans, buying a home, or starting a business. Once again, a few will be absolutely positive that they can invest their lump sum in hot stocks or leveraged rental properties and grow it faster than the discount rate.

This looks a lot like REDUX and the CSB all over again… on a new generation of unsuspecting recruits.

Think ahead: ask yourself why DoD would be so nice to you at retirement. If you’re not sticking around for longer or doing a tougher job, then why should they give you a lump sum at all? Now do the math. If those discount rates are still being used against you then you’ll know that DoD has learned to apply the lessons of REDUX and the CSB for their own benefit.


New changes to the new military retirement system

In early 2015 the Military Compensation and Retirement Modernization Commission released the most comprehensive study of the military’s pension system since WWII. They heard the testimony of tens of thousands of servicemembers and families. The commission’s work was closely tracked by dozens of veteran’s organizations, and the government even extended the reporting deadline to allow for additional research and analysis. The MCRMC report was considered so important that the Commander In Chief actually canceled the latest quadrennial review of military compensation so that the Pentagon staff could support the MCRMC’s research.

The legislation for the military’s new blended retirement system was drafted by DoD, approved by Congress, and signed into law. It’s supposed to take effect in January 2018. The Defense Finance and Accounting Service and the Thrift Savings Plan have a lot of computer networks to reprogram by then, and thousands of military pay clerks have to be trained on the new system. Hundreds of thousands of servicemembers (and new recruits) have to be educated on the plan and their options. You’d expect that DoD would be hustling to implement the new pension’s details before the deadline, right?

Not so fast. DoD actually wants Congress to change the new retirement system before it’s even been implemented. They want to cut back on their matching contributions to the servicemembers’ Thrift Savings Plans.

When the MCRMC was taking testimony from the military, the most overwhelming complaint was that the pension only “cliff vests” at 20 years. 83% of today’s servicemembers leave before vesting the military pension, and they get zero pension benefits. Meanwhile, tens of thousands of civilian 401(k) pension plans (and the federal civil service system) include matching of their employee contributions.

The MCRMC listened. The original plan for the new retirement system (the legislation already passed by Congress) starts making matching contributions to TSP accounts at the beginning of the third year of service. Recruits typically obligate for contracts of 4-8 years, so for at least half of their enlistment, they’d receive a match of up to 5% of their pay. At the end of the contract, they’d be able to leave the service and keep that balance. Ideally, they’d be inspired to stay for another obligation, partly because of the TSP matching.


TSP matching begins in the fifth year?!?

DoD has apparently changed their mind. Even though the legislation has already been signed into law, DoD has asked Congress to delay the start of the matching to the beginning of the fifth year of service. In other words, a few military recruits could serve an entire enlistment and never see a single matched dollar in their TSP. Even those who stick around longer would still lose an additional two years of contributions and compounding. Instead of at least giving the 83% a bit more in their TSP, DoD wants to wipe out most of the TSP matching for the first enlistment.

DoD’s theory is that the TSP matching should be a retention incentive for the second service obligation. They seem to think that they’re already getting enough recruits and they don’t want to give anyone more incentive to join. They want to hold back until the second enlistment.

You servicemembers (and veterans) know what’s been done to retention bonuses over the last five years. Instead of giving away thousands of dollars for each new contract, DoD’s new retention incentive would be the TSP match. A 5% match on an annual contribution of $18K is… $900. Per year.  A 5% match on an annual salary is a lot less than a bonus.  For an E-3 earning $1963/month that’s about $1178/year.  For an O-2 earning $3900/month it’s about $2340/year.  Assuming that the servicemember makes the contribution in the first place.

(Thanks to alert reader Charles for noting my conceptual error in calculating the match!)

As always, nobody should sign a military contract just for the money. Everyone should stay on active duty only if they’re feeling challenged and fulfilled and maybe having a little fun.

But it stings a little when DoD decides to cut back on the promised reforms after the law has been enacted. It’s even worse when DoD tries to circumvent the entire MCRMC process (and everyone’s hard work) by quietly sliding their change into a subcommittee request. They’re not only breaking faith with today’s servicemembers and everyone they hope to recruit over the next few years. They’re also subverting the work invested by Congress to fulfill their commitments to their constituents.

Again, this is just a budget proposal. Nobody has changed any laws yet. I have not seen any indication that Congress plans to give in to DoD’s request. But apparently DoD cares just as much for its “valued headcount” as any other large corporate bureaucracy cares for its employees.


Now what?!?

I’ll post occasional updates on the implementation of the blended retirement system. I’m also seeking calculators to help analyze which retirement system works out best for today’s servicemembers.

If you entered the military after roughly 2010 then you will probably benefit from switching over to the blended retirement system— especially if you don’t plan to stick around for 20 years and you want to have DoD matching in your TSP account. My daughter and her spouse started active duty in 2014, and I’m advising both of them to switch to the blended retirement system.

