DoD Retirement - A New Approach


After years of silence on the intensely controversial issue of military retirement reform, the Pentagon on 6 MAR unveiled a detailed proposal for fundamental, far-reaching changes to the current pension system, Military Times has learned. The changes would preserve the current system’s defining feature of a 20-year, “cliff-vesting,” fixed-income pension. But it would ultimately provide smaller monthly checks, according to documents obtained by Military Times. To compensate for that, the new proposal would offer three new cash payments to be provided long before old age — a 401(k)-style defined contribution benefit awarded to all troops who serve at least six years; a cash retention bonus at around 12 years of service; and a potentially large lump-sum “transition pay” provided upon retirement to those who serve 20 years or more. In the broad view, the new plan would lower the total economic value of the military retirement package. But maybe not by that much. Details vary, but several options show a roughly 10 percent reduction in cumulative lifetime payments.

Pairing that long-term reduction with the new cash payments is a strategic decision by Pentagon personnel experts, based on the notion that troops would prefer a plan that gives them more money up front to reduce the impact of smaller pension payments later in life. “When compensation is paid out sooner, it has more value to the typical member who is assessing whether to continue in the military,” according to a 44-page report outlining the new proposals. Less than 20 percent of service members ever see any retirement benefits under the current system, so the new proposal may be welcomed by the vast majority of troops who do not plan to stay for a 20-year career. What is sure to be one of the most controversial options outlined in the report would give “working age” retirees only a “partial benefit” pension check, forcing them to wait until a traditional retirement age, probably age 62, until becoming eligible for more robust monthly checks that reflect the “full benefit.” That is a recognition that most service members go on to second careers in the civilian world before leaving the workforce and retiring for good.

The basic building blocks of the new proposal are the cash incentives that would come while a member is still in uniform and right at retirement:

  • For all troops, DoD would set up a Thrift Savings Plan account, the federal government’s 401(k)-style savings account. Starting after two years of service, DoD would provide an annual direct deposit equal to 5 percent of basic pay. No contribution is required from service members, although they could contribute more on their own if they chose to. Full ownership of these accounts would transfer to individual service members after they reach six years of service, with the money available for withdrawal beginning at age 59½. Speaking hypothetically, Pentagon officials say that if such accounts had been in effect for the past 20 years, a retiring E-7 would have accumulated a total of about $37,600 in his or her account, while a retiring O-5 would have an account worth about $76,200. Both figures assume that the service members made no additional contributions, and that the annual rate of return on the investment was about 5 percent.
  • The services would offer a retention incentive payment for troops who clear a midcareer milestone, most likely the 12-year mark. Also known as a “continuation pay,” this bonus might be equal to two months’ pay for enlisted troops and six months’ pay for officers. The individual services would control this payment, and it could vary by career field if manpower planners need to bolster retention in specific pockets of the force.
  • Upon final separation, troops who have served at least 20 years would get lump-sum transition pay. That might be as much as three years basic pay under scenarios that substantially reduce pension checks. It might be less than one year’s basic pay under options that do not reduce the pension income as much. The size of this payment could be standardized under law to make it the same regardless of service or career field.

Building on those three incentives, the Pentagon report offers two “options” for a complete retirement overhaul, both of which involve reducing the “multiplier” used to calculate military retirement pay. The new Pentagon report does not appear to favor one approach over the other, saying only that research shows either option is workable and would not damage retention or force structure. Under both alternatives, the report notes, retirees could expect their income in old age to rise after their TSP money becomes available for withdrawal at age 59½. The options would be:

  1. Structured similar to the existing system: Retirees would begin collecting pension checks immediately upon separation and continue receiving those payments, with minor annual cost-of-living adjustments, for life.
  2. A second — and potentially far more divisive — option would offer similar cash benefits up front but would provide a two-tiered pension with only “partial” monthly payments immediately after separating from the military, probably capped at 25 percent of late-career basic pay. This “partial benefit” would shift to a more generous full benefit after an individual reaches a traditional retirement age, probably 62. The fixed-income retirement system is based on a yearly multiplier, currently 2.5 percentage points. That means a member’s retirement pay equals 2.5 percent of their average basic pay over their three highest earning years — almost always the last three — for each year of active-duty service. Serving 20 years results in a monthly check equal to 50 percent of that “high-three” average.

A central question about the new retirement proposals is where to set the new multiplier.

Option 1: Offers full benefits immediately after retirement but the multiplier would be reduced to 1.75 percent, giving troops retiring after 20 years monthly checks worth about 35 percent of their final high-three average. For example, an E-7 retiring after 20 years initially would get an annual retirement income of about $19,970, which would rise to $23,508 later in life, when additional income from the Thrift Savings Plan becomes available. Under the current system, that E-7 would get $24,640 per year. For an officer retiring at the O-5 paygrade after 20 years, this option would result in an annual retirement income of $37,884 during working-age retirement, rising to $45,375 later when additional income from the Thrift Savings Plan becomes available. By comparison, that same officer under the current system would receive $46,748.

