New Retirement System: A Good Deal Missed?
Some soldiers may be sorry down the road for not signing up for the Blended Retirement System during the opt-in period that ended Dec. 31. The results of the opt-in, which required a complex decision with difficult choices, will have researchers examining why more troops did not choose the new system. The answers will impact retention and readiness. One question that might be asked, based on early data, is whether soldiers missed out on a good deal.
The system replaces the High-3 system in which individuals had to have served 20 years’ active or equivalent reserve service to qualify for retirement benefits. The Blended Retirement System offers service members a reduced annuity combined with automatic and government-matched deposits to the Thrift Savings Plan, where individuals can invest in a range of low-cost investment funds. In addition, troops may take a lump-sum distribution upon retirement of up to 50% of the discounted value of their retirement in exchange for reduced annuity payments until full retirement age.
While not part of the Blended Retirement System, the authorizing legislation also created a midcareer Continuation Pay for service members in which they may receive a minimum of 2.5 times monthly pay as a one-time bonus at midcareer (8–12 years of service) up to a maximum of 13 months’ pay, with the rate set by the needs of the service. The Blended Retirement System clearly offers soldiers more choice.
A Personal Choice
So did service members miss a good deal if they did not opt for the new retirement system? The answer depends on individual circumstances, as is often the case for financial decisions. But a few broad conclusions can focus our thinking and make sure this new system helps retention over time.
For service members who know life will call them out of the military before the 20-year mark, opting in was clearly the better path. Under the Blended Retirement System, the government contributes 1% of the soldier’s basic pay to an individual Thrift Savings Plan account and matches individual contributions up to 5% of basic pay. This translates to an immediate 100% return on service member contributions, with the added benefit that those contributions will grow at compounded rates within a chosen Thrift Savings Plan fund. Matching contributions vest immediately, and the 1% automatic contribution vests in as little as two years.
State of Nondecision
If service members knew their intentions to remain in service and completely understood the Blended Retirement System, then opt-in rates should have been higher. Subsequent research will likely reveal service members allowed uncertainty and “status quo bias” to leave them in a state of nondecision and locked into the legacy system. Should they decide to leave service before the 20-year mark, they may regret their indecision.
One service had a better opt-in rate than others, which will likely be of interest to researchers. The Marine Corps had each member make a positive choice to opt in or remain in the legacy system following the training associated with the new system. The other services left the choice up to individual initiative. The dynamic of having individuals make a positive choice likely brought greater clarity of goals and plans to leave the service short of retirement.
Subsequent research will likely show that education, counseling and leadership are key inputs necessary to bring about informed choice. But one clear conclusion is that the new system involves more complex and difficult choices.
For those who know the military is their calling and will likely serve for 20 or more years, the picture involves more complicated choices. For this population, the legacy system is often the better choice on a present-value basis. To its credit, DoD provided financial calculators on its Blended Retirement System website and examples in its education materials to walk service members through personal factors in making a good decision. As always in financial models, the variables you include and assumptions you make in your model shape the results you generate.
DoD materials also encouraged service members to seek counseling as they made decisions, important resources since complexity and risk mark the path forward for this population.
A few simple scenarios generated through the DoD calculators demonstrate a broad comparison. First, I ran an active-duty O-3 who intended to retire at the 20-year mark and earned due-course promotions along the way. I did the same for an active-duty E-7 who was sure of E-8 promotion and transition at the same 20-year mark. Each individual received a 2.5 times basic pay continuation bonus along the way and deposited the proceeds in full to the Thrift Savings Plan account. Finally, each of the individuals made the full 5% contribution to earn the full government match and earned a 7% nominal return on their Thrift Savings Plan account, roughly in line with the results they could expect from a broad common stock fund based on the S&P 500 or the TSP C Fund. I figured each of the individuals would live to age 90, not an uncommon expectation given life expectancy trends.
Briefly stated, the annuity portion of the Blended Retirement System turns out to be about 20% less than the comparable present value of the annuity it replaces under High-3. Given the assumptions above, the legacy High-3 system turned out to be about $300,000 more valuable to the notional captain and about $150,000 more valuable to the sergeant first class. These example service members were able to make up the difference by taking more risk in their investment portfolio, at an assumed investment return of 8.35%, to be exact. Returns in this range require a heavier weighting into more risky assets, such as small or international stocks found in the Thrift Savings Plan’s S or I funds. A more robust Continuation Pay invested in the Thrift Savings Plan would close some, but not all, of the reduced annuity value.
Risk Shifts to Individual
With the size of Continuation Pay contingent on retention conditions at the time, service members can’t predict what the number will be in advance. The findings are in line with most 401(k) arrangements in corporations. Mixed defined benefit and defined contribution plans achieve savings to the corporation in the annuity portion and give more choice to the individual. At the same time, they shift risk and choice onto the individual in order to make up the haircut to the annuity provided by a defined benefit at retirement.
Blended retirement is now the system of record, and with it comes a host of choices service members must make. Unanswered questions include whether the combination of choice, Continuation Pay and a reduced annuity will retain soldiers over the long term. The system was built on extensive research, so the pieces are in place to make good evaluations.
What the experience of the open season does tell us is that managing your finances in the military—an already complicated endeavor—has entered a new age of complexity in which individuals will be much more responsible for their choices. Service members will have to educate themselves and find good advice from professionals who approach the question from an angle considering the best outcome for the soldier. A new age of choice, opportunity and complexity is upon us.
Kirk Taylor contributed to this article.