Paycheck Chronicles

What Blended Retirement Means To You

Congress agree to change military retirement: what will that mean for you?Update 7 October 2015:  The NDAA has passed through both houses of Congress and will be headed to the President for signature or veto.

Congress is well on its way to passing a 2016 National Defense Authorization Act that contains significant reforms to the current military retirement system.  There is a lot of confusion about this new retirement plan, which is often called a "blended" retirement plan because it contains aspects of both the current military retirement system (a defined benefit plan) and a more modern, 401(k)-style retirement system (a defined contribution plan.)

At the current time, it is anticipated that the President may veto this bill for reasons unrelated to the retirement reforms.  Even if this happens, it is likely that the retirement changes will be part of whatever final bill is passed.

It is important to note that these changes do not become effective until 1 January 2018.  After that date, all new service members will fall under the new blended retirement plan.  Service members who have less than 12 years of service will have the option to opt-in to the new plan, or they will automatically remain under the old plan.   Currently serving military members are not required to use this new blended retirement plan.

Important Terms You Need To Know

There are four terms that you need to understand in order to make sense of the new retirement plan.

A defined benefit retirement plan  is a plan by which the employer makes a promise to pay certain benefits after retirement, and those benefits are defined from the outside, usually related to the length of service, earnings history, and (sometimes) age.  The current military retirement plan is a defined benefit plan: retirement pay is calculated at 2.5% of high-36 month pay times years of service, plus cost-of-living adjustment, for the rest of your life.*

A defined contribution retirement plan  is a plan where the employers, the employees, or both, contribute to an individual account that invests in outside investments, like stocks and bonds.  The value of the defined contribution plan varies depending on the performance of the underlying investments.  The eventual benefit from a defined contribution plan also varies.  The Thrift Savings Plan (TSP) is a defined contribution plan:  the employee contributes money to an individual account, and directs how that money is to be invested.  At the time of retirement, the employee may have the options of taking out the balance in full, having periodic payments, or some combination thereof.

For purposes of retirement accounts, vesting is the term used to describe a person’s right to control an asset.  Specifically, when a person is vested in their retirement plan, the money in the account belongs to them, regardless of whether they can access it or not.  There are two types of vesting used in retirement plans:  cliff vesting or graduated vesting.  In cliff vesting, the employee owns the retirement assets after a certain number of years, often three or five.  With graduated vesting, the employee obtains ownership of the retirement assets in portions, perhaps 20% per year, until they have 100% ownerships.  (Note:  this vesting only applies to the employers’ contributions to the plan.  Employee contributions always remain in their own possession.)

Auto-enrollment is a procedure where employees are automatically set up to have a certain portion of their pay directed into their defined contribution retirement plan.  Employees can always reverse the auto enrollment, but the practice increases participation by eliminating the indecision factor.

The Current Military Retirement System

Under the current retirement system, military members belong to a defined benefit program with a very steep vesting cliff.  Service members become fully vested in the defined benefit plan at 20 years of service.  Prior to 20 years of service, military members have no benefit from the military’s defined benefit retirement plan.

In addition to the regular military pension, military members also have the choice to participate in the defined contribution Thrift Savings Plan (TSP).  Most people don’t consider TSP part of the current retirement plan, because it does not currently have any employer contribution.  However, according to a survey conducted by the Iraq and Afghanistan Veterans of America (IAVA), 67% of polled were in favor of the change to a retirement plan that has a larger TSP component.

The New Blended Retirement Plan

What Blended Retirement Means To YouThe new blended retirement plan makes changes to both the defined benefit military pension system and the defined contribution TSP program.   The changes would mean more individual control over a larger portion of the total retirement package, and a larger portion of their retirement savings would be available to those who leave the military prior to the 20 year vesting cliff.  It would also require more individual responsibility for making wise choices along the way. Changes to the Defined Benefit Pension The new blended retirement plan includes a smaller defined benefit retirement paycheck, what most people call a pension.  Military retirement pay would be calculated at 2% times the number of years of service, then multiplied by the average highest 36 month's pay.  For example, a 20 year retiree would receive 40% of their high-36 month average pay.  Under the current system, military retirement pay is calculated at 2.5% times the number of years of service, then multiplied by the average highest 36 month's pay:  a 20 year retiree earns 50% of their high-36 month average pay.  The new system results in retirement pay that is 20% less than the current retirement pay (40% vs. 50%) for a service member who retires at 20 years of service.  The details would be different for lengths of service.

