Servicemembers who enter the military after Jan. 1, 2018, may receive retirement payouts that are as much as 18% lower than current servicemembers', according to a white paper released Wednesday by First Command Financial Services.
That decline is due to the new retirement system that will affect future servicemembers. Troops who join before 2018 may opt in to the modernized plan, or be automatically covered under the current system. The December 2015 First Command Financial Behaviors Index found about 30% of troops who plan to serve to full retirement want to opt in to the modernized plan.
The 2016 National Defense Authorization Act adopted several of the recommended changes to the military retirement system that were put forth by the Military Compensation and Retirement Modernization Commission (MCRMC) in January 2015. One of the biggest changes is a switch from a cliff vesting system where participants are eligible for retirement benefits after 20 years of service — and nothing before — to a system that combines participation in the Thrift Savings Plan and lump sum payouts.
First Command compared the switch to the modernized plan from the cliff vesting plan to the private industry's move to defined contribution plans rather than defined benefits.
"Certainly it was a successful trade for many employers, who were able to transfer the uncertainty of long-term financial risk from their company balance sheets to the household finances of their employees," the report said, referring to employers' preference for defined contribution plans. "But for a good portion of American workers, the trade hasn't worked nearly as well."
A December report from the Center for Retirement Research at Boston College found that defined benefit plans outperformed defined contribution plans by 0.7%, regardless of plan size and allocation.
The modernized retirement plan will benefit servicemembers who don't serve 20 years; with the cliff vesting plan, they would leave the service with no retirement benefits at all. However, as First Command noted in the white paper, "those who serve out a 20-year career will see smaller pensions and be required to make up the difference through a greater reliance on their own savings and investment behaviors."
That could be a problem, as a March 2015 report by First Command found financial literacy was falling among military families.
The New Retirement Plan
The modernized plan is based on four components. One is a reduced multiplier to calculate retirement pay, from 2.5% per year of service to 2%, which reduces pensions by 20%, according to First Command.
However, one of the biggest changes is the focus on participation in the 401(k)-style Thrift Savings Plan available to federal employees. Servicemembers have only been eligible to participate in this plan since 2001, and until now, there's been no automatic deduction or matching contribution to encourage enrollment. First Command found in January that even among military families who work with a financial advisor, just 53% participate in TSP.
The modernized retirement plan introduces a minimum 1% automatic contribution to TSP. In the private sector, the average default contribution rate is 2.8%, according to the Bureau of Labor Statistics.
Troops can also earn a 100% matching contribution from the Department of Defense on the first 3% and a 50% match on the next 2%, for a total 4% match. Total contributions are maxed out at 5% of basic pay.
The MCRMC report that recommended these changes assumed troops would invest their TSP contributions in the Lifecycle L2050 fund with a constant 7.3% return. However, First Command noted that assumption doesn't match current participants' behavior, as 43% of account balances were invested in the G Fund (government securities) and F Fund (fixed income securities) as of 2012.
At 12 years of service, active duty servicemembers will be eligible for a continuation pay bonus if they commit to another four years. They can receive between 2.5 and 15.5 months of basic pay, as determined by their service department, either in a lump sum or spread over four payments. If they retire before the four years are up, they'll have to pay back a portion of the bonus.
