Top financial experts are worried about a key piece of the military's new blended retirement system and are urging the Pentagon not to shortchange career troops — especially enlisted service members.
Specifically, the American Academy of Actuaries is scrutinizing the new system's lump-sum payout option and precisely how the the Pentagon will calculate it for those who elect to cash such a large portion of their pension.
Military retirement reform became law last year and takes effect in 2018, giving future retirees the option of taking traditional monthly pension checks or accepting smaller monthly pay along with a lump-sum cash payment at the time of separation. The lump sum would total either 50 percent or 25 percent of a service member's promised pension benefits.
It’s similar to the military's longstanding "REDUX" retirement option, which offers cash up front in exchange for smaller monthly checks. But unlike REDUX, which offers a flat $30,000 cash payment, the new lump-sum option will offer cash payments that will vary for individual troops based on the value of their personal retirement package as defined by pay grade and years of service.
Determining the amount of that lump-sum check is more complicated than simply totaling future monthly pension checks. Rather, the calculations will rest upon a "discount rate," a device that financial professionals use to measure the current value of future payments. Discount rates assume money today is more valuable than money tomorrow. Akin to reverse interest rates, the process shaves money from the current value of a future benefit. So higher discount rates yield smaller lump-sum payments.
Therein lies the actuaries' concern.
During the debate over military retirement reform, estimates varied dramatically for the total value of a service member's retirement benefit. An independent commission, for example, said last year that a senior enlisted service member in the E-7 pay grade could expect retirement benefits worth $201,282. By contrast, the Defense Department suggested that same E-7 could expect $1.1 million in "lifetime retirement income."
The difference hinged on the discount rate. As it evaluated the consequences of reform, the independent Military Compensation and Retirement Modernization Commission assumed a rate of 8 percent for officers and 12 percent for enlisted service members. In today’s financial markets, discount rates typically hover between 2 and 4 percent.
“This higher rate would result in settlement amounts … that are, in some cases, less than half the amount that the same benefit would be settled for in a corporate pension plan, as part of a domestic relations action, or in the broader financial markets,” William Hallmark, chairman of the American Academy of Actuaries' pension practice council, wrote to the Defense Department this month.
Such a steep discount rate would be a bad deal for troops, Hallmark warned, appealing primarily to those who don’t understand what they risk losing or who face such financial hardship they simply don't have another choice. He also questioned the military compensation commission’s suggestion that different discount rates should apply to officers and enlisted troops, resulting in enlisted troops receiving far less money. The commission based that recommendation on studies suggesting enlisted troops would be more eager to take the cash up front and therefore won't require much convincing to take an option that, ultimately, would saves the government money.
Veterans advocates have criticized the disparity, likening it to a payday loan — one that exploits people with less financial education and fewer options for a traditional bank loan. The American Academy of Actuaries said the Pentagon should set a fair and across-the-board discount rate similar to those applied by large corporations.
"We encourage the department to carefully consider the extent to which the discount rate should reflect a service member’s financial sophistication and immediate financial needs, or whether the discount rate should be independent of these considerations,” Hallmark wrote. “Furthermore, we believe consideration should be given to whether all service members should be offered lump sums based on the same discount rate and whether that discount rate should be comparable to the discount rate required for lump sum payments from corporate pension plans.
"Regardless, ... we strongly encourage the department to provide a full and thorough disclosure about the discount rates used to calculate the settlement offers. Such a disclosure should include comparisons to settlement amounts that are calculated based on widely used discount rates and/or comparisons to what it would cost to replace the foregone pension benefits in the financial markets."
The Pentagon has never explicitly supported the use of “personal discount rates.” Instead, a Defense Department spokesman noted that applying the rate is required by the retirement reform law passed by Congress. “The department has made no decisions on personal discount rates and is working with outside experts on this issue,” said Air Force Maj. Ben Sakrisson.
The partial lump-sum payout would replace a portion of the retiree's monthly pension checks until the recipient reaches age 67. After age 67, military retirees would receive full retirement checks regardless of whether they opted for the lump-sum payout.
When the new retirement system takes effect in 2018, all current troops will have the choice to remain under the current system or opt into the new one. Future recruits joining the military in 2018 and beyond will have no choice other than the new system.
The new plan also would provide some retirement benefits, via a new 401(k)-style investment account, to almost all troops who serve at least two years.
Career troops would receive the same 401(k)-style benefits, plus a traditional pension that is 20 percent smaller than the current one.