This article was substantially updated on 29 October 2016.
The 2016 National Defense Authorization Act (NDAA) contains some significant changes to military retirement. The new system, called the Blended Retirement System (BRS), will begin on 1 January 2018, with some current service members eligible to opt-in to the new system.
First, let’s dispel some myths that I’ve heard:
The military is ending retirement pay.
Nope, not even close. Military retirement is being tweaked to shift more of the responsibility to the service member, but military retirement still exists and it is still a great deal.
I’m so close to retirement, and they’re changing the rules.
These changes don’t go into effect until 1 January 2018. Everyone on active duty prior to 1 January 2018 is automatically grandfathered to remain with the old system. Those who have less than 12 years active duty service on 1 January 2018 will have the option to switch to the new system.
These changes are screwing the service member.
These changes have the potential to be great for almost all service members. For the 81% who leave active duty before earning retirement pay, they’ll have government dollars in a retirement account that belongs to them. For those who continue serving until retirement age, they’ll have substantial assets outside of their retirement, if they contribute enough to TSP to receive the full government match.
So, What Are The Changes?
Before we start, it is important to understand two different concepts of retirement income: defined contribution and defined benefit. Understanding defined benefit and defined contribution plans is crucial to understanding the changes to military retirement.
A defined benefit plan is a plan that has a set amount of benefit based upon certain criteria. Most traditional pensions, including military retirement pay, are a defined benefit plan. Defined benefit plans are tied to the employer. The individual funds are not attributed to an individual employee. The Department of Defense often uses the term annuity to explain the military retirement pay system because it is a series of payments.
A defined contribution plan is a special kind of savings account. The employee, and sometimes the employer, contribute various amounts to the account throughout the employee’s working career. Most current retirement plans, such as 401(k) plans, are defined contribution plans. The federal government and military’s Thrift Savings plan is a defined contribution plan. The employee owns the balance of the account (with vesting restrictions) and can transfer it with them between jobs.
In its simplest form, the changes to military retirement move a portion of total amount from a defined benefit plan to a defined contribution plan.
The New Plan
Smaller Defined Benefit Pensions
Under this blended retirement plan, service members would receive a smaller defined benefit pension. Under current law, retirees who selected the High Three retirement plan (not CSB/Redux) earn retirement benefits at a rate of 2.5% per year of service. Under BRS, retirement benefits would be calculated at a rate of 2.0% per year of service. Therefore, a service member who retires under the blended retirement plan would receive 40% of base pay for 20 years of service, a reduction from the current 50% retirement amount that most current retirees receive.
Automatic Government Contribution to Thrift Savings Plans
Each service member would have a Thrift Savings Plan (TSP) account created for them. The government would automatically contribute to this TSP account, at the rate of 1% of base pay. Service members would be “vested,” or own, these contributions after 2 years of service.
Service members would be automatically enrolled to contribute 3% of their base pay to their TSP account. Disenrollment or changes would only be permitted after financial literacy education.
Government Match for TSP Contributions
After two years of service (up to 26 years of service), service members would be eligible for a government match of their TSP contributions. This match is 1-for-1 for the first 3% of income, and the government will match 50% of the next 2% of income.
This government match, combined with the automatic government contributions listed above, would give service members a retirement savings account that isn’t tied to 20 years of service. Service members leaving the military prior to receiving the defined benefit pension (retirement pay) would still have retirement savings funded, in part, by the government contribution..
Of course, service members should already be contributing to TSP. However, we know that few service members take advantage of TSP. This will give more savings to those who would have contributed to TSP anyway, and create some retirement savings for those who would not have contributed.
Each of the proposed plans includes a recommendation for continuation pay, which would be a special payment made to mid-career service members in return for a service obligation. Continuation pay is very similar to a re-enlistment bonus.
Continuation pay will be paid at 12 years of service and will incur an obligation to serve for an additional four years. Each branch is authorized to structure continuation pay amounts in order to meet retention goals of individual career fields.. The amount of the continuation pay may range range from 2.5 to 13 times monthly base pay for active duty members. Prior experience shows that most people would receive bonuses significantly smaller than the allowed maximum.
