In January of 2018, the military retirement system as we know it will cease to exist. Instead, service members who joined after 2006 but before January 1, 2018 will have to choose whether to stay with the existing system or opt into the new “Blended Retirement System.”
We’ll see dozens of articles and calculators on the new military blended retirement system during 2016-17, but here’s the quick answer for most of today’s servicemembers:
- If you think you’re staying on active duty for at least 20 years, then stick with the current High Three retirement.
- If you’re pretty sure that you’re leaving active duty before 20 years then take the new Blended Retirement System.
While we’re awaiting the calculators, think about these big-picture issues affecting you and your family. (If you’re building a calculator to help crunch the numbers then I’d love to join your team of beta testers.) Remember that the Department of Defense gets at least as much out of the blended retirement system as you could.
Don’t Join The Military To Get Rich
Don’t take any job for its pension plan. You have far more human capital than that.
Join the military for the irresistible challenge, or to get out of a dead-end situation. Join to become part of something bigger with an incredible team. Join for the responsibility, the training, and the self-discipline. Join to make something better of yourself.
Stay in the military if you’re challenged and fulfilled, but don’t join just to stick it out for a pension. If the pension is your only motivation then you won’t last past the first obligation. When the fun stops then you should leave active duty for the Reserves or National Guard instead of grimly clenching your jaw and gutting it out for 20.
You Probably Won’t Earn A Pension
83% of veterans have no retirement benefits. Only 17% of the military’s servicemembers stay on active duty or in the Reserves/Guard for long enough to earn a pension. (Retention is about twice as high for Air Force officers and about half as much for enlisted Marines.) That’s only one out of six.
If you’re on your first commitment then you can’t predict how hard you’ll have to work for a pension. When you reach 15 years of service, you’ll find that your billet choices are narrower and the assignment officers want you to make even greater personal sacrifices to “break out of the pack”. By that point in your career, you might be raising a family who’s also getting a little tired of making their own sacrifices.
The best way to earn a military pension is to take your career one obligation at a time. Don’t set a long-term goal that only has a 17% chance. Instead set a series of shorter goals (Three years? Six years?) and keep going only if you’re feeling fulfilled and challenged. If you’re miserable at the end of an obligation then leave active duty. The skills that lead you to success on active duty will also help you succeed in the Reserves/Guard and in your civilian career. A Reserve/Guard pension still has most of the benefits of an active-duty pension, but a Reserve career has a much better quality of life.
Instead of “just” a pension, your goal should be financial independence! When you have a high savings rate then you’ll build up enough assets to have options. Even if you leave active duty at 17 years, you’ll dramatically improve your work/life balance while staying on track for financial independence. You may delay your pension by 25-35 years, but you’ll invest enough replacement income during your bridge career. If you maintain a 40% savings rate for 15 years then you may not even need the bridge career or the military pension.
We Asked For The Blended Retirement System
You older veterans may remember that the High Three pension system was passed in the 1980s largely at the urging of Congress and the Department of Defense. It was designed to encourage servicemembers to stay longer than 20 years, but by 1999 it was clear that retention was plunging. Today’s High Three and REDUX pensions came as a last-ditch effort to persuade mid-career servicemembers to stay until 20.
In 2012 DoD decided to build consensus for the blended retirement system. The Military Compensation and Retirement Modernization Committee held hearing for nearly 18 months and received feedback from over 100,000 servicemembers, veterans, and families. They heard testimony by veteran’s groups and military family organizations. They added several surveys and Congressional hearings. Publicity (and media analysis) was widespread and intense.
The key to retirement modernization was the “unfairness” of cliff vesting. (An assignment officer would call it a “retention incentive”, but that’s a whole different post.) The MCRMC hearings showed that today’s servicemembers want a more portable pension system with more money under their control. Instead of cliff vesting at 20 years, people want military benefits to resemble the civilian 401(k) and the federal civil-service retirement systems. Servicemembers want to leave active duty with a little more in their retirement accounts. Instead of a defined benefits pension, people favor a defined contribution plan.
We did it to ourselves. We asked for exactly the type of compensation that 83% of us will qualify for.
Why Are They Being So Nice To You?
DoD leaped on the MCRMC bandwagon because a defined contribution plan saves the federal government billions of dollars. For over 30 years, DoD has been required by law to fund military pensions in advance (accrual basis) instead of when they’re actually paid (cash basis). Even “worse”, from DoD’s perspective, the money set aside for pensions is invested in non-negotiable government securities paying a pitifully small (but very secure) interest rate.
The blended retirement system will cost DoD a lot less. It pays a 40% High Three pension instead of the current 50%, and that means DoD immediately saves 20% (10 percentage points) on its lifetime pension expenses. DoD can invest a smaller amount every year in the special-purpose low-yield Treasuries that fund the military pension account. DoD still has to set aside some payroll money every year to match the servicemember Thrift Savings Plan contributions, but those are one-time expenses instead of lifetime annuity obligations. (Click the link on the graphic for the details.) The total of the smaller pension and those matching funds is still less than they’d have to contribute to the current pension fund.
DoD’s cost of matching the TSP contributions for all servicemembers is a complicated calculation. TSP contributions will (usually) earn higher returns than special-purpose Treasuries, so they’ll grow faster and can be funded with less money. The sad fact is that not every servicemember will contribute enough to the TSP to earn a full DoD match, so DoD will “save” even more at the servicemember’s expense. I’m sure that an entire battalion of eagle-eyed DoD CPAs has already determined that paying a TSP match is a bargain when they’re saving 20% on pensions. DoD is thrilled to pay a match for each year of a military career (if the servicemember actually contributes their share) instead of having to pay pensions for decades.
