Blended Military Retirement System

Under the new “blended” retirement system, military members may be able to save more than the current system; however, it requires action on the service member and an exposure to market risk—both concern me.

The current retirement system allows us to retire at 20 years, and is called a defined benefit retirement system.  If we serve less than 20 years, we get nothing.  The value of the current retirement is abstract.  It is calculated at 50% of base pay, with an extra 2.5% a year, up to 75%.  We can also contribute to the Thrift Savings Plan (TSP) up to the maximum contribution limit ($17,500 in 2016).  Check out my blog post here where I explain how much a military retirement is worth.  I compare it to a 30-year bond.  Right now, the interest rates (and inflation) are low, making the current value of a military retirement valuable.  When inflation rises, our retirement loses value, or in economic terms, we are exposed to inflation risk.  The main reason for a change is to escape the “all or nothing” scenario, where a military member honorably serves for 1-19 years and 11 months and gets nothing if he or she gets out. 

I also feel that this change is designed to cost costs since the American public sucks at saving money.  The blended retirement system requires action on us, which after nearly 2 decades of helping people with finances, concerns me a lot.  It also pours money into the stock market through the TSP funds, and what government wouldn’t want more control over the financial system right?

For members entering service after 1 Jan 2018, the blended retirement reduces the defined portion of the retirement to 40% at 20 years.  No government system would be complete without the corrupt misguided option of offering us a lump sum payment.  We have the redux under the current retirement system.  A lump sum payment is a way for the government to save money, by not inflation-adjusting the payment.  You’d have to put that lump-sum payment to serious work to ensure you keep up with inflation.  I still haven’t met someone who took the redux and made that $30K earn more than a traditional retirement.

The Department of Defense (DoD) will put 1% of every military member’s paycheck into the TSP.  We will be auto-enrolled into 3% of our pay, which we’ll have to update annually.  The 4%, the 1% DoD and 3% auto-enroll, will be ours, and we keep that portion if we were to separate before 20 years.  A 4% retirement-savings rate is not ideal but at least it will “force” military members to start saving for retirement.  The best part of the blended system is that we’ll finally get a matching TSP contribution.

I refuse to share any graphic created by the DoD that shows a comparison between the two retirement systems because the DoD assumes an unstainable rate of return from the stock market.  While the stock market generally goes up, a good portion of our retirement is now reliant on the bond and stock market.  Additionally, I’ve spent nearly 2 decades trying to get military members to save more for retirement, and it’s not happening quickly.  For this new blended retirement system to be “better”, we must save more and hope for good market returns.

Should you opt-in?  If you know, with all your heart that you’ll be separating before hitting 20 years then yes.  But remember, like nearly everyone I met still serving after 10 years, I was only supposed to be in for 6 years, and now I’ve been in for 16 years.  The current system is still superior thanks to the 50% plus 2.5% each year (versus 40% and 2% each year) and the TSP contributions.

Military Financial Report Video Series - Episode #7 - Military Retirement Information

Check out the seventh video in my Youtube series.  I show you the value of your military retirement, using the U.S. treasury 30-year bond interest rate.  I also show how rising interest rates can impact the "value" of your retirement.

Changes to Military Retirement

This January the final version of the Report of the Military Compensation and Retirement Modernization Commission was published. (http://www.mcrmc.gov/index.php/reports) We’ve been hearing a lot about changing the military retirement plan since Secretary of Defense Hagel announced his ideas in 2013. Unfortunately, this topic is highly political, causes emotional stress and is very misunderstood so much that normal conversations quickly turn unproductive. Here are my thoughts on the situation.
THE PROBLEM
I’ve only been in for 15 years, but I’ve conclude that one of the major problems in the military is the inability to address the root problem. Here are the problems with the current military retirement system—as I see it.

1)      The Defense Budget is one of the largest expenses in discretionary spending. This post isn’t intended to discuss the ideologies about Mandatory and Discretionary spending; however, if there are cuts in the budget to be made, the Defense Budget would be the first place politicians look toward. Like all forms of business, Personnel and Labor are the largest cost drivers. For the military, our unique 20-year, annual inflation-adjusted, retirement plan is one of the most costly expenses. So the first problem is…budgets need to be cut and military retirement is a major cost driver to focus on by politicians.

2)      The second problem is the 20-year cliff dive. We have many Armed Forces members who serve honorably for less than 20 years and decide to separate. Besides what they’ve managed to save in their TSP or other savings, they do not receive any portion of their military retirement. This creates a 20-year, all or nothing, retirement plan. Many civilian jobs offer matching 401(k)s and pensions which compensate employees after an outlined amount of years.

