[This post is written by Joel Schofer, MD, MBA. Joel is an Emergency Physician and Commander in the US Navy who blogs about career management for Naval physicians at MCCareer.org and personal finance for military members at MilitaryMillions.com. As an interesting side note, when I left active duty practice he took my office at the Naval hospital I used to work in. We have no financial relationship.]
A New Military Retirement
The Department of Defense’s (DoD) new retirement system, known as the Blended Retirement System (BRS), takes effect January 1, 2018 and will mean smaller pension checks with cash contributions to service members’ retirement accounts, known as the Thrift Savings Plan (TSP). This means that for the first time service members who leave the military before 20 years of service will have a DoD provided retirement benefit to take with them.
Do I Get the Old or the New System?
All Service members who enter the military on or after January 1, 2018, will automatically be enrolled in the new BRS.
All members serving as of December 31, 2017, are grandfathered under the current retirement system. No one will be automatically switched to the new BRS.
Though they are grandfathered under the current retirement system, active duty with fewer than 12 years since their Pay Entry Base Date, and those in the reserves who have accrued fewer than 4,320 retirement points as of December 31, 2017, will have the option to opt into the BRS. Once made, the choice is irrevocable.
The Current System
The current military retirement system consists of a defined benefit pension plan. While pension plans disappear from the civilian workplace, the military pension provides lifetime income with a cost of living adjustment to protect against inflation. Eligibility for the pension starts after 20 years of active duty service and is paid immediately upon retirement.
The amount you are paid is:
Monthly pension = 2.5% x (# years of service) x (average monthly base pay of your highest 36 months)
Some would include the TSP as part of the current system. Other than making the TSP available, though, the DoD does not match any service member contributions and isn’t really providing any additional benefit to those that serve. All TSP contributions in the current system come from the service member.
If you leave the military before you accumulate 20 years of service, you leave with only your TSP contributions and get no DoD provided retirement benefit.
The New Blended Retirement System
Pension Reduction, DoD Contribution and TSP Match
The new system keeps but reduces the pension and adds a DoD contribution and match to the TSP. When a service member enters the military, or chooses to opt-in to the new system, they automatically get a 1% contribution to the TSP from the DoD. After 2 years, the DoD contributions become fully vested and the service member is eligible for a voluntary match up to 4% of base pay on top of the 1%. In other words, if the member contributes 5% of his/her base pay to the TSP, the military matches it, for a total contribution of 10%. The match stops when you hit your 26th year of service.
“Continuation Pay” Bonus
After 12 years of service, the BRS includes a bonus called “continuation pay” of 2.5 times the member’s monthly basic pay (0.5 times for the reserves) to those service members who agree to remain in uniform for four more years. The continuation pay multiplier could be as high as 13, but as of now all services have gone with the minimum multiplier allowed by law. The continuation pay multiplier may be adjusted in the future based on factors such as hard-to-fill positions, retention rates, and specialty skill. So far there has been no mention of an increased multiplier for physicians.
While the pension is retained in the BRS, the overall amount of the pension is cut by 20% because the multiple is cut from 2.5% to 2%:
Monthly pension = 2% x (# years of service) x (average monthly base pay of your highest 36 months)
Lump Sum Payment
After retirement, there is now an option to forgo some of your pension for a lump sum payment. The lump sum is discounted due to the fact that money today is worth more than money received in the future. The lump sum can total either 25 percent or 50 percent of the service member’s total pension payout (they can pick either option), with the amount received varying based on the value of their personal retirement package.
Determining the amount of that lump sum check is more complicated than simply totaling future monthly pension checks. Rather, the calculations will depend on the discount rate that is used to measure the current value of future payments. Acting almost like a reverse interest rate, discounting lowers the current value of a future benefit. This means that higher discount rates yield smaller lump-sum payments, and the discount rate will be adjusted annually. For calendar year 2018, the rate is 6.99%.
The lump sum payout would reduce pension checks only until the recipient reaches full retirement age (67 in most cases). After full retirement age, military retirees would receive 100% of their original pension amount regardless of whether they opted for the lump-sum payout.
Arguments for the New System
Why did Congress legislate this change? There are a few major arguments in favor of this new, blended system.
Participation and Expanded Benefit For Those Serving Less Than 20 years
Approximately 81% of active duty service members, 87% of enlisted members, and 57% of officers leave the military before serving 20 years and get no DoD provided retirement benefit. In addition, only 46% of service members participate in the TSP. The new system will increase participation in the TSP and allow those who serve less than 20 years to leave with a DoD provided retirement benefit.
More Options for Managing Investments
The BRS gives service members say in how the DoD contribution to their retirement is invested. If they choose not to manage their investments, the TSP defaults to the most age-appropriate Lifecycle Fund, the military’s version of target date funds, instead of the low-risk G fund, which is the default in the current system. This change alone will likely force service members to take on additional but appropriate investment risk and (hopefully) will allow them to achieve increased investment returns. On the whole, Lifecycle funds are invested more conservatively than most target date funds you’ll find at investment firms.
Under the new system, if a service member achieves superior investment returns the combination of the DoD and service member contributions to the TSP could make up for the 20% reduction in their military pension.
In addition, the DoD matching contributions do not count against the annual contribution limit. For example, if you fill up the TSP with $18,500 of your own money (the 2018 contribution limit), the DoD match would allow you to contribute above that limit in your TSP.
