[September 2020 update: We have a new answer on this question! Financially, you’ll get the biggest pension boost from retiring on 1 March of your chosen year. See the end of this post to download Douglas Fowler’s research paper and review the math.
You’ll still have to pick the best date for your family, your bridge career, your travel plans, and maybe the surf forecast. But now you can make an informed choice.]
The question was asked on the Facebook group “Military Spouse Retirement Information”:
“Is there a date that is better to retire on than any other day of the year? It used to be the case that it was better to retire sometime after 1 January or 1 February. I believe it had something to do with COLA, but I don’t recall.”
I realize that the military’s Blended Retirement System is advertised as the biggest overhaul of the pension in many years. Yet those who’ve been around for a while know that Congress and the Department of Defense have been messing with pensions quite a bit over the last 40 years.
Servicemembers all know “someone” (a shipmate, or a spouse of a friend of a spouse) who did the math for their particular pension rules. That mentor determined the optimal rank and timing of their retirement, and pretty soon that advice was passed along to everyone else. Decades later we’re still seeing the echoes of that scuttlebutt, only now it’s leveled up to urban legend and it’s being mistakenly applied to completely different situations.
Let’s start with the retirement date question, and then we’ll get into COLAs.
“What’s my pension?”
Everybody in the military knows (you’ve done the training!!) that today’s latest pension is the Blended Retirement System.
However, most of today’s servicemembers are under the rules for the legacy High Three pension. Briefly, that pension starts by calculating the average of the highest 36 months (“high three years”) of pay. Some of you may have taken the Career Status Bonus / REDUX pension, and that uses the same High Three average.
A very few servicemembers are under an even older retirement system known as Final Pay. That pension is based on, um, your final base pay. There’s no averaging. If you’re getting paid at a certain rate in the pay tables on the day you retire, then that’s the number entered into the pension formula.
Over the last 35 years, the military has started its pay raises on 1 January. There’ve been a few exceptions (in April 2007 the military shifted to 40-year pay tables) but the tradition has become 1 January.
If you retired on 1 December under Final Pay then your pension was based on that year’s pay tables. But if you were able to tweak your retirement timing to retire on 1 January, then your pension was based on the new year’s pay tables– and those pay tables were usually higher. Simply by hanging around for another month, you’d enjoy a higher pension for life.
Let’s take my personal Final Pay example: I retired on 1 June 2002, and I started my terminal leave in late February. I essentially only showed up for seven weeks of work in 2002.
However, the military was having trouble with O-4 retention, and for 2002 they rolled out a “targeted pay raise” of 6.5%. This was supposed to motivate O-4s with more than 18 years of service to stick around for a few more years, but my retirement date had been approved long before the pay tables were published. Because I worked my last day in 2002 instead of in 2001, I was deemed to be 6.5% more valuable– for the rest of my life.
The Final Pay rules are why the scuttlebutt recommended retiring on 1 January.
That advice lost its value for those who joined the military after 8 September 1980, the date when the military ended the Final Pay pension system eligibility and moved to High Three. Today, retiring in January’s higher pay scales only affects 1/36th of the High Three average.
A Note For Final Pay Reserve/Guard Retirees
The Final Pay finagling continues even today among a small group of Reserve and National Guard servicemembers who have filed for “retired awaiting pay” but who have not yet started their pensions.
As you know from reading this blog, the Reserve/Guard pension starts at age 60. (It could start a little earlier for combat deployments after January 2008, but I digress.) It’s calculated using the future pay tables which will be in effect when you start that pension at age 60.
If your Date of Initial Entry into Military Service is before 8 September 1980, then you’re under Final Pay. Unbelievably, you have the option to delay your pension start date past your 60th birthday. DoD is willing to let you make a bet, and you want to live long enough to make them regret it.
Why in the world would anyone want to delay their pension? Well, it’s especially compelling for Reserve/Guard Final Pay retirees born in November or December. If you delay the start of your Final Pay pension until the following January then you’ll get the pay tables in effect for that new year. You’ll give up a month or two of pension, but you’ll make it up with a higher pay scale.