SOLUTIONS (so far)

1)      Status Quo - Like I said, this issue is highly political and emotional. On most news sites, there are 300+ comments from retired military members and veterans regaling their war stories and any change to the military retirement plan offends them. All current recommendations would only apply to new military members so they wouldn’t even be impacted anyway. This solution will not last. There are some strong proponents of the status quo, including high-ranking members of professional enlisted and officer organizations. Regardless, the political pressure is getting stronger every year with little appetite to cut any budget anywhere else.

2)      Commission’s Recommendations - Senator Graham (R-NC) recently supported the Commission’s recommendation which is 40% of base pay at 20 years instead of 50%. Military members will get matching TSP contributions so if they choose to honorably separate before 20 years, they will have some retirement savings. (http://militaryadvantage.military.com/2015/02/graham-defends-pay-commission-after-hearing-its-critics/#idc-cover) Many professional organizations are opponents of this solution. They point several inconsistencies with the analysis the commission performed on their recommendation. These inconsistencies must be addressed because mathematically, even a one-percentage slip could cost a military member hundreds of thousands of dollars over several decades.

MY THOUGHTS

Personally, I believe the military retirement should be changed. Military members separating before 20 years should receive sufficient compensation; especially in light of how inept Veteran’s Affairs (VA) is. It’s is unacceptable to leave the fates of veterans with the support from the VA. Selfishly, I would not like the amount of retirement to change. I don’t have a solution at this time but I think about it regularly and I do know that if we're going to change it then we should provide a solution before Congress provides one for us.

What solutions do you have?

3 Steps to Reduce the Impacts of the Military Retirement Cuts

As you may have read in the news, a two-year budget deal was proposed by Rep Paul Ryan (R) and Senator Patty Murray (D). The deal proposes to reduce the Cost of Living Adjustment (COLA) by 1% from the Consumer Price Index for military retirees under 62. The proposal enraged the public and may be taken out of the bill this month. The political fallout was too much and was exasperated when Mr. Ryan said that military retirement reform was supported by all the Secretary Chiefs; however, none of the Chiefs knew nor did they, later we found out, agree with the COLA reduction. But if this is/was as concerning to you, as it was for me, then this blog post will explain what the reduction would mean to your retirement and how to reduce those impacts.

How would or does this COLA decrease affect you?

First of all, this would start in 2015 for only those currently receiving a military retirement check and for those under the age of 62. The Consumer Price Index (CPI) measures the price changes for different goods and services and basically tracks if prices of the stuff we purchase everyday is increasing or decreasing. The CPI is measured by the Bureau of Labor and Statistics and more information can be found here: http://www.bls.gov/cpi/.  Currently, at the start of every year, your military retirement is adjusted for inflation based off the CPI change.  Your military retirement is “fixed” and is based on the retirement plan you retired with.  It only changes with inflation, but once it is adjusted for inflation, then you are still getting paid the same.  Inflation is a slow, often invisible killer and is the biggest risk to anyone’s financial plan.  Inflation reduces your purchasing power and you have to pay more to purchase the same goods or services (i.e. movie theatre tickets, gas, food, electricity, etc.)  This is one of the major reasons that the military retirement system is highly coveted and we sacrifice so much for it.

This budget deal proposes to reduce the annual COLA by 1% of the CPI.  So, if implemented, every year your retirement check would always lag the CPI by 1%.  Over a long period of time, this “decoupling” from CPI would have a huge, negative-compounding effect.  If this deal were to be passed, here are some steps that would have stopped the negative-compounding problem and should be considered by retirees regardless.

Steps to reduce the impacts of the proposed military retirement budget cuts.