It’s Grandfathered In
Anyone who is on active duty on 1 January 2018 will remain in in the old system, unless they want to switch to the new system. Those with less than 12 years of service will be given the option to switch to the new system.
Service members who already have significant time in service are unlikely to want to switch, because they will not be able to benefit from years of automatic contributions and government match. There is no provision for retroactive government matching of TSP contributions.
Younger service members may find that the new plan is very appealing due to the portability of the TSP portion of the plan.
Benefits for currently retired service members remain unchanged.
Because I’m a dork, I’ve built a spreadsheet that showing potential government automatic TSP contributions, service member contributions, and government matching contributions. You can see it in a Google Doc, or download it this PDF of Retirement Change TSP Chart. It has a page for the enlisted pay scale and a page for the officer pay scale, which can be accessed by using the tabs at the bottom of the page.
I’m offline right now, updating this chart. Give me a couple of hours!
The chart obviously has to make a lot of assumptions. It uses the 2016 base pay charts, and the DoD averages for promotion. It also assumes that a service member will contribute 5% of their base pay to TSP each year to earn the full government match. There are separate columns to look at account balances with no growth, 2% growth, and 4% growth.
The chart shows the total saving a service member would have after years of service, and breaks down how much of that savings comes directly from the government contribution and match to TSP.
Leaving Before Retirement
One of the major appeals of the proposed blended system is the ability for all service members to build up retirement savings with a government contribution. This is important because currently only about 19% of active duty folks remain in the military long enough to earn a retirement paycheck. Under the current retirement plan, those who leave the military prior to 20 years of service do not have any government contribution to any retirement plan. The proposed blended retirement will allow those who serve fewer years to still benefit from government contributions to their overall retirement savings.
An E-5 who decides to leave the service at 10 years would have approximately $32,000 in TSP savings (assuming 4% growth), about $14,500 of which came from government contributions. An 0-3 who decides to leave the service at 10 years would have approximately $52,000 in TSP savings (assuming 4% growth), about $24,000 of which came from government contributions.
Serving 20 Years or More
For those who do make it to retirement, the numbers will grow significantly. An E-7 retiring with 20 years of service would have approximately $110,000 in their TSP account (assuming 4% growth), with just about half the balance coming from government contributions. An E-9 with 30 years of service would have approximately $255,000 in their TSP account (assuming 4% growth), with about $133,000 of the balance being the result of government contributions. An O-5 with 20 years of service would expect to have $208,000 in their TSP account (assuming 4% growth), with about $106,000 of the balance coming from government contributions.
When considering the proposed retirement changes, it is important to consider the TSP balances against the reduced defined benefit pension. Therefore, I added two sheets to show how much less the retiree would receive each year from the reduced pension.
I started to add a breakeven point showing how many years of retirement would have elapsed before the value of the TSP account was less than the amount of retirement benefits lost, but there are too many variables to truly make that comparison. We can, however, do some rough math and say that even if the TSP balance never grew at all, during the service member’s career or after retirement, the value of the government’s portion of the TSP balance would be between 7 and 13 times the difference in pension amounts. Add in a reasonable rate of growth, and the TSP’s value as a portion of retirement benefits increases. Depending on the individual’s investment choices and the market’s performance, the TSP balance has the potential to grow well beyond the amount of reduced pension.
This chart doesn’t address some important issues, such as the taxability of government TSP contributions, because there are too many variables to account for every situation.
Summing It Up
There’s a lot to like in this new military retirement plan. These changes will allow active duty service members to accumulate portable retirement savings that are not dependent on attaining 20 years of service. Those who do make it to retirement would enjoy greater flexibility with their overall retirement portfolio who still having the security of a lifetime, cost-of-living adjusted defined benefit pension.
Please, if you have friends, neighbors or co-workers who are confused about the changes, help them to understand what is actually happening. Bad information benefits no one!