April 4 2016
An In-depth Look at the New Military Retirement System
Currently, uniformed personnel are entitled to retirement payments after 20 years of military service. Payments start immediately after separation and are calculated via a formula equating to 2.5 percent of base pay multiplied by the total number of years in uniform up to 40 years. The new retirement system replaces the current 20-year vesting retirement with a blended defined benefit and 401k-style Thrift Savings Plan (TSP) retirement package. This “blended” benefit allows service members who serve as little as two years to leave with a personal retirement account (401k), but it creates more uncertainty over retirement benefits for those who serve 20 or more years.
The new military retirement system will take effect on January 1, 2018. All those who join after that date will be automatically enrolled in the new system and the old system will be phased out. Service members who joined before 2018 will be grandfathered into the old system; those who joined between January 1, 2006 and 2018 will have the option to choose between the current 20-year retirement benefit and the new blended benefit. Which system is better for you?
FRA supports initiatives that provide a “portable” Thrift Savings Plan (TSP or 401 K-type investment) with an employer contribution and a voluntary employee contribution for service members, who can take the benefit with them if they leave before 20-year vesting for defined benefit plan (retainer pay), as long as it is not paid for by reducing the retainer/retirement pay of those who serve 20 years or more.
Service members who serve for at least 20 years under the new system will earn a smaller pension than under the current system, which service members are able to collect immediately upon separation. A study was conducted that determined that an E-7 retiring with 20 years of service under the new blended retirement plan could lose $267,000 in lifetime retirement value. However, if the same E-7 stays for 30 years and is promoted to E-9, the lifetime loss in retirement rises to $740,000. That’s assuming a 5 percent government match and a 5 percent rate of return in the TSP. The new pension will be calculated at 2 percent instead of 2.5 percent of base pay per year. Service members who retire at 20 years will receive a pension of 40 percent instead of 50 percent and those who retire at 30 will receive 60 percent instead of 75 percent of base pay.
Under the new plan, service members will receive “continuation pay” upon reaching 12 years of service if they agree to a new four-year service agreement. Continuation pay will vary by career field but will be at minimum equal to 2.5 months of basic pay. These funds will be paid as cash, so the service member has the choice of spending it or investing it in his or her retirement.
The Defense Department will create an individual investment account—a modified Thrift Savings Plan (TSP)—for all recruits who show up at boot camp. These service members will automatically receive monthly deposits equal to 1 percent of their basic pay and they will be fully vested after reaching two years of service, which means they will have full ownership of their TSP accounts. Please note that DoD is already considering changing the time period from two to five years of service to be fully vested. The DoD will offer a dollar-for-dollar match to individual contributions up to an additional 3 percent of pre-tax basic pay. The DoD will also match at 50 cents on the dollar service member contributions beyond 3 percent, up to 5 percent. Those who separate before reaching the traditional 20 years of service will be able to withdraw from their TSP/401K when they reach retirement age, which is currently 67.
The new retirement system goes into effect on January 1, 2018. That’s when the new system becomes the only option for those arriving at boot camp. Those who joined before that day and are still eligible to opt in to the new will have one year to fill out the proper paperwork and give up their current retirement plan. The last chance to sign up to participate in the new benefit is expected to be late December 2018.
Among the biggest changes to the retirement benefit is a new option for those leaving after 20 years of service to receive part of their pension benefit in the form of a “lump sum” cash payout. This is similar to today’s “Redux” plan that gives service members the option of taking $30,000 at 15 years in exchange for reduced lifetime pensions, which ends up costing the service member over $250,000 over his or her lifetime. Under the new retirement plan, service members will have the option of receiving 25 percent or 50 percent of their retirement pension benefit in a cash payout upon separation in exchange for future years of reduced pension payments. The lump-sum payout after taxes is expected to be worth less than $100,000. This lump-sum option also reduces monthly pension checks but, unlike Redux, it remains in effect only through the traditional retirement age (currently age 67). After that, all retirees will receive the full monthly pension benefit.
Which Should You Choose?
Service members who opt into the new retirement system will face an array of new and constantly shifting variables. What are the best investment fund options for a TSP/401K plan? How are the financial markets going to impact the growth of my retirement accounts? How much will the 12-year continuation pay be for my MOS? Is the lump-sum option worth considering? How long do I intend to stay in the service?
The new system hinges on big variables, such as future stock market returns and the extent to which individual service members contribute their own pre-tax money to their retirement account and are in turn able to draw on the matching government contributions. For those in the early stages of their careers, especially the several hundred thousand who are first-term enlistees or junior officers, this may be a difficult choice. The question really is, do I plan on staying in for 20 years and making a career out of it or not? Studies have shown that the current system is better for those who make a career out of the service, but those who are unlikely to stay through 20 years of service would clearly be better off under the new system.
OnWatch is a quarterly news update for active duty and Reserve
personnel, written by Stephen Tassin. He recently transitioned from
active duty to service as a Chief Warrant Officer 2 in the Marine Corps
Reserve Force, and has a personal interest in these matters. As the
assistant director of Legislative Programs for the Fleet Reserve
Association (FRA), he’s also committed to FRA’s mission to
maintain and improve the quality of life for Navy, Marine Corps and
Coast Guard personnel and their families. He looks forward to keeping
you up to date on FRA’s legislative efforts to protect and enhance
your earned military and veterans’ benefits.