• Move to a lower cost area – Except for the annual COLA, your retirement is fixed based on your basic pay.  If you move to a high cost of living area then your retirement check would be worth “less” than someone who chose to move to a lower cost area.  The COLA is adjusted to the national CPI and is applied equally to all retirees regardless of location.  If these budget cuts were imposed, then moving to a lower cost of living area would give you a “theoretical” increase in purchasing power that could limit the impact of a COLA reduction.  This is something all retirees and those close to retirement should consider.  Most civilian pensions operate the same way as the military retirement and living in a higher cost of living area takes more of your “fixed” retirement income.
• Reduce debt levels – Reducing your debt is always a quick way to “increase” your income whether you pay something off and now you have that payment back as disposable income or you reduce your debt levels and your minimum payment is decreased.  Either way, when facing a potential decrease in your “fixed” income, paying off debt is always a good way to have more money.
• Purchase inflation-protected investments – There are several investments you can make that would help bridge the gap from a 1% loss of your retirement compared to the CPI.  The first is dividend-paying stocks.  You could modify your current portfolio and increase the yield by 1% by investing in higher-paying dividend stocks.  If you stick to “blue-chip” stocks then you would also be better protected against violent volatility as dividend-paying stocks tend to weather market volatility better.  Another option is to invest in Inflation-protected bonds through major mutual fund companies like Fidelity or Vanguard.  These types of bonds have a yield that goes up as inflation goes up and would protect you against inflation increases.  Both of these strategies should be considered for retirees, but not really for younger people as they are more conservative and wouldn’t have as much capital appreciation.

What do you think about the potential COLA cuts?  Should we reform the military retirement?

Should I Invest in the Traditional TSP or the ROTH TSP

Here is some information about the two types of Thrift Savings Plan (TSP) contribution options you can invest in.  They are the Traditional TSP and the ROTH TSP (started in 2012/2013).  If you want a short answer in which one you should invest in, then I suggest that people under 50 should do the ROTH TSP.  This is because ROTH accounts aren't taxed when the money is finally withdrawn.  But there are many variables before making this decision.

Traditional - The traditional option takes money out pre-tax and lowers your taxable income for that year.  So if you make $25K a year and invest $5K in a traditional TSP, then you will only have $20K of taxable income.  This benefit can be very useful for people that need to lower their taxable income to qualify for financial aid, have variable student loans or annuities and anything else that benefits you to have a lower taxable income.  Once you invest, then you can choose the fund allocation you want and your money will grow tax free.  Once you withdraw the money, it will be taxed as income that year.  Being taxed in retirement is unfavorable because you need to maximize your income as a retiree.  As time goes by, you will become  more dependent on that income which I why recommend the ROTH option.

ROTH - The ROTH option takes money out post taxes and has no affect on your taxable income.  Your money will also grow tax free and WILL NOT be taxed when you withdraw your money.  This option is amazing for people that start investing early in their career because they are currently at a low tax bracket and will get to be tax free when they are in a larger tax bracket because their money grew so much with so much time.

Both TSP accounts are retirement accounts and act like 401(k)s more than IRAs.  There are no income limits to invest in the TSP like IRAs, but most people in the military or civil service don't have to worry about that.  This is an important choice for anyone.  Seek advice or do your own research before making the final choice; however, most financial advisers will recommend the ROTH option for those under 50.

For more detailed information go here: https://www.tsp.gov/PDF/formspubs/tspbk08.pdf

What's the Value of a Military Retirement?

With all the talk about the Federal Reserve eventually raising interest rates, we should discuss how it affects the value of the military retirement.  As interest rates rise, the theoretical value of a military retirement is reduced.  This is because you can get a higher rate of return on safer, long-term assets with civilian 401(k)s or saving-account equivalents.  Also, the military retirement is fixed for that year and as mortgage rates and loan rates go up, it makes the retirement worth less than the previous year.  The COLA annual increase helps decrease the impact of rising interest rates.

If an O4 with 20 years was about to retire this year (2013), he or she could expect to receive $43,702, annually, before taxes in retirement ($7,283.70/50% * 12 months).  To generate this annual income, one would have to invest in the safest, longest-term asset and the usual measure for this is the 30-year US government bond which currently yields 3.567%.  The value of the retirement at this interest rate is $1,225,175.  This is all theoretical and the only practical use would be to compare what you would have had in a 401(k) after 20 years in a civilian company.

Using the same assumptions, an E7 at 20 years would expect to receive $25,970 before taxes.  The value of the retirement would be $728,074.

If the 30-year bond interest rate goes up 1% to 4.567%, then the O4's retirement value would decrease to $956,913 and the E7's to $568,653.  Again, these values are theoretical, but it is important to know that fixed incomes, like a military retirement, is worth "less" in an environment of higher interest rates.

Military Retirement Age Changing?

Luckily, there is discussion about a grandfather clause for the youngest in uniform.

Tilghman, A. (2011). Defense Department Studies Retirement Reforms. Airforcetimes.com.

A push to overhaul the military retirement system for the first time in 60 years is rising rapidly on the political radar and could become a key component of the controversial budget battles coming early next year.

Read more: http://www.airforcetimes.com/news/2011/06/military-money-defense-studies-retirement-reforms-060211w/