A version of this was first published at Military Life Planning, and Daniel is graciously sharing it here because it is so important! See his bio at the bottom for more information.
As the rollout for the Blended Retirement System (BRS) continues, specific implementation details continue to be released. On January 27th of this year, DoD released the policy memorandum that will implement BRS guidance including some of the major updates from the 2017 NDAA that modified some of the original plan of the BRS as outlined in the 2016 NDAA.
You can read the entire 31 page BRS implementation memo here, but I’ve summarized the key changes, updates, and implementation details below. If you haven’t studied much about the BRS before this, you should go read this post first as it explains the basic details before coming back to read the updates below. Major Change or Updates The 2017 NDAA makes several changes and clarifications to the Continuation Pay portion of BRS:
- Continuation Pay can now be given anywhere from the 8 – 12 year point in a service member’s career, instead of the original time of only 12 years. The determination of when a service member can receive Continuation Pay is determined by their Service Secretary.
- Upon receiving Continuation Pay, the service member is now only obligated to serve a minimum of 3 years, instead of the original 4 years.
- Obligation runs concurrently with any other service commitments.
- If a service member received Continuation Pay, but fails to complete period of obligated service he or she will be required to repay either the full or partial repayment. While all situations are unique, Continuation Pay may be subject to repayment of a pro-rated amount dependent upon why the service member did not complete their obligation; similar to other bonuses paid today (for example the retention bonus).
- A member who qualifies for continuation pay may elect to receive the payment in a single lump sum or elect a series of equal installment payments, not to exceed four annual payments over 4 consecutive years. This provision may be especially helpful when analyzing the tax impact that such a large payment could have in a single year.
Grandfathering of delayed entry enlistees and ROTC and Academy cadets:
- Any midshipman/cadet attending one of the Service Academies or under contract in ROTC as of 31 Dec 2017 who has signed an agreement to serve as a commissioned officer in an Uniformed Service upon graduation, will remain grandfathered into the High-3 retirement system, but will be also eligible to enroll in the new BRS. Except for those commissioning during 2018 who have all of CY18 to enroll, the others will have 30 days from the first day of entering active duty in which to elect to enroll in BRS otherwise they will remain grandfathered in the High-3 system for the remainder of their military career.
- Any individual who has signed an enlistment contract under the delayed entry program with a Date of Initial Entry into Military Service (DIEMS) or Date of Initial Entry into Uniformed Services (DIEUS) on or before December 31, 2017, will remain grandfathered into the High-3 retirement system, but are also eligible to enroll in the new BRS upon entering active duty.
Service members who were placed on the Temporary Disability Retired List (TDRL), but are later determined fit for duty and reenter active service are eligible to enroll in the BRS provided they meet the other conditions just as if they had never left active duty.
For individuals that are unable to enroll in BRS due to a case of hardship, their respective Service Secretary will have the authority to adjudicate those requests and/or determine eligibility for extensions of the enrollment period. Lump Sum Details The Lump Sum Option of the BRS has been clarified. The service member may elect to receive the discounted present value of either 25 percent or 50 percent of the gross estimated retired pay in return for reduced retirement payments. The subsequently reduced pension lasts until the member reaches full retirement age (FRA) according to the Social Security Act, which is currently 67 for most service members. One important note here is that the member’s FRA is grandfathered in at the time when they make the lump sum selection, in case the FRA would rise later on.
TimelineThe retiree must make the decision to select the Lump Sum payment not later than 90 days before their retirement date or, for those in the Reserve Component, not later than 90 days before the they first becomes eligible to receive retired pay under the non-regular retirement program (usually at age 60).
DFAS will make lump sum payments to the retiree no later than 60 days after the date of retirement.
Understanding Discounted ValueA military pension is an annuity that will pay the retiree a guaranteed stream of income for their rest of his or her life. The formula to determine the value of a retiree’s lump sum is calculated by the Present Value of an Annuity where a discount rate (7.3% in this example) is used to determine how much the future set of cash flows are worth in today’s dollars. Go watch this Investopedia video if you need an example.
The financial concept of the Time Value of Money determines that receiving money today is worth more than receiving the same amount money in the future because the money today can be invested at a given rate of return. That means that any lump sum payment the retiree will receive will be discounted back into today’s dollars.
The Lump Sum discounted value calculation has been released. Computing the discount for the lump sum will be determined by taking the inflation-adjusted, 7-year average of the Department of Treasury High-Quality Market (HQM) Corporate Bond Spot Rate Yield Curve at a 23-year maturity plus an adjustment factor of 4.28%. The inflation-adjustment applied is the Department of Treasury “Breakeven Inflation Spot Rate Yield Curve.”
By my estimates, the discount rate calculated as of Jan 2017 would be approximately 7.3% (3.02% + 4.28%). The OSD office of the actuary’s figure will differ based on when they calculate the rate. An approximate way to think about this is borrowing from your retirement pension at an interest rate of 7.3% which is pretty steep when you consider the guaranteed nature of the pension and completely unguaranteed aspect of anything else you could use this money for.
I’ve created a very rough lump sum “guessestimate” calculator on Google Docs where you can see an approximation of what a lump sum might look like in 2017 dollars for an E-7 or O-5 who retires at 20 years. Note that these numbers could look very different once more details are released by DoD.