While you’re waiting for the 2018 rollout, get ready for TSP matching. This is a great reason to sign up, and if you’re already signed up then now is the time to maximize your contributions. By the time DoD starts offering a match, you’ll already have your finances and your contributions in autopilot. You won’t miss out on a single dollar of the match.





Related articles:
Should You Choose The Military’s Blended Retirement System?
“Present Value” Estimate Of A Military Pension

WHAT I DO: I help you reach financial independence. For free. 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, veterans, and families. All of my writing revenue is donated to military-friendly charities.

  1. Why are you advising your daughter and her spouse to make the switch? I built a calculator that calculates the value of the 10% of your last 36 you’ll be missing and found that Blended Retirement is never better unless you are not planning on doing 20.

    • Well, Logan, your last phrase is an important point. Nobody should plan on doing 20.

      83% of the people who join the military end up leaving the service (for whatever reason) before they’re eligible for a pension. My daughter and her spouse are planning to take it one obligation at a time, and they’re also focused on reaching financial independence via a high savings rate. That way they have more flexibility at deciding whether they’ll be among the 1 out of 6 servicemembers who beat the odds, and by taking the matching feature of the BRS they’ll have more in their TSP accounts if they don’t stay for 20.

      As part of their high savings rate, they’re maximizing their TSP and IRA contributions (as well as saving even more in taxable accounts). When they convert to the BRS then they’ll maximize the DoD matching contributions as well. If they go for 20 under the BRS, it’s possible that the matching funds in their TSPs will compound faster than the larger High Three pension would have yielded. That’s what I hope we can analyze with DoD’s BRS calculator, which is expected to be released next month.

      However the most important factor is that nobody should plan on doing 20. Not even aviators who obligate for 10+ years upon commissioning.

  2. Good article and good points but I wanted to point out a flaw in your math on this one point that will change its significance.
    “A 5% match on an annual contribution of $18K is… $900. Per year. Assuming that the service member makes the contribution in the first place.”
    The match is equal to 5% of your pay not of your contributions. An E3 over 2 currently makes $1963.00 of which 5% is $98.15 and annually is $1177.80. An O2 over 2 makes $3900.00 which comes to $195 a month and $2340 per year.

  3. Great article. I remember the hey days of the nineties; wished I invested in Amazon liked I wanted to, but was discouraged may Jeff Bezos’ advice at the time. I have mixed feelings about the BRS. I love the idea of a matching TSP. I wish they would match like FERS and folks can be vested after three years. If you do not serve 20 years, you are already behind your peers. As a prior enlisted person, I also agree that most youngsters would rather have a bonus than a promise of a match. Young enlisted folks are already susceptible to pay day loans and other predatory practices, why play around with their match when most would rather have the money?

  4. Excellent analysis and feedback. Part of the disconnect is that from the DOD perspective military “retirement” was never viewed as a reward for service or a defined benefit. Military retirement in the E ring of the Pentagon has always been viewed as force-shaping, force-management tool. No more greater evidence of that is the 5 current ‘retirement’ systems still the DOD inventory and yet to repealed. The traditional ‘final pay’ plan pre 1980, High three, post “81, of course REDUX, and do not forget the VSP, 15 year retirement rolled out in the 90’s draw-down. now this. Each was a reaction too changes in the surrounding issues of retention and budget pressures and each served a purpose, to either keep folks in or ‘encourage’ them to leave. I still have the letter I got from the Navy in 1992 inviting my participation in the such a scheme, VSP, after a pass over to 0-4, made it the following year, but I never underestimated the DOD in terms of their honest appraisal of the relative value they place on human resources.

    On this current policy lets be clear, the DOD never “reforms” something in the matters of personnel or benefits to give more to the service person. Always less, same will apply to their rework of Tri-care. Nor will it provide education to post 2018 recruits as it will ‘marketing’ of proposed system. My guess the driver of this push to reform retirement is the ongoing cash crush of Sequester, year 6 of 10, vice ant crises in the ranks or a retention issue. But if history is a guide, I give this new system about 5-7 years post implementation. Recruitment, readiness will crash again, or a real war with a rising advisory, China, will force the DOD to open up the pay and benefits spigot once more. As was the case post 9-11, 2001-2008.

    • Thanks, Peter, I agree that this is a giant bet on retention.

      DoD also cuts their long-term pension costs in the hopes of persuading servicemembers with shorter-term incentives like the TSP match and re-enlistment bonuses.

      From the corporate perspective, it’s always cheaper to hand out a bonus if they can avoid a lifetime pension payment.

