Military Retirement Overhaul Calls for DC, DB Blend

Lawmakers are debating major reforms to the military retirement system, proposing a new system that combines the current defined benefit plan with elements of a 401(k).

On April 22, the House Committee on Armed Services Subcommittee for Military Personnel released proposals for the National Defense Authorization Act for fiscal year 2016.

"The Military Personnel proposal is a vital part of the NDAA supporting and protecting our war fighters with the care and benefits they need, deserve and have earned," according to a statement from the subcommittee.

Among various proposals raised is one to "reform the military retirement system to provide servicemembers with a portable 401(k)-like benefit while retaining a defined retirement benefit at 20 years of service in an effort to help recruit and retain the best and the brightest in our Armed Forces and to ease their transition into civilian life."

The Military Compensation and Retirement Modernization Commission (MCRMC) released a report in January that proposed major changes to the way servicemembers are compensated, including a shift from a defined benefit style retirement plan to a mix of defined benefit and defined contribution features.

Sen. Lindsey Graham, R-S.C., said in mid-May that the Senate's draft of the 2016 defense authorization bill will include changes to retirement benefits based on those recommendations, Military Times reported.

Currently, servicemembers are only eligible for retirement benefits after they've completed 20 years of service. An April 2014 report by the Department of Defense Office of the Actuary found that as of September 2012, 49% of new officers and 17% of new enlistees serve 20 years or more and become eligible for nondisability retirement.

In the private sector, DB plans are required to begin such cliff vesting after only five years of employment or to gradually vest during a seven-year period, according to the MCRMC report. DC plans must cliff vest within three years.

"As a result of these shorter private-sector vesting times, a much higher percentage of private-sector employees receive some type of retirement benefit, as compared to servicemembers who can only receive the retirement annuity upon reaching 20 [years of service]," according to the report.

The current DB style retirement plan provides annuity payments to military retirees beginning the month after retirement begins. They're generally calculated by multiplying the retired pay base by 2.5% for each year of creditable service.

The House's proposal would blend the current system with a defined contribution system by allowing servicemembers to contribute to the Thrift Savings Plan with a matching contribution from the government, which they currently don't receive; offering lump-sum "career continuation pay and retention bonuses" at defined milestones; and provide "mandatory lump-sum career continuation pay after 12 years of service with an agreement by the servicemember to continue in service for 4 more years," according to the subcommittee markup. Current servicemembers would be able to be grandfathered into the current system.

Scott Spiker, CEO of First Command Financial Services, said that the shift from defined benefit to defined contribution is "not new news."

"We've seen a mirror image of this play out through the private sector," he told ThinkAdvisor.com in April.

Thrift Savings Plan

Servicemembers currently have a defined contribution option available through the Thrift Savings Plan, which has been open to members of the military since 2000. However, military investors in TSP don't receive employer contributions, although other federal employees do.

According to financial statements for the Thrift Savings Plan, there were approximately 4.6 million participants in the TSP plan in 2013 and 2012, although the report didn't provide a breakdown of military versus nonmilitary participants. By comparison, the Investment Company Institute found that in 2012, there were about 52 million Americans participating in a 401(k) plan.

Spiker said that only 38% of those eligible to participate in TSP actually do. Furthermore, 43% of assets invested in TSP by military participants are held in the "G Fund," Spiker said. The fund is a "special Treasury security that doesn't behave like fixed income, and it effectively means they are locking themselves below the rate of inflation forevermore."

The MCRMC report noted that flexibility is a key attraction to younger workers, who will increasingly make up the military force.

"The All-Volunteer Force increasingly comprises servicemembers born after 1980, members of the 'millennial' generation. Research has shown members of this generation change jobs frequently and tend to favor flexible retirement options, rather than the defined benefit pension plans preferred by previous generations."

Those younger servicemembers who leave before completing 20 years of service are eligible for some benefits, the report noted, including education benefits and employment assistance, but are not eligible for retirement benefits.

Military retirees tend to be younger than retirees from other industries. The average enlisted servicemember is 43 with 22 years of service at retirement, according to a May 2014 report from the Congressional Research Service, and the average officer is 45 with 24 years of service.

The proposals change "who bears the risk for those who make it all the way through their career, but we ought to be very careful as we move forward," Spiker said, noting the average savings in a DC plan for investors between 56 and 64 is $80,000. "I think all of us can see that for a good portion of Americans, defined contribution plans have worked well, but for a good portion of Americans, they haven't worked well at all."

Other Recommendations

Spiker said it remains to be seen what form the final bill takes. "Right now we're in the throes of the House and the Senate working to modify their proposals."

A survey of servicemembers by First Command found that 69% of respondents are in favor of the proposal being offered, but 61% said they'd still like to use the current defined benefit style plan, Spiker said.

"People like options, especially when they're free options. The way this has been construed, if you're serving today, you get to keep what you have or you can trade it for what's behind door No. 3," he said.

In addition to the proposal for the retirement system overhaul, the MCRMC made 14 other recommendations that would affect military benefits.

One of the biggest is an increase in financial literacy education provided for servicemembers. The commission report referred to a 2008 study by the National Bureau of Economic Research that found newly hired employees who had access to "relatively simple planning tools" increased enrollment from 12% to 21%, an increase that was two to three times "the effect of employer matching, and more cost effective."

"If servicemembers are provided the financial education necessary to make informed choices when utilizing a DC plan, they would be more likely to use the plan and more likely to make choices tailored to their individual situations—an important component of a modernized retirement model," according to the commission report.

"By [the commission's] own admission in their executive summary, only 12% of service members recall ever having had financial literacy training," Spiker said. "So we're going to give you this much more complicated, much more likely to blow up in your face set of solutions, but you freely admit that 88% of you haven't had financial literacy training."

Spiker urged Congress to "be very cautious" in approving military retirement reform. "People need to have choices laid out for them that aren't easily undermined," he explained. "My fear is if you give folks a big lump sum payment at the 12-year point [...], if these folks are not savvy at the time that money shows up, they could find [...] that they've really hindered their ability to retire securely."