Option 2: Offers only a partial benefit for working-age retirees. The yearly multiplier might remain at 2.5 or be lowered to 2 percentage points, Pentagon documents show. Under this more aggressive version that lowers the multiplier to 2.0, troops retiring after 20 years would receive about 40 percent of their high-three basic pay average after age 62. Before then, the partial benefit plan would give retirees pension checks capped at 25 percent of their high-three basic pay average. In effect, under this option, an E-7 retiring after 20 years would get initial annual retirement income of about $18,117, which would rise to $26,946 later in life after full benefit checks kick in and additional income from the Thrift Savings Plan becomes available. The partial benefit option offers a higher income in old age when compared to the current system, which would give that same E-7 about $24,640 per year, mainly because it would be paid for a far fewer number of years. For the example of an officer retiring at the O-5 pay grade, that “partial benefit” system would result in an annual income of $34,369 during his or her working-age retirement, which would rise to $52,020 in old age after “full benefit” checks kick in and additional income from the Thrift Savings Plan becomes available. Again, compared to the current system, that “partial benefit” offers a higher income in old age.

Note: An important difference between the two options involves the “transition pay.” Under the “partial benefit” plan that reduces retirement pay during the “working age” years and increases it at age 62, DoD would offer a generous lump-sum transition pay that amounts to about 2 1/2 or three years of basic pay.

Under the other option that more closely resembles today’s system, transition pay would probably be equal to one-half or three-quarters of one year’s basic pay. The proposals are detailed in a report prepared by the Defense Department’s Personnel and Readiness Office and sent on Thursday to Capitol Hill and also to the Commission on Military Compensation and Retirement Modernization, which is conducting a detailed study of military pay and benefits. The proposals are not formal recommendations and are not included in the Pentagon’s 2015 budget proposal. Making public the detailed analysis, known inside the Pentagon as a “white paper,” is intended only to inform public debate on a politically delicate issue that could have far-reaching effects on military retention. “These are the department’s views of potential options for modernizing retirement,” said a senior defense official who helped write the report.

The proposal is based on a deeper level of analysis than other plans drawn up outside the Pentagon. Manpowerrs to shape a future force that requires an increasingly complex mix of skills and experience. “Saving money was not of paramount importance,” said another defense official who worked on the proposal. “It was of equal importance to making sure our members maintain a very good retirement and, secondly, giving our force managers a retirement system that will be able to maintain the force and give them some additional flexibility. “We were not trying to squeeze as much money as we can out of this thing, the defense official said.

The proposals include changes to retirement for active-duty troops, reservists, wounded warriors and also revamps the survivors benefit program for retirees. Any changes to military retirement would require approval from Congress, and lawmakers are unlikely to take any action until after the military compensation commission submits its formal report, due next February. Top defense officials strongly support grandfathering any and all of today’s troops under the current system. Yet defense officials also support giving today’s troops a choice to “opt into” the new system. Officials believe it might appeal to young enlistees or junior officers who have been in the military for only a year or two and remain far from certain about whether they plan to stay in for a full 20 years — and would see at least some retirement benefit for serving as few as six years. “The analysis conducted for this review suggests that a large fraction of personnel would opt into the new system,” the report said.  experts used complex computer models to help gauge how subtle adjustments in compensation affect troops’ decisions about their own careers. “Unlike some of the proposals in the past, we were able to model various concepts to determine their impact on recruitment and retention,” the senior defense official said. Those retention models show that previous proposals calling for the elimination of the fixed-benefit pension and replacing it entirely with a 401(k)-style investment account would have a “devastating” effect on retention.

Still, the Pentagon’s top brass believes the military retirement system has become too expensive and may soon begin to inhibit spending on weapons modernization and research. Today for every dollar paid in current compensation for active duty troops, the federal government sets aside 44 cents to cover the accrual cost of future benefits. Under the current system, the total lifetime value of an enlisted retirement package is usually at least $1 million and for officers it is often more than $2 million. Defense officials acknowledge that the total savings from the new proposals would be modest, especially in light of the Pentagon’s current budget environment that emphasizes large-scale cost reductions to meet near-term spending caps imposed by Congress. Rather, the personnel experts who developed the proposal aimed to make it more efficient, to integrate the active- and reserve components under a single system and to give manpower planners more leave

Officials acknowledge that fewer troops are likely to opt into a system that offers only “partial” retirement pay for working-age retirees. In other words, the belief is that troops would be more likely to opt into a new system with TSP contributions and transition pay if they can still count on a “full benefit” upon leaving service. “Nonetheless, the number of members who choose to participate in a new system would be sufficient to generate considerable cost savings in the initial years after the system is implemented,” the report said. Under all of the various plans, the cost of funding military retirement would go up temporarily as the Pentagon would have to meet new up-front commitments for the Thrift Savings Plan contributions for all troops, retention payments around the 12-year mark and the “transition pay” for departing troops. But in the long run, the new retirement plan would cost taxpayers less, with the savings growing over time as grandfathered troops retired and the force becomes filled with younger troops recruited under a new policy. Full savings would manifest only after about 30 years...

The Pentagon’s proposal could cut year-in, year-out accrual costs by more than 15 percent under the most aggressive options. The current retirement program costs taxpayers about $25 billion annually in accrual costs. The new proposals would ultimately reduce that by between $1.5 billion to $4 billion, or between 5 percent and 15 percent. That amount of annual savings amounts to less than one percent of the overall defense budget, which this year is more than $500 billion. [Source: ArmyTimes | Andrew Tilghman | 6 Mar 2014 ++]