The change also includes a "lump sum" option under which service members will be able to take a portion of their retirement pay in advance of earning it.  No such lump sum option currently exists.  This feature worries critics of the new plan.  Retiring service members may be tempted by the opportunity to buy a house, pay off debt, pay for colleges, or open a new business.  Doug Nordman, of The-Military-Guide.com, suggests that "An inflation-adjusted pension is a very good benefit, so do the math before you get excited about a lump sum." Government Contributions to Thrift Savings Plan The new blended retirement plan includes three major changes to the Thrift Savings Plan portion of a service member's military retirement package.  TSP is similar to civilian employee's 401(k) retirement accounts, with account owners owning shares of various funds that have an actual cash value.

Under the new plan:

  • The Department of Defense (DoD) will contribute 1% of each service member’s monthly pay to the service member’s Thrift Savings Plan (TSP) defined contribution plan, beginning at the service entry date.  The service member would be fully vested in these contributions after 2 years of service.
  • Members will be auto-enrolled to contribute 3% of their pay, and re-enrolled again every year.  This money remains the property of the service member at all times.
  • The DoD will match TSP contributions up to 4% of pay, beginning after 2 years of service and continuing through 26 years of service.  The DoD matching contributions are automatically vested to the service member.
TSP accounts are defined contribution plans belong to the service member.  This is important for the 83% of military service members who do not remain on active duty.  Under the current retirement plan, those members leave the military without any DoD contributions to their overall savings.  Under the new plan, an estimated 75% of service members would leave the military with some sort of DoD-funded retirement savings.  Upon separating from the service, members would have the option to leave their money to continue growing within the Thrift Savings Plan, roll the money into a different type of tax-advantaged retirement account, or withdraw their money (with a tax penalty.) Career Continuation Payments The commission proposes a mid-career continuation payment, like a bonus, to aid in retention. This one-time payment, available to those who agree to serve an additional three years, will have a minimum amount of 2.5 times monthly basic pay.  However, the services will have the ability to increase the amount of the career continuation payment to meet retention needs in areas facing a personnel shortage.

Is The Blended Retirement Plan A Good Thing?

The new blended retirement plan has the potential to be a good thing for many of the people who serve in the military.  Obviously, having some sort of portable retirement funding will be fabulous for the 83% of members who currently leave the military with no DoD-funded retirement savings.

The biggest potential problem with the new system is that it relies heavily on the service member making regular contributions to his or her TSP account in order to earn the government matching funds.  While members will be automatically enrolled to contribute 3% of their pay, they will be able to opt-out of that automatic contribution.  Without the matching TSP funds, the new plan doesn't provide much value for the service member.  Ryan Guina, founder of TheMilitaryWallet.com and CashMoneyLife.com and current member of the Air National Guard, points out, "This only works for someone who has the discipline to max out their TSP contributions up to the government match."

Another potential problem with the 3% automatic enrollment is that it may give service members the feeling that 3% is a good rate of savings, and fewer members may opt to change to higher savings rates.  While 3% is a good start, most members need to be saving at a significantly higher rate to meet their retirement goals.

While the changes are significant, it is very important to remember that these changes will not apply to any existing service members unless they actively choose to switch to this new plan.  As Guina points out, "Future generations of servicemembers who join the military will do so having the opportunity to understand the retirement system in place when they join."

I'll be addressing the "how to choose" question at a much later date, closer to when service members will be making actual decisions.   In the meantime, I'd love to hear your comments, questions, or concerns about the new plan.

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