Based on an adjustment factor of 4.28% plus the prevailing market conditions, it will be very difficult for any military retiree to gain more through investing the lump sum amount than he or she would have earned keeping the full pension. Add in the taxes paid on the large lump sum payment/s and the decision to take the lump sum becomes even worse. Based on what I know now, I cannot recommend that anyone should take it.
Other Lump Sum NotesThis discount rate will be calculated annually by the Deputy Assistant Secretary of Defense for Military Personnel Policy (DASD (MPP)) NLT June 1 of each year and will be effective as of January 1 of the following year.
The retiree may choose to receive the lump sum payment in up to four annual installments paid over no more than 4 years instead of all of the lump sum at once.
Retirees who accept the lump sum distribution may not seek any kind of retroactive review or challenge of the amount due to any changes in the future from deviations in the cost-of-living adjustments, actuarial assumptions, or other factors used in computing the lump sum amount.
Lump sum payments to retirees will remain subject to the same conditions as military retired pay when it comes to divorce decrees and other court orders.
Survivor Benefit Plan (SBP) under the Lump SumThe retiree remains eligible to elect to cover their spouse or other dependents, or qualified insurable interests through SBP. The manner in which premiums are collected in the event a member elects to receive a lump sum distribution of their retired pay, and the consequent payment of benefits in the event of that member’s death, will be addressed in forthcoming guidance including the next update to DoDI 1332.42, “Survivor Annuity Program Administration.” Disability Retirement Details For service members that enroll in the BRS and are given a disability retirement, their retirement multiplier will be 2% just as it would be for their regular retirement calculation. Just as is currently in effect however, the service member may choose to receive retired pay equal to their retired base pay multiplied by the member’s rated percent of disability.
Due to the prohibition against duplication of benefits if a disabled retiree chooses to receive the lump sum option, the VA will withhold disability payments until the amount withheld (i.e., not paid to the retiree on a monthly basis) equals the gross amount of the lump sum payment received by that retiree. Service members who are retired for a physical disability for Concurrent Retirement and Disability Payment (CRDP) due to a service-connected disability rating of 50 percent or more are not subject to withholding of VA disability compensation.
A retiree who would otherwise be eligible for Combat-Related Special Compensation (CRSC) will still require a waiver of retired pay before a retiree can receive VA disability compensation. Further guidance of this policy will be addressed in a subsequent memorandum to be issued by the USD (P&R). Thrift Savings Plan (TSP) Implementation Service members who decide to enroll in the BRS but already have a TSP account will be required to reaffirm their TSP individual contribution percentage once they make the BRS election. No prior TSP contributions will be matched.
All BRS enrollees who did not previously have a TSP account will have one automatically created for them.
New accessions into an Uniformed Service on or after January 1, 2018, will be automatically enrolled in TSP at the level of a 3 percent individual contribution. The service member has the option at that time to modify the default TSP contribution to whatever they desire.
Automatic Enrollment: Service members who decline the automatic enrollment of 3% and have a 0% TSP contribution rate in December will be automatically re-enrolled January 1st at the 3% contribution rate again. The service member may continue to decline the auto enrollment every year.
Default Selections: The default type of individual TSP contributions will be in the Traditional TSP as tax-deferred contributions. Service members may change this default selection to the Roth TSP option in myPay at any time. All of the government automatic and matching contributions will always be tax-deferred “traditional” contributions.
Unlike the current default TSP investment into the G fund, BRS enrollees will be automatically invested in the most age-appropriated Lifecycle fund. For most young service members today, this will be the L-2050 fund.
For new accession BRS enrollees who leave service before their vesting at 2 years of service, the automatic government 1% contribution will go back into the TSP to help cover the administrative expenses.
No matching TSP contributions will be made once the service member completes 26 years of service.
While we now know a bit more about some of the finer details of the BRS, there are still some questions to be addressed. Take advantage of your base Personal Financial Counselors who offer free education and individual one-on-one training and assistance to understand these concepts. The DoD will soon also be rolling out some major education initiatives to help address financial literacy among service members.
The DoD is also scheduled to release the official BRS calculator where service members can compare their options for switching to the BRS or staying in the high-3 legacy system. I’ll continue to work to analyze and evaluate all BRS updates and news to help keep you informed. Let me know what questions you may have!
*DIEMS or DIEUS: Date an individual was initially enlisted, inducted, or appointed in a regular or reserve component of an Uniformed Service as a commissioned officer, warrant officer, or enlisted member. For cadets/midshipmen at one of the Military Service Academies, it is the date of entry into the academy; for ROTC cadets/midshipmen it is the date of scholarship contract or date the cadet/midshipman began the advanced ROTC course, whichever is earlier; and for members of the delayed entry program it is the date an enlistment contract is signed, regardless of when the member actually enters active duty. Breaks in service do not affect a DIEMS/DIEUS date.
Daniel Kopp is an active duty officer in the Air Force and the founder of Military Life Planning where he writes to help inform, educate, and advise military members and their families about the best ways to optimize their personal finances with their military benefits and plan their future to align with their goals and values. He has a passion to help military members and their families achieve financial freedom and has spent hundreds of hours doing pro-bono counseling. Daniel graduated from ROTC at Purdue University with a degree in Economics and is currently pursuing certification as a Certified Financial Planner ® along with a 2nd Masters in Financial Planning from the College for Financial Planning.
Disclaimer: These opinions are his own, and do not represent the Department of Defense, the Department of Veterans Affairs, or any government agency.