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Understanding Proposed Reforms to Military Retirement

By Brian Collins

Tuesday, February 3, 2015

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A congressionally-sponsored commission has recommended significant changes to military retirement benefits that would apply to newly enlisted and commissioned service members; current service members could choose to join the new program or stay in the existing benefit. The proposal would:

  • Include new government contributions to a 401(k)-style defined contribution retirement savings account;
  • Provide for a new mid-career retention bonus; and
  • Reduce by 20 percent the existing defined benefit pension for those who serve at least 20 years.

The package would result in slightly higher government-paid military retirement benefits for those who serve 20 years or more and also provide a government-paid retirement benefit, for the first time, to service members who serve less than 20 years (the vast majority). In total, the reforms would reduce Department of Defense budgetary costs by an estimated $6.1 billion over five years (Fiscal Years 2016 through 2020).

Background: The Existing Military Retirement System

The current military retirement benefit is unlike typical public- and private-sector retirement programs. In most cases, active service members who serve less than 20 years do not receive any retirement benefits; this includes the vast majority of enlisted service members, who typically serve for just a few years. Those who serve 20 years or more (about 17 percent of enlisted personnel and about half of officers) receive a generous defined benefit pension, which includes a monthly payment for life (plus annual cost-of-living adjustments) that begins immediately upon separation from the armed services. Military pensions can thus begin as early as age 38 (for an individual who joins at age 18 and retires after 20 years of service).

Service members are allowed to make voluntary contributions of their own funds to the Federal Employees Thrift Savings Plan (TSP), which is a defined contribution account-based program with a handful of investment choices for participants, but the military makes no matching or guaranteed contributions to these accounts. This contrasts to the retirement benefit for federal civilian employees, which includes automatic and matching contributions to TSP.

The Proposed New System

Under the Military Compensation and Retirement Modernization Commission proposal, newly enlisted and commissioned service members, as well as current service members who opt to switch to the new system, would receive the following retirement benefits:

Government Contributions to a 401(k)-style account. Newly enlisted service members and commissioned officers would be automatically enrolled into the TSP at a default contribution rate of 3 percent of basic pay. Participants could change this contribution rate or opt out entirely. (Those who opt out for the year would be reenrolled automatically the following January, unless they opt out again.) The government would provide an automatic contribution of 1 percent of basic pay for all military personnel in the new system and would also provide a dollar-for-dollar matching contribution of up to 5 percent of basic pay (meaning that if participating service members contribute 5 percent, the government would contribute another 5 percent, in addition to the 1 percent automatic contribution). Because of this, automatically enrolled service members would need to take action to increase their contribution rate from the default 3 percent to 5 percent in order to receive the maximum government match. The government contributions would vest after two years, which means that service members who leave before two years would lose all government contributions (the automatic contribution and any matching contributions), but participants would keep their own contributions and earnings.

A new mid-career retention bonus. In the new system, active service members in their 12th year of service who commit to serving at least an additional four years would receive a new continuation pay benefit equal to at least 2.5 times monthly basic pay. The commission suggested that the bonus could be adjusted higher for some specialties and for officers in order to meet the retention needs of the services. Service members could choose to receive their bonus either in cash or through a special contribution to their TSP retirement account.

A smaller defined benefit pension with more flexible distribution options. The commission recommended that the basic structure of the military’s defined benefit pension should remain intact. Service members participating in the new system would continue to be eligible for a pension immediately upon retirement after 20 years of service. However, the benefit formula would be adjusted downward to 2 percent (from the current 2.5 percent) of retired base pay for each year of service. (Retired base pay is an average of pay over the final three years of service.) For example, under the existing system, a retiree with 20 years of service would receive a monthly pension payment equal to 50 percent of retired base pay; under the proposed system, a retiree with the same service tenure would receive a pension equal to 40 percent of retired base pay.

The proposed new system would also have additional distribution options. Under current law, military retirees must receive their pensions as monthly payments for life beginning upon retirement. Unlike in many private-sector defined benefit plans, there is no option for a lump-sum distribution in which participants give up the lifetime monthly payments for one large, immediate distribution (this can be hundreds of thousands of dollars for a long-tenured retiree) that is usually rolled over to an Individual Retirement Account. The commission proposed that retirees participating in the new system be able to choose to access the value of working-age retirement benefits (meaning any monthly pension payments scheduled between the retirement date and Social Security Full Retirement Age, which is rising to 67 under current law) either as a lump sum or as a partial lump sum combined with a reduced monthly benefit. This option might be attractive to younger retirees who, for example, might use the funds to start a business. For those who elect the lump-sum distribution, normal monthly retirement benefits would resume at Social Security Full Retirement Age; in order to help protect against longevity risk (the risk of outliving one’s savings), retirees would not be allowed to take those benefits as a lump sum.

A Fairer and Less Expensive Military Retirement System

The proposed new approach to service member retirement benefits would distribute its benefits in different forms and far more equitably among service members. Those who serve less than 20 years – the vast majority of service members – would, for the first time, receive a government-paid, portable retirement benefit. Long-serving retirees would receive slightly higher benefits overall (than under current law) in the form of a smaller defined benefit pension combined with new government contributions to the TSP, including a new mid-career retention bonus. The proposal would generate savings for the federal budget; after full implementation (in the 2040s, when all service members will receive the new benefit), these savings would reach about $2 billion per year in 2016 dollars. To put these projected savings in perspective, current law military pension costs are projected to be about $26 billion in 2016. To learn more, see Trends in Military Compensation – A Chartbook, a joint publication of the Bipartisan Policy Center and the American Enterprise Institute.

The commission expressed its intent that the recommended reform is not a budget-cutting exercise but an attempt to advance a necessary modernization that would provide greater benefits to more service members in a more flexible and efficient manner. How can benefits be richer for service members but cost less for taxpayers? By utilizing the TSP, which enables retirement savings contributions to be invested in equities and corporate bonds. Those securities have higher potential returns (along with higher volatility and risk) than the government bonds in which the military defined benefit pension funds are invested.

The commission also surveyed the force about the proposed new design and found that the majority of enlisted personnel and officers preferred it to the existing system.

The commission deserves thanks for crafting a thoughtful proposal for reform of military retirement benefits that balances the need to fairly compensate the individuals that serve our nation in uniform and the challenging fiscal environment. If I could make one change to the proposal, the default contribution rate for auto-enrollment into the TSP would be raised to 5 percent, which would increase the likelihood that service members would receive the full benefit of the government match. Including that small change, Congress and the administration should consider the commission’s proposal seriously.

KEYWORDS: DEPARTMENT OF DEFENSE, SOCIAL SECURITY, MILITARY PENSIONS, 401(K)S, DEFINED BENEFIT PENSION PLANS, COMMISSION ON RETIREMENT SECURITY AND PERSONAL SAVINGS