DoD saves so much money on the blended retirement system that they’re even willing to pay a retention bonus. The continuation pay (after 12 years of service) is a one-time expense (with a four-year obligation!) instead of a pay raise that they’d have to pay out for a lifetime pension. Think of it as a lump-sum advance payment on your pension, very much like the REDUX Career Status Bonus. You’re paying for it with four more years of service, yet this advance payment only augments your financial independence when you invest it.
“But wait, there’s more!” Matching TSP funds can be a tremendously cost-efficient precision retention tool. Instead of paying huge bonuses, DoD can simply contribute a little extra money to a servicemember’s TSP account. (Existing legislation already allows the military and the TSP to do this, but the services haven’t implemented this option– yet.) Now instead of paying a bonus to everyone in an understaffed skill, DoD can quietly boost the TSP match of precisely those servicemembers who they want to retain.
DoD can save a lot of money because servicemembers take on the burden of saving for the match. The challenge is that we have to be responsible enough to handle the burden. Most American pensions have shifted to a defined contribution plan, but few of today’s workers contribute enough to the plan. Most employees are investing their assets too conservatively or (even worse) they’re cashing out their 401(k)s for other reasons.
DoD doesn’t have to care about underfunded TSP accounts because they’re saving billions of dollars. It’s the servicemember’s responsibility to exert the discipline and motivation to do a better job of investing for financial independence.
Mandatory Thrift Savings Plan enrollment
The best feature of the new blended retirement system is mandatory enrollment. Fewer than half of today’s servicemembers are even contributing to a TSP account! The federal civil service’s mandatory TSP enrollment has created an 88% contribution rate, and among new employees it’s over 95%. Ideally, the military’s mandatory enrollment would include default contributions to the L2050 fund. It would be even better if the default contributions are set high enough to at least maximize the DoD match, but again sadly the proposed default contribution is a paltry 3%.
Maximize Your Contributions And Invest Aggressively
The flaw in the blended retirement system is that it shifts the burden to the servicemember. The summary sheet (see that image linked above) certainly sends the wrong signal. The graphic for the 12-year continuation pay shows the money going to a car, a house, and a pickup truck— instead of being deposited in the TSP and an IRA and a taxable account.
[Nords note: Someone on SECDEF staff must be reading this site: version 2.0 of the above graphic was spotted on 29 December 2015. This time it adds a piggy bank to the continuation pay graphic and retitles the page “The U.S. Uniformed Services Blended Retirement System”. (Now NOAA and the U.S. Public Health Service are in the club.) These changes improve the graphic, but it shows that DoD is still implementing the legislation. We’ll be watching these tweaks for at least the next 18 months.]
You Can Do Better
The blended retirement system is only a good deal if you’re already maximizing your TSP and IRA contributions as well as saving more money in taxable accounts. It’s only a good deal if you’re aggressively investing in an asset allocation that’s high in stocks (instead of bonds or the G fund). It’s only a good deal if you’re already saving most of your pay raises, bonuses, and promotion pay. In other words, it’s only a good deal if you have the motivation and discipline to pursue your financial independence.
The blended retirement system is a great deal for the 83% who won’t retire from the military– those who just want to serve an obligation or two and pile up a higher balance in the TSP.
But What About The Lump-Sum Pension Option?
One of the features of the new blended retirement system is the option to exchange your full pension 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 government than it’s put into servicemember’s bank accounts.
I agree that there are military retirees who are capable of investing a lump sum and earning more (after-tax) returns than the full pension would offer. However, I’m highly skeptical that there are so many potential Warren Buffetts in the ranks. Behavioral psychology studies have shown many times that way too many retirees will use the lump sum for expenses which fail to create more value than the pension.
If you think you can handle a lump sum pension option, then do the math. You’ll probably decide that it’s better to invest your other savings more aggressively because your asset allocation will include the federal government’s inflation-adjusted annuity. You may also decide that it’s better to keep the full pension and save up the money for your lump-sum expense.
If you think that you’re one of the special snowflakes who’s starting a billion-dollar business by taking the lump-sum option, then forget about the lump sum and keep your pension. Instead, find other eager investors who are willing to fund your entrepreneurial startup’s aspirations. Please contact me with your pitch and your term sheet.
So, Nords, what would you do?!?
Here’s the advice that I gave my active-duty daughter last week. The blended retirement system is only a good deal as long as she:
- maximizes her TSP and IRA contributions,
- saves even more in taxable accounts,
- invests the 12-year continuation pay, and
- invests most of her pay raises and promotions.
The reason it’s a good deal is not because of the pension. It’s a good deal because she’ll reach financial independence on her own high savings rate and she won’t be
bribed tempted to stay until 20 years of service. If she chooses to stay on active duty, it’ll be for the challenge of a fulfilling career instead of two decades of cliff vesting. If she moves to the Reserves or Guard then she’ll have solid investments for starting her bridge career and reaching financial independence.
When you reach financial independence, you have choices and you can retire on your terms. The blended retirement system can get you there a little faster, even if you never actually stay long enough for the pension. Remember that more of the responsibility has been put on you, and don’t expect the government or DoD to take care of your benefits for you.
You don’t have to wait until 2018 either. Start maximizing your contributions now, and invest in a more aggressive asset allocation.
Every good blog post is supposed to end with a call to action. Here’s yours:
- If you haven’t signed up for the TSP yet, then go sign up now. (Use myPay or this link to the TSP form.)
- If you haven’t maximized your TSP contribution this year, then boost it by one percent. (Login here.)
Military Blended Retirement System Spreadsheet
Retiring Without A Military Pension
Retiring From The Reserves And National Guard
How Many Years Does It Take To Reach Financial Independence?
Saving Base Pay And Promotion Raises
Over a decade later, REDUX still sucks
Don’t Gut It Out To 20: Leave Active Duty For The Reserves Or National Guard