Taking a page from the private sector, Congress is cutting the guaranteed defined benefit pension plan for service members–and to make the change more palatable, adding sweeteners: a 1% base pay contribution and up to 4% match in the government Thrift Savings Plan and lump sum bonuses. Great in theory. But in practice will service members do the right things to get the secure retirement they deserve?
“You’re only better off if you do all the right behaviors every step of the way, the markets perform, and you keep all the money in,” says Scott Spiker, ceo of First Command Financial Services, a brokerage and advisory firm that caters to military families. “What’s difficult is these people are deployed; they’re going to look and see, ‘The market’s down, I’m going to move my money today?’ They’re in a fox hole in Iraq.” First Command figures that career service members are likely to see an 18% decrease (or more) in retirement benefits under the new system.
The reforms, under the 2016 National Defense Authorization Act, go into effect for service members who enter the military starting Jan. 1, 2018. Under the current system, you have to serve for 20 years to get a pension at 50% of pay, or 30 years for 75% of pay. Serve less than 20 years, you get nothing. So for those who don’t make the military a career, the new benefits are valuable, albeit variable. The new system shifts the burden of saving and investment risk onto the individual. Welcome to the real world.
If you’ve served more than 12 years, you get to stick with the old pension program. If you’ve served under 12 years, you have the option to opt into the new program. “You’d be a sucker if you took the new option unless you knew for sure you were going to get out,” says Spiker.
The reforms cut the defined benefit pension annuity by 20%. To make up for that, the Department of Defense will automatically contribute 1% of basic pay into a TSP account, and match 3% of contributions dollar for dollar, and 50 cents on the dollar for the next 2% a service member contributes. So DoD contributions to the TSP can reach 5% of basic pay. There’s a continuation pay “bonus” after 12 years if you commit to serving an additional four years (the bonus could be as little as 2.5 months of basic pay, up to a maximum of 15.5 months). But whether that makes up for the pension cuts depends on a lot of assumptions.
Under the government’s best case scenario, a 20-year veteran comes out ahead by 12%, assuming the service member contributes at least 5% of their basic pay to the TSP in order to earn full government matching, invests it in the aggressive L2050 fund and earns an assumed 7.3% return, and invests 15.5 months of net continuation pay (after taxes) into an investment that also returns 7.3%. Take out the service member’s contributions and you come out just 2% ahead.
“It’s ridiculous,” says Spiker of these rosy assumptions. Only 42% of service members contribute to the TSP now, and for those who do, 38% of the balances are in the most conservative option–the G fund, invested in government bonds. And who is to say that service members will invest their continuation bonuses? “If you take that out in cash to buy new wheels or a trip to Disney World with your family, you’ve substantially hampered your future retirement,” Spiker says.
So what does a worst case scenario look like? What if the service member doesn’t make TSP contributions and gets a continuation pay bonus of only 2.5 months and spends it? Then their monthly retirement pay will fall 18% short of what it does under the current system, First Command figures. And that’s still assuming the government’s unrealistic 7.3% rate of return.
There’s another part of the reform program that troubles Spiker even more. Career retirees will have a new option of taking a quarter or half of their pension as a lump sum, with the pension annuity being reduced accordingly until they reach full retirement age (typically 67). “This is where it gets frightening,” he says. Private sector employers are doing the opposite—trying to find ways to help retirees turn accumulated 401(k) retirement plan balances into fixed income streams.
This article was written by Ashlea Ebeling from Forbes and was legally licensed through the NewsCred publisher network.