Lump Sum Flexibility
The lump sum option that is available under the new system will allow service members some flexibility if they need that money for their post-military life. For example, they could start a business, purchase a franchise, or buy their dream home.
Arguments for the Current System and Against the New System
There is certainly a fair share of arguments against the new system and in favor of the current system.
Savings at a Price
The Congressional Budget Office determined the new system would generate significant savings to the government over time. These savings can likely only come from one place, and that is the pocket of service members.
Many of the 81% of service members who currently leave without any DoD provided retirement benefits are the members who are least likely to participate in the TSP due to their low disposable income (junior enlisted, for example). In order to obtain maximal benefit from the new BRS and the full government match, a service member must choose to contribute at least 5% of their base pay to the TSP. We’ve already discussed that only 46% of service members participate at all in the TSP, so how many will contribute this 5% matched for a total of 10%? Financial Engines found in their research that 1 in 4 employees do not contribute enough to their companies’ retirement plans to receive their employers’ full matches.
The increased reliance on the TSP and reduced pension benefit puts more reliance on a positive investment return of the stock and bond markets as well as appropriate investor behavior. What if the TSP funds encounter a significant and prolonged downturn? What if the service member can’t handle the volatility of the market, sells low during this downturn, and moves their money from stocks to bonds instead of continuing to invest when stocks are on sale? It is well known that the average investor does not receive the return of the funds they are invested in, most often due to their poor behavior (buying high and selling low). The current system with a higher pension benefit offers more protection in the face of reduced market returns (which most are predicting for the next 10 years) or poor investor behavior.
In addition, with an increased reliance on the TSP, anyone who takes a loan against their TSP will have a reduced TSP balance to accrue investment returns toward their retirement.
The lump sum option under the new system could be used to purchase a franchise or start a small business, but it could also be used to purchase a Maserati or invest in pyramid schemes. In other words, the current system prevents service members from making poor choices with their retirement benefits.
There has also been some criticism from the American Academy of Actuaries about the discount rate the DoD is using to calculate the lump sums. As already discussed, the discount rate for 2018 is 6.99%. The actuaries feel that a discount rate between 2-4% would be more in line with today’s financial markets and corporate practice, which would raise the value of any lump sum payments received by service members.
If You Have the Choice, Which Should You Choose?
The best choice will heavily depend on whether you intend to serve for 20 years, your investment behavior, and investment returns. The BRS may provide the same, less, or more retirement income than the current system does, depending on the choices you make and your investment returns.
If You Plan to Serve for 20+ Years
If you plan 20 years of service and you can stick with the old system, that is likely the best choice. The current DoD pension system is like retirement insurance. The largest financial risk you run in retirement is that you outlive your financial assets. Social security insures against that, but so does your military pension.
Although the new system has a pension as well, it is reduced, shifting more of this risk to you. Opting for the new system and its 20% cut in your inflation-adjusted pension benefits will dramatically reduce your guaranteed lifetime earnings unless you earn very high investment returns and are a disciplined investor. The closer you are to retirement, the less time you have to earn these investment returns in efforts to try to equal and surpass the value of the pension. Plus, the DoD match stops when you hit your 26th year of service. Finally, the temptation of the discounted lump sum payment is not available. The lump sum will probably turn out to be less valuable than the pension.
Readers of this blog are generally high-income individuals. At the higher income levels available in the military, if you control your spending, live in a reasonable house, and drive a reasonable car, you can enjoy the higher pension of the current retirement system and fill up your TSP every year, enjoying the benefit of both worlds without the need for DoD matched funds. My wife and I have routinely saved 30% of our pre-tax income for retirement during nearly our entire military career, invested aggressively, and reaped the benefits. And I have a full pension on top of that? That’s definitely a nice problem to have and one you should strive to have one day as well.
If You Do Not Plan to Serve 20 Years
If you are absolutely certain you will not serve for 20 years, you should go with the new system to get the DoD match. Taking advantage of the match is the only way you’ll leave with a DoD provided retirement benefit.
If You’re Not Sure Whether You’ll Serve 20 Years
You have a complex decision to make. Here are my general recommendations and some tools available to help you decide.
- If you look at the previously discussed statistics, the odds are stacked against you staying in for 20 years if you’re on the fence. To review, only 13% of enlisted and 43% of officers stay in for 20 years. I don’t have any data to support it, but I suspect the percentage is lower for physicians.
- You need to save at least 5% of your basic pay to get the full government match. If you are not a saver and are not disciplined enough to do this, you get less of a benefit from the BRS because it places more of a burden on you to save consistently.
- If you think you’ll be taking loans against your TSP, you should avoid the BRS. A TSP loan is not something I recommend with the current system either, but the BRS relies on your TSP balance to increase. If you’ve taken a loan against it, that money won’t increase.
When it comes to tools to help you decide, both USAA and the DoD have developed calculators you can use to run various scenarios. The DoD’s calculator is so complicated that they developed on-line training (which we all love) just to teach you how to use it. Luckily, USAA’s calculator is much simpler.
In addition, I’ve created a BRS resource center at MilitaryMillions and the DoD has one as well that you can access here.
What’s the Bottom Line?
In the military, we love the bottom line…
- If you’re staying in for 20, keep the current system.
- If you’re not, take the new system.
- If you’re not sure, run the various scenarios through the calculators, educate yourself, and make the best choice you can.
*Note: The views expressed in this article are those of the author and do not necessarily reflect the official policy or position of the Department of the Navy, Department of Defense or the United States Government.
What do you think of this new Blended Retirement System? Sound off below!