Military Pension Changes on the Horizon

Take-Away: A change is soon coming for veterans who have served in the military long enough to earn a military pension. A companion change may also help those veterans who served in the military for less than 20 years.

Background: The current military pension system provides a defined benefit pension for those service personnel who have served in the armed forces for 20 or more years. Called the Legacy plan, those military retirees who served 20 or more years in the military are entitled to an annual payout equal to 50% of their base pay. Base pay is the average of their three highest paying years while in the military. For example, if a military retiree served 20+ years and his three highest years of pay averaged $90,000 a year, the annual pension benefit would be $45,000, starting immediately upon retirement from the military and lasting for life. This pension can increase with added service time in the military. There is also a Survivor Benefit Plan that is available to protect a surviving spouse of the veteran. This Legacy pension benefit can be adjusted to reflect cost-of-living increases. But if the service retiree has less than 20 years of service with the military there will not be any retirement benefit available. According to the government, less than 20% of military personnel qualify for the Legacy pension benefit because they have less than 20 years of military service.

In addition to the Legacy pension benefit, military personnel are also eligible to participate in a federal Thrift Service Plan, which is comparable to a conventional 401(k) plan. Like a 401(k) account, the contributed earnings and investment growth of those contributed earnings are deferred from taxation until withdrawn. But unlike a 401(k) plan in the private sector, there is no ‘match’ paid by the Defense Department into a Thrift Service account. Consequently the primary benefit is income tax deferral, which may mean that participation in the Thrift Service Plan may not be all that great.

Blended Plan: Starting in 2018 changes will occur in both the Legacy pension plan and also the Thrift Service Plan. The combination of these changes are referred to as the Blended Plan.

The changes are that the basic pension payout under the Legacy plan will change from a 50% of 3-year-highest-pay to 40% of 3-year-highest-pay after 20 years of service. Accordingly, the service member who earned on average $90,000 a year will now receive a pension benefit of $36,000 a year, not $45,000 a year, due to this change. But to offset this reduced pension benefit, the Blended Plan will provide automatic matching Thrift Service Plan contributions by the Department of Defense. If the service person contributes 5% of his or her military pay, the government will match that contribution, up to 5% of his/her pay. 5% is the maximum that the government will match. There is a short two year vesting schedule for these matching contributions, which means that even if an individual does not serve a full 20 years in the military to be entitled to receive a Legacy pension benefit, he/she may still accumulate some retirement savings through their participation in the Blended Plan.

Some National Guard and Reserve service members may also be eligible to participate in the Blended Plan.

Devil in the Details:

For those existing military personnel with 12 or more years of service, they are locked into the Legacy In order to receive retirement benefits, they must stay in the military until they have their 20 years of service with the military.
For new recruits, they will automatically join the Blended Plan. They will qualify for Thrift Service Plan matching contributions after two years, but they will receive a smaller pension if they stay in the military for at least 20 years.
For those members of the military who joined between 2006 and through 2017, they will have a choice. They will have all of 2018 to stay in the Legacy plan or to opt into the Blended Plan. If no formal election is made, by default they will remain in the Legacy
Once in the Blended Plan the participant will receive an automatic annualized 1%-of-pay contribution to their Thrift Service Plan account, whether or not they contribute any of their own earnings. Thus, a service member who is earning $45,000 a year will have $450 contributed to his/her Thrift Service Plan account, even if he/she contributes nothing.
The matching contribution of the Defense Department to the Thrift Service Plan account will be 100% of earnings up to 3% of military pay, and 50% of the next 2% of military pay contributed by the service person.
The matching funds will be invested in an age-appropriate lifecycle, aka target-date, fund.
Yet another change from the Legacy plan retirement pension benefit is the ability of the plan participant under the Blended Plan to choose to receive a lump sum payout of the discounted present value of either 25% or 50% of their gross estimated pay in retirement. In return for the up-front lump sum payment, ongoing pension checks will be reduced. This smaller pension check will continue until the participant attains full retirement age, or 67 years for most service personnel.
Obviously, the higher the military rank and salary associated with that rank, the more significant the advantage of that service person remaining in the Legacy If the service member has no intention of staying in the military for at least 20 years and making it a career, that person should consider participating in the Blended Plan. However, there are many variables to consider in deciding to stay in the Legacy plan or shifting to the Blended Plan if a career in the military is strongly considered. Each service rank has its own pay grade, which might affect Legacy pension benefits. And the Legacy pension benefit is calculated using the individual’s three highest years of compensation while in the military, in contrast to the Thrift Service Plan’s matching contribution which is based on actual earned compensation throughout the individual’s time of military service.

Conclusion: For those of us old enough to remember, this change in retirement benefits for military personnel is comparable to what happened in the 1980’s when the Federal Employees Retirement System (FERS) was created and the Civil Service Retirement System (CSRS) members were given the choice to transfer into that ‘new’ defined contribution retirement system. Most of the federal civil employees who made that switch 30+ years ago now which that they had stayed in the CSRS defined benefit pension system.