Veterans entering the service after July 1986 are eligible to choose between two different retirement systems. The first system, High Three, offers a multiplier of 50% at 20 years of service and raises it 2.5%/year to 75% at 30 years of service. Each year after retiring, the pension is raised by a cost of living adjustment (COLA) that’s an estimate of last year’s increase in the consumer price index (CPI). This COLA is intended to keep up with inflation, which the government typically measures with the CPI.
The second retirement system, CSB/REDUX, starts its multiplier at only 40% for 20 years of service but raises it 3.5%/year to 75% at 30 years of service. It also includes a COLA, but the COLA is capped at 1% less than the CPI. When the retiree reaches age 62 their REDUX pension is “reset” to the value it would have reached with a full COLA. After age 62, though, the REDUX COLA returns to its cap of 1% less than the CPI.
The biggest difference between the two systems is the Career Status Bonus (CSB) paid during the 15th year of service to servicemembers choosing REDUX. If the entire after-tax amount of the bonus is invested and the veteran stays on active duty long enough, then under certain optimistic assumptions their total CSB and REDUX pension lifetime value will be greater than if they had opted for the High Three pension without the CSB. At most ranks and years of service, though, the High Three’s full COLA grows faster than the CSB can compound.
Even worse, every year the CSB program has lost ground to inflation. 10 years after the REDUX system was modified, the CSB is still $30,000. Even if inflation was only an average of 3%, the CSB has already declined in “real” (inflation-adjusted) dollars by over 25%. As military pay and pensions continue to rise, inflation will continue to erode the CSB program and make it less valuable to a REDUX retirement.
The Department of Defense REDUX calculator is difficult to evaluate without adjusting its numbers for inflation. The following chart is based on a spreadsheet that adjusts each year’s pensions (both High Three and REDUX) for inflation. If the CPI equals the actual rate of inflation, then the High Three pension’s COLA keeps up with inflation and the inflation-adjusted value of the High Three pension stays constant. The REDUX CPI, however, is capped at 1% below COLA. The inflation-adjusted value of the REDUX pension loses 1% every year until age 62. At age 62 the REDUX pension is reset to its original inflation-adjusted value. After age 62, though, the REDUX pension again loses 1% per year for the rest of the veteran’s life.
The chart assumes that the REDUX retiree invested 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 has more money than the High Three retiree until both are 46 years old, 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.
Graph of High Three pension vs REDUX. (That link downloads a PDF.)
The DoD’s REDUX website shows several case studies for different lengths of service and ranks to conclude that the CSB can produce more earnings than the High Three pension. However, the DoD calculation assumes that the entire CSB (after taxes) is invested at a very optimistic rate of return (8% before taxes) and is saved for passing on to the veteran’s heirs. Even with these liberal assumptions, the REDUX pension earnings don’t pull ahead until the veteran is 75 years old. The payoff? $4000 out of more than a million dollars. Other military-media websites have more criticisms of the REDUX system and its effect on veterans who don’t clearly understand its risks.
For those who seek more detailed examples, the DoD website shows that most REDUX retirements lose out to their equivalent High Three retirement– even if the Career Status Bonus is invested. (The sole clear REDUX winner is the E-9 retiring with 30 years of service.) When using the REDUX calculator for your situation, consider using a lower rate of return from investing the Career Status Bonus. Even the E-9 example may not be a significant amount of money over the rest of a lifetime.
The CSB decision is not just about the math. Whether or not you “know” that you’ll be retiring after 25-30 years instead of 20 years, consider whether you’re willing to risk the happiness of yourself and your family if your situation changes after the 15-year point. When you accept the CSB, you’re essentially telling the assignment officer that you’re willing to do anything, anywhere, anytime. You lose the flexibility of resigning before 20 years unless you pay back the CSB. More importantly, you lose the flexibility of leaving active duty for the Reserves or National Guard. The odds are probably in your favor, but this “bet” involves a risk of “losing”– one that you don’t want to have to endure.
Graph of High Three pension vs REDUX