Claims that a new proposal for overhauling military retirement may give service members a bigger and more lucrative benefit in the end are facing initial skepticism from military compensation and pension experts.
"It is premature to say whether this is better or worse because there are so many variables that are as of yet undefined," said Scott Spiker, CEO of First Command Financial Planning, a Texas-based company that specializes in helping military families manage their money.
The Military Compensation and Retirement Modernization Commission's highly anticipated report released Jan. 29 calls for shrinking pensions for military careerists by about 20 percent and creating a new benefit of 401(k)-style contributions for troops who leave before reaching the 20-year milestone.
At the core of the report are charts comparing the current military retirement system with the commission's proposed "blended" system. Those charts were widely distributed and displayed prominently when commissioners testified on Capitol Hill in early February.
For example, the charts lay out a comparison for a hypothetical service member who retires as an E-7 after 20 years. The current system would give that member a total retirement benefits package worth $201,282, while the proposed system could offer total assets worth more than $248,000.
The difference hinges on an array of assumptions, including that service members contribute some of their own income, make good, informed financial decisions and earn solid returns in the stock market.
The commission's plan also places the total estimated value of the military's traditional retirement benefit at a figure starkly lower than past studies.
Commissioners said their plan is based in part on the belief that today's service members want more choice in crafting their own benefits menu. But critics say that greater choice will come with risk if service members don't make the best long-term decisions.
Or as Spiker bluntly put it in an interview: "This would give people the opportunity to slit their own long-term retirement-benefit throat."
The commissioners acknowledged that some of today's service members may not be fully equipped to shoulder the responsibility implicit in the new retirement proposal. That's why the commission's plan includes a recommendation that the Pentagon set aside $85 million a year for a new forcewide education program to improve financial literacy.
Something for everyone
The new retirement plan aims to tap the magic of the marketplace and simultaneously benefit everyone — a new benefit for troops who leave before 20 years, cost savings for the government, and an increase in the net value of career service members' retirement package.
But some outside experts say the calculations are skewed. For example, the report raised some eyebrows when it distilled the promise of a lifelong pension into precise, present-day dollar values.
By that measure, the total value of the current retirement benefits for a senior enlisted member was pegged at $201,282 — a small fraction of the $1.1 million figure cited for "lifetime retirement income" for the same hypothetical E-7 retiree in a Defense Department report just last year.
The commission's estimate is far smaller because it does not simply add up the total lifetime pension payments. Rather, the commission's calculations rest upon an unusually high "discount rate," a device that financial professionals use to measure the current value of future payments.
Discount rates can reflect individual preferences. For example, a gallon of gasoline typically costs a few dollars. But someone stranded on the roadside with an empty tank likely would be willing to pay far more for that same gallon of gas.
Discount rates assume money today is more valuable than money tomorrow. They're like reverse interest rates, shaving money from the current value of a future benefit.
Experts say the commission's report low-balls the price tag on a military retirement package by using a discount rate of 12.7 percent, which is far higher than the rate typically used in the private sector.
"Twelve percent! My gosh, that is an outrageous rate to use for something like that," Donald Fuerst, the senior pension fellow for the American Academy of Actuaries in Washington, D.C., said in an interview.
In the financial markets, discount rates typically track interest rates. Most private-sector companies use rates of 4 percent to 5 percent, Fuerst said.
In the case of a military retirement, he suggested an even lower rate should be used, maybe 2 percent or 3 percent, because the U.S. government is considered the safest lender in the world.
Applying a lower discount rate to the military retirement benefit would vastly expand its present-day value. Conversely, a high discount rate on a long-term income stream lowers the present-day value.
Perception vs. reality
The data in the commission report also reflects very different discount rates for officers and enlisted members. The commission's estimate on the value of an enlisted member's retirement benefit was cropped by 12.7 percent a year.
But the estimate of the value of a hypothetical O-5's retirement benefit was discounted by just 6.4 percent.
A commission spokesman told Military Times that the figures reflect the perceived value of the benefit, rather than an objective value, with the perceived value derived from extensive previous studies by the RAND Corp. think tank.
"We used these rates to describe how a particular enlisted service member and a specific officer would value the retirement assets that result from our proposed blended retirement system," said Jamie Graybeal, a spokesman for the commission.
The perceived value is derived by extensive studies by the Rand Corp., Graybeal added.
The distinction between officers and enlisted reflects academic studies that show enlisted members, on average, are more eager to take cash up front and more willing to accept a greater penalty, or "discount," for not having to wait for their money years from now.
On the other hand, officers are more likely to recognize the real long-term value of deferred retirement benefits and reject offers of cash up front, studies show.
The commission's charts, published in the Military Times newspapers and displayed during testimony on Capitol Hill in early February, do not clarify that the values shown actually illustrate perception rather than hard financial analysis; the chart's headline simply stated: "Retirement Assets of a Retiring Active-Duty E7."
That's somewhat misleading, said Mike Hayden, the director of government relations for the Military Officers Association of America.
"I call it the pay-day lending mentality," Hayden said in an interview. "If Congress is going to make a decision about this, it should not be based on the perceived values, it should be based on the actual values."
Hayden noted that by lowering the long-term value of the traditional pension, that calculation also shrinks the 20-percent reduction in the benefit that is at the heart of the commission's proposal — making it easier to build a case that this proposal is better.
"They've used some economic factors that help make the case," Hayden said.
The lump-sum question
Another key element of the commission's plan would give troops the option of taking a lump-sum payment as an alternative to regular checks during their working-age retirement years.
Commissioners say this would save money because it's cheaper for the government to pay troops in current-day dollars rather than make monthly payments in later years.
Specifically, retirees leaving after 20 years of service could opt for a lump-sum in place of all pension payments up through age 67, or split the difference by getting half of the benefit up front and the other half spread out in monthly checks.
All options would resume monthly payments to retirees at age 67, according to the commission's proposal.
That option — take the cash now or wait for the monthly checks — would be a major life decision for career troops under the proposed system.
Yet precisely how that lump sum would be calculated remains unclear.
"That is really a theory. They have the idea that we will buy out a portion of your retirement up to age 67, but they don't have the method," Spiker said.
The wide gap between the estimates on total value for the retirement package — DoD's $1.1 million vs. the commission's $201,000 — highlights the far-reaching effect that arcane financial details can have on the real value of benefits.
"How they calculate that significantly impacts whether it's a good idea for someone to take a lump sum or not," Spiker said.
The commission's plan pushes that question off with a legislative proposal that would task the secretary of defense with creating "the actuarial procedures that shall be used to calculate the amount of the lump sum made."
Fuerst, the actuary, said that's not a good idea, because any new defense secretary could change the formula with the stroke of a pen. Instead, Congress should spell out a definition for present-day value and lump-sum payments, possibly by linking the Pentagon's calculation to current interest rates.
"I absolutely think that should be in the statute," Fuerst said. "That is too big of an issue to leave to the policy discussion."