If your new January pay table is 1% higher, then you’ll have to stay alive for roughly 100 months (less than 8.5 years) to make up for that month of missing pay. A 2% pay raise? Well, you only need to survive a little past age 64 to win that math. Two months of pension and a 1% pay raise? Ooh, now it’s going to be nearly 17 years, and approaching the life expectancy of the average male. DoD doesn’t really care whether you make that bet, and very few people even know it exists.
But now you know. Please tell your friends you read it here.
My spouse (a Reserve Final Pay retiree) was born late in the year. She’s going for that delayed January pension. She has the healthy habits and the genes to take that bet, and DoD’s gonna regret it. We’ll update this post in 2022.
Caution for Reserve/Guard servicemembers with a DIEMS date after 7 September 1980: you’re under High Three or BRS. This section of the post does not apply to you. Start your pension as soon as you can.
What’s your COLA going to be?
Here’s the next point of confusion: which COLA are we discussing?
This post refers to the military retiree Cost Of Living Adjustment, not the servicemember’s Cost Of Living Allowance. (That other COLA is set by a separate part of the Department of Defense, and that information is linked at the bottom of this post.) In the rest of this post, we’re going to talk about the COLA which raises the value of a military pension. It’s the same COLA calculation used by Social Security.
[Disclaimer: I’m not an accountant or an actuary, and I don’t have have any three-letter financial certificates after my name. I simply have the time (and the twisted interests) to read a lot of weird stuff about money. If I make an error then I’m pretty sure I’ll be swiftly educated by a financial professional who had to pass an exam on the topic, and I’ll update this post.]
Let me start this post on the right note: the COLA rules are all based on logic, but federal law has very little in common with that logic. I’m sure they started out with the best of intentions, but over time those laws have changed for easier tracking and better technology. Various elected representatives have tinkered at the edges to save a few billion dollars, so today’s COLA laws are a patchwork of amendments.
COLAs are designed to keep a pension real. (In real dollars, not nominal ones.) Instead of starting a lifetime stream of payments at a certain nominal value and watching that value be savaged by decades of inflation, a COLA is intended to keep your hard-earned military pension fighting inflation at the same value of real dollars for the rest of your life.
Whose inflation are we fighting? Well, that’s another problem. The Consumer Price Index has been around for over a century, and it’s been updated many times. Your personal rate of inflation is different from mine, and we all differ from the national average. For now, it’s enough to know that the CPI we care about is the CPI-W for “Urban Wage Earners and Clerical Workers”, even though we’re talking about retiree pensions. And military servicemembers.
The actual COLA calculation is set by federal law. It’s based on the difference between the average monthly CPI-W from the third quarter of this year to the average monthly CPI-W from the third quarter of last year. (Thanks to CPA Mike Piper at Oblivious Investor for sharing a sentence with only a few three-syllable words.) Every summer, a bunch of us personal-finance bloggers start tracking the monthly rate of inflation. (You can see an example of that in MOAA’s “COLA Watch” articles.) At the end of September, the Department of Labor’s Bureau of Labor Statistics has enough data to tell us what next year’s COLA will be.
Let’s not get into how the BLS gathers that data and analyzes it. (Hint: they started with phone surveys. They still use them today.) The data (and its analysis) have been controversial among both politicians and economists. There are many different proposals for computing the CPI and applying COLAs, and a “chained” CPI may affect future military pensions. For now, all you really care to know is that the military pension COLA is based on the CPI-W rate of inflation.
That COLA takes effect in December of this year for the following year, and most military retirees see it in their pension deposit at the end of December.
What if you’re retired for less than a year?
The first COLA after starting a military pension is generally pro-rated by the quarter of the year in which the retirement occurred.
It’s hard to parse the verbiage, but for High Three (no CSB or REDUX) it’s:
“… equal to the difference between the percent by which—
(1) the price index for the base quarter of that year, exceeds
(2) the price index for the calendar quarter immediately before the calendar quarter during which the member became entitled to retired pay.”
This federal law also applies to the COLA for the Blended Retirement System.
