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Military Retirement Overhaul Calls for DC, DB Blend

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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 Committee on Armed Services Subcommittee for Military Personnel released proposals for the National Defense Authorization Act for fiscal 2016.

“The Military Personnel proposal is a vital part of the NDAA supporting and protecting our warfighters 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 service members 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.”

Military Times reported on Monday that the chairman of the Committee on Armed Services, Rep. Mac Thornberry, R-Texas, said, “This is the sort of change that isn’t going to save a lot of money, but it’s designed to attract and keep up the quality of talent in the military.”

The Military Compensation and Retirement Modernization Commission 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.

The report noted that “profound and constant change” since the all-volunteer force was established over 40 years ago and the pressures of a 13-year war are driving the overhaul.

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.  

Cliff vesting occurs much earlier in private sector DB plans. The report pointed out that private-sector DB plans are required to cliff vest by five years of employment or to gradually vest during a seven-year period. 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 Service members 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 service member to continue in service for 4 more years,” according to the subcommittee markup.

The proposal requires a report to be filed by March 1, 2016, to the Committees on Armed Service of the Senate and the House of Representatives, the Committee on Energy and Commerce, the Committee on Natural Resources and the Committee on Transportation and Infrastructure of the House of Representatives. Implementation would be expected by Oct. 1, 2017. Current servicemembers would be able to be grandfathered into the current system.

The committee will meet on Wednesday to consider the proposal.

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 on Monday. “This is a change from a 20-year cliff vesting program with a defined benefit plan at the back end that has been in place for about 80 years, to a defined contribution plan with different optionality.”

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 from the Armed Services, 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 commission 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 Service members 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.”

“They’re taking a retirement benefit that serves about a sixth of the military, the career force, where the risk is entirely on the U.S. government and they are shifting it to a defined contribution plan where the risk for their eventual retirement sits solely on the shoulders of the servicemembers,” he added.

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 commission 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 Service members 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 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, referring to a 2013 Blue Star Families Annual Lifestyle Survey that asked servicemembers if they had ever received financial information from their command or installation. “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.”

He pointed out that the fiduciary burden of helping military members make the right choices has become more complicated. “With these options, they have a number of career choices where they need to make the right choice and the disciplined choice. If they do not do that, if they don’t keep their assets in tax-deferred vehicles and put a sufficient amount in, they, like the rest of society, are going to wake up without security in their retirement years.”

Spiker urged Congress to “be very cautious” in approving a reformed military retirement plan. “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 at a time when they’ve got families that are emerging and they’ve got long deployments, if these folks are not savvy at the time that money shows up, they could find that by not investing it and compounding it for the next 40 years, that they’ve really hindered their ability to retire securely.”

Ultimately, Spiker said, “These are the folks that we ask to go to faraway places for very long periods of time, leaving their families to fend for themselves. Do we really want to put them in this much financial risk and ask them to become wizards of their own finances when they’re deployed in places where they cannot affect those finances on a daily basis?”

— Check out Military Still Worried About Sequestration, Confident About Repeal on ThinkAdvisor.