  5. Nords,
    Excellent analysis and historical perspective! I recall the CSB/REDUX when I was a young Company Commander, as I tried to dissuade a couple of my senior NCOs from taking the “bum deal”. My efforts were for naught (in retrospect, I probably didn’t make a more convincing argument against the CSB/REDUX as I wasn’t as informed as I am now but just intuitively knew it was a bad deal…like you wrote, “why would DoD be so nice to you at retirement?”) and both of them opted for the CSB/REDUX, with the promise/plan to remain in service for at least 24 years to recoup the 10% (40% instead of 50% after 20 years) lost by taking the deal. I often wonder how they feel about that now…some 15 years after the fact.

    With regards to “DoD’s theory that the TSP matching should be a retention incentive for the second service obligation”…well as a former enlisted Soldier, a matching contribution to the TSP (granted there was no TSP back then) would probably not rank high on my list of enticements/incentives to reenlist. Like most young GIs, I was short-sighted and more interested in something that was more immediate than a retirement perk that would benefit me years down the road…and I can only surmise most younger GIs today feel the same way. Additionally, when I’ve read less than 50% of servicemembers are taking advantage of the TSP, it makes me wonder how effective the TSP matching can be as a reenlistment incentive?

    When I read what you wrote about why DoD would be so nice to you at retirement, I can’t help but smile and think about the scene in the movie “Cool Hand Luke” right before the “failure to communicate” line:
    Captain: You gonna get used to wearing them chains after a while, Luke. Don’t you never stop listening to them clinking, ’cause they gonna remind you what I been saying for your own good.
    Luke: I wish you’d stop being so good to me, Cap’n.

    • Good quote, Mel, that’s exactly right!

      I agree with your skepticism on re-enlistment incentives, too.

      The really painful issue for those CSB/REDUX soldiers was losing all those years of COLAs. The new lump-sum proposal is very similar– people will give up decades of pension benefits for the sake of a little money now. It’s almost as bad as a payday loan…

  6. Doug,

    Great article! Blended retirement system is the first step in the DoD’s shift from a purely defined benefit pension system to a partially defined contribution program (hence the reference to ‘blended retirement system’). Outstanding analysis!

    • Exactly, Forrest, implementing the new system is hard enough without a bunch of last-minute modifications.

      The best news about this is “mandatory TSP enrollment”. However servicemembers will still be responsible for contributing enough to earn the match…

  7. Thanks for laying out the details on this.

    That change DoD proposed sounds like something the Marine Corps would like — and that’s not necessarily good. The Marines are happy for a majority of new recruits to carry a rifle for 4 years and then move on to the civilian world; the chain of command gets to approve the best Marines for re-enlistment as NCOs and they just recruit another 30,000 teenagers (the last time I checked about 50% of USMC enlisted are E-3 and below).

    The other services are not as extreme, but none of them want 100% of first-termers to re-enlist.

    I think it would be a shame for the first-termers to miss out on the matching funds, and the incentive to save for retirement.

    Will the proposed changes go through? Will you be better off? Will matching TSP funds assist with retention? Who knows?

    All I know is (unrelated to this subject perhaps), if you’re still in uniform then you haven’t had your last pay problem yet.

    • Good points, Rob. I just hope that Congress ignores this DoD change request and we can all get on with analyzing the finances of the original legislation.

      And, yeah, there will be pay problems.

  8. Doug,

    Snark first – I am not surprised at that behavior on the part of the DoD – they are under a lot of pressure so of course they would try to minimize their exposure. And the management style is a blend of carrots and sticks, with either prevailing depending on the situation.

    With the above, however, the overall message of live below your means becomes so important. My first job out of the military had me fully vested at 7 years…..I left at 3 years and only received $1500 of the amount they had been setting aside for me as a ‘pension’ – I had more in my 403B based on my own effort with no matching. At my next job, I immediately signed up for the 403B, and when they vested me at 2 years, made sure I maxed out at least to the match percentage. Matching is free money in a sense – you don’t have to have your portfolio earn that.

    So, yes, it is a bait and switch, however, I still think the message of working to manage these things for yourself and taking advantage of matching, etc, while it is available is a valid message. Also, while the COLA pension is a nice benefit from enduring 20+ years in either active or Reserve service, your admonition regarding the toll it can take is a very valid one. The military offers many things, however, you will work for it and that pension is definitely earned.

    Btw – I did not know the DoD pension obligation finances were as sound as they were – I, too, have kept track of what is going on pension-wise for government service personnel at all levels of government and have been dismayed at the poor management and callous risk-taking regarding discount rates. When a government’s obligations for pensions is larger than that for present-day operations, there is a huge problem. However, that does not negate our individual responsibilities to try and have several streams of income to cushion those risks for ourselves.

    Thanks again for keeping up on this and posting…great info – if only there had been matching when I was in :-)

    • Great comments, Deserat, glad this is helping!

      Here’s an interesting history point: the TSP was only available for the final six months of my career. It’ll be great if everyone can maximize their TSP match under the new blended retirement system, but first the other half of the military will have to sign up for a TSP account!

    Comment? Question? What's on your mind?