The following is a guest post from Spencer from Military Money Manual. Spencer has a fantastic site structured to help our men and women in uniform make the most of the their finances so they don’t have to worry when they have more important things on their mind – like protecting our country. Thanks Spencer….and thanks to all the American Military personnel throughout the world. Here’s a great post on how the military retirement system is changing and what you need to know.
The new U.S. Uniformed Services Blended Retirement System will arrive in 2018. Authorized in the 2016 National Defense Authorization Act (NDAA), the new military retirement system is the most radical change since the Career Status Bonus/REDUX scheme passed by Congress in 1986.
The CSB/REDUX scheme was a terrible deal for servicemembers. The new system is actually quite a good deal, especially for the 83% of the force that leaves before the current 20 year retirement vesting cliff. Let’s examine who is eligible, the three main components, and whether or not it’s a good deal to opt in to the new plan.
Who is eligible for the new military retirement?
The new Blended Retirement System (BRS) will be fully implemented on January 1, 2018 for all troops enlisting or commissioning after that date.
Also, military personnel with 12 or less years of service on Dec 31, 2018 (those who joined after Dec 31, 2005) or who join before Jan 1, 2018 will be given the option to opt into the new retirement plan. This opt-in period will be from Jan 1 – Dec 31 2018. This raises the question of whether you should opt in or not.
Here’s the bottom line: if you have any doubts about whether you will stay in for 20 years or more, the new military retirement system offers extra retirement opportunities that can substantially increase your retirement income.
If you are 100% sure you’ll stay in for 20, especially if you’re close to 12 years in 2018, stick with the old plan.
If not, I would recommend signing up for the new plan.
There’s a 83% chance you won’t make 20 years. Under the old plan, that would leave you with no TSP match, no pension, and no opportunity for a continuation bonus. The new plan offers many monetary benefits to those who get out before their 20 years.
As a refresher, the old military retirement system consisted of the Thrift Savings Plan / (TSP) (with no matching) and a pension that began immediately upon retirement, calculated at 50% of the average base pay for the last 3 years of the service member’s career. This is a great scheme for those who make it to 20 years. But it leaves the 83% of the armed forces that doesn’t make it to 20 years without any retirement benefits outside of their personal savings into the TSP and IRAs.
The Blended Retirement System should change the system for the better and offer every service member a bit of extra retirement savings.
The BRS consists of three main parts:
- retirement pay or pension
- automatic contributions plus matching contributions to the employee’s Thrift Savings Plan
- continuation pay
Let’s break these down…
New Military Pension
The new system offers the traditional inflation-adjusted pension paid immediately upon retirement from the uniformed services. The calculation is a bit different from the old system. In both the old and new system, retired pay is calculated on your “retired base pay.”
Retired base pay is calculated by taking the average of your highest 36 months of base pay (usually the last 3 years of your career). Remember, in both old and new systems this is only calculated off your base pay, not any special pays you received or your BAH, which could make up a large percentage of your income on active duty.
Once you have your retired base pay, in the old system you would multiply that by your years of service and then by 2.5%. So if you served for 20 years, you would receive 20 x 2.5% = 50% of the average of your last 36 months of base pay.
In the new system the multiplier has changed to 2.0%. So now if you served and retired at 20 years, you would receive 40% of your retired base pay. This means that you will receive a 20% reduction in your pension, which could cost you hundreds of thousands of dollars over your lifetime.
While the cut is substantial, if you diligently save and invest your TSP match and your continuation bonus, the 20% pension gap shrinks between the old and the new system, especially for younger personnel.
New Military TSP Match
The new system introduces a maximum 5% DoD match on TSP contributions. The Thrift Savings Plan is the best employee sponsored retirement plan in the world (It is very similar to a 401k). The TSP offers simple and diversified index funds at the lowest costs available anywhere, making it easy and cheap for service members to invest wisely.
Under the new system, every recruit will be automatically enrolled with 3% of their base pay going into the TSP. After 60 days of service, the DoD will automatically begin kicking in an additional 1% of their base pay until the member separates, retires, or reaches 26 years of service. This adds up to 4% total (3% from service member’s pay + 1% match from Dod) of the service member’s base pay going into the TSP.
Additionally, after 2 years of service the DoD will match up to an additional 4% of the service member’s basic pay. This is on top of the 1% automatic contribution. The maximum match is 5% if the service member is contributing 5% of their base pay. This matching is already widely used in the civilian sector so it’s good to see it coming to the military side. It can substantially increase your tax advantaged retirement investing.
Over a 20 year career, the new matching scheme could mean $70,000+ of additional savings into your TSP. For a O-1 lieutenant or ensign, contributing 5% of their pay every year for a 20 year career could mean $1 million in their TSP (assuming a 7% annual growth rate). Without the new match, the account would only be half a million.
The continuation pay bonus is paid upon completion of 12 years of service, in exchange for a 4 year additional service commitment. The amount of the pay is 2.5 months of basic pay.
The continuation pay is an incentive for military service members to stick around past their initial commitment and make it to the 16 year mark. Initial enlistments and officer active duty service commitments usually range between 2 years for new enlisted personnel and 10 years for Air Force pilots. Re-enlistments also range widely in length.
In the current system, there is no marginal benefit to staying another year, other than re-enlistment bonuses and pay raises. Now with the new continuation pay benefit, there’s a monetary incentive to stay in until 16 years but not necessarily until the 20 year point.
For a 12 year Army or Air Force major or Navy lieutenant commander (O-4), the value of this bonus pay in 2016 would be $17702.50. For a 12 year E-4 or E-6, the value of the continuation pay would be between $8000-$9000.
The continuation pay will most likely be taxable, unless the service member was eligible for the combat zone tax exclusion. The smart service member will invest this pay immediately into their TSP, as it can substantially increase their available retirement savings at age 60.
Is the new military retirement a good deal?
While the 20 year, 50% of base pay pension was a good deal for service members, the new plan offers many opportunities for the savvy investing service member. If the TSP match is utilized to it’s full potential, the difference between the new plan and the old plan shrinks substantially.
However, the new plan does rely much more on the service member to invest smartly over the course of their career, in a properly diversified portfolio with enough equities to provide a decent (6%+) return.
I will sign up for the new plan in 2018. The uncertainty of staying for 20 years and the additional benefits (especially TSP matching) are worth sacrificing a potential 20% cut in pension pay. Remember, only 17% of the total force sticks around for a full 20+ years. At 6 years in, there’s no guarantee that I’ll be able to stay in for the full 20, whether it’s for family, personal, or professional reasons. The new plan offers increased flexibility and more investable assets in my TSP. Those are worth switching for me.
If you are eligible, are you going to opt in to the new plan? Or will you stick with the old plan and aim for 20 years of service?