[For those of you who elected the Career Status Bonus and REDUX pension, you’re already keenly aware that the REDUX COLA is one percentage point lower than the High Three COLA. By the time you reach age 62 for the COLA reset, you’ve lagged the High Three COLA by at least 20%. Even after the reset, your COLA reverts back to that “CPI-1%” rate and continues to lose ground to High Three for the rest of your life. The REDUX pension is no longer available, but this is why it sucks so badly to get that $30K CSB.]
The COLA calculation is explained in more gory detail in the obscure Financial Management Regulation (DoD 7000.14-R) Volume 7B page 8-36, article 080513.A.2. The example on this page shows that for High Three pensions (no CSB or REDUX), those who retired in October-December of 2016 got zero COLA in 2017. Those who retired before October 2016 got the full 2017 COLA of 0.3%.
Here’s the military SECDEF COLA memo for 2018. (It’s released late each year before the FMR update is added to Volume 7B.) The military retiree COLA for 2018 is 2.0%. Those who retired under High Three in 2017 get a little less in the letter’s paragraph 2:
For you history buffs, FMR Volume 7B pages 8-37 through 8-40 list all the COLAs since 1965. They’re a great way to demonstrate the value of an inflation-fighting pension.
The real inflation-fighting value of a COLA
Even though I retired in June 2002, us Final Pay dinosaurs (under a separate section of federal law for retiree COLA) got a full 1.4% COLA in late 2002 for calendar year 2003. Note that we also had zero COLAs in 2009, 2010, and 2015.
My pension COLAs from 2002-2017 have compounded to nearly 38%. My pension has grown from $2655/month to $3647/month simply to keep up with inflation.
That’s the real power of a COLA in:
- a military pension,
- Survivor Benefit Plan payments,
- VA disability compensation, and
- Social Security.
Postscript: COLAs versus inflation, stocks, and mortgages
Now that you’ve seen the effect of the military retiree COLA, consider the devastating effects of its evil twin: inflation. If you hide your dollars in a mattress (or in a low-interest savings account), then inflation takes away at least 1% of the value every year. The dollars are “safe”, but the value of those dollars has been savaged by inflation like a rabid wolverine slashing at your ankles.
This is why so many financial advisors want their clients to invest in the stock market: it’s one of the very few assets to grow faster than inflation.
Even real estate “only” appreciates at about the rate of inflation, although you can leverage that growth with a mortgage.
Inflation also affects mortgage payments. If you take out a fixed-rate mortgage, then over 30 years the actual value of that principal & interest payment declines by at least 50%. The payment is fixed at the same dollar amount yet its value has been greatly reduced by inflation.
This inflation math is why a financially-independent military retiree can invest heavily in a high asset allocation of stocks and carry a mortgage with less risk of losing principal. We not only have a very safe pension (from lawmakers who can raise the tax revenue) but it grows with inflation. Meanwhile the investments grow faster than inflation while the fixed mortgage payment is declining in value with that same inflation.
It might seem like a large leap of faith to start a military retirement with a $1500/month pension and a $1000/month fixed-rate mortgage payment. However, 15 years later that pension has grown by over 30% (to at least $2000/month) while the mortgage payment is still $1000/month.
Yeah, but what about the other COLA, the Cost Of Living Allowance?
Those of you who are still in uniform and wondering about the other COLA, your Cost Of Living Allowance, can find the COLA calculator here.
Calls to action:
If you’re eligible to opt in to the Blended Retirement System, that also means you’re unlikely to stay in the military long enough to earn a pension. You should strongly consider opting in before the end of 2018.
If you’re in the BRS then you still only have a 1 out of 6 chance of earning a pension. Make sure you’re contributing at least 5% to your Thrift Savings Plan for the full DoD BRS matching contributions.
Are you just a few years away from a military retirement? Make sure you know how to calculate your pension. The Reserve/National Guard pension calculation is particularly tricky.
Do you have more questions about military retirement? Post a comment here, or contact me, or join the Facebook group “Military Spouse Retirement Information”.
Here’s the link to download a PDF of the research paper: “The COLA Trap: Picking the Wrong Retirement Date Could Cost You Thousands” by Douglas Fowler.