Career troops will have an extraordinary new choice to make under the new retirement system approved by Congress: Take the traditional pension checks or opt to receive up to half the promised pension benefit in the form of a one-time, lump-sum cash payment.
That lump-sum option is one of the most controversial features of the new system that appears likely to become law later this year. The Defense Department and many veterans advocates opposed the option, but lawmakers nevertheless included it in their final agreement reached in early October.
Critics say the lump-sum option will be a bad deal for troops. But precisely how bad remains unclear, because Congress is leaving it up to the Defense Department to determine exactly how that lump-sum cash payment is calculated.
That will require Pentagon officials to peg a number to the present value of a promised military retirement pension and its annual cost-of-living increases.
Over the past several years, those estimates have varied dramatically. For example, the Pentagon estimated the total value of lifetime retirement annuities for a retiree leaving at the paygrade of E-7 to be about $1.1 million. But an independent military compensation commission's projection was just a fraction of that — closer to $200,000.
Where does that difference come from?
The estimates don't necessarily just add up the total lifetime pension payments. Rather, the calculations can 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, shaving money from the current value of a future benefit.
The higher the discount rate applied, the lower the value of the lump sum payment today.
The Pentagon will have a big decision to make in setting that discount rate, one that will add or cut hundreds of thousands of dollars from individual troops' lump-sum options.
"It's not clear how the legislation will be interpreted," Bill Hallmark, who tracks government pensions for the American Academy of Actuaries, said in an interview.
When private-sector corporations offer pension buyouts, they are required by law to peg the discount rates to key financial market indicators like bond rates, putting them in the range of 2 percent to 4 percent, Hallmark said.
But the Pentagon would be allowed to set a far higher discount rate. Hallmark notes the the military retirement legislation refers to "personal discount rates," which likely means far higher rates, potentially upward of 10 percent in some cases.
A personal discount rate is based on quasi-scientific economic studies about people's personal preferences, or "what someone would be willing to accept in exchange for their monthly payments," Hallmark said.
Some studies show that enlisted troops are far more eager than officers to take lump-sum payouts. That suggests the Pentagon could consider giving officers a better discount rate simply because academic-style studies show they are more skeptical of the lump-sum options.
"The details of the regulations, when they come out, will be critical to see if they use the same rate for everyone or different rates for different people," Hallmark said. "All of that is uncertain."
The retirement restructuring is authorized in the defense policy bill passed by the Senate on Wednesday. The House approved it earlier in the month.
The defense secretary ultimately would decide the discount rate for lump-sum payouts, according to the legislation.
The Pentagon can save billions by setting a higher discount rate and shaving money from those lump-sum payments. Yet officials may not want to squeeze troops too hard on that score, lest large numbers reject the lump-sum deal and opt instead for the long-term benefit of monthly pension checks.
"It puts the government in the position of being a payday lender — convince people to take a small lump-sum value that saves the government a heck of a lot of money over the long term," said Steve Strobridge, director of government relations for the Military Officers Association of America.
"DoD certainly saves a lot of money if people would take the lump sum," he said. "But DoD is also under the obligation to inform them about it. And in our view, most of the people who are properly informed about it won't be taking it."
In June, the Defense Department officially opposed the lump-sum option. In a memo to lawmakers, defense officials said lump-sum payments are a smart financial decision only "in very limited circumstances."
Officials ran some models and found that the concept resulted "in relatively small lump sums," while the value of the forfeited annuities was "significant," according to the June memo.
Lawmakers appear to have acknowledged that in their final agreement; initial versions of the retirement reform proposal gave troops the option of receiving their entire pension up to age 60 in the form of a lump-sum payment, but the final provision limits their lump-sum payment options to 50 percent or 25 percent of their total pension benefit.
All lump-sum options apply only to the retirement benefits projected up through the traditional retirement age when all Americans become eligible for Social Security. All military retirees over age 60 would receive full retirement checks.
The new military retirement system would take effect in 2018. All current troops would have a grandfather clause and a choice to remain under the current system or opt into the new one. Future recruits joining the military in 2018 and beyond would have no choice other than the new system.
The new plan would, for the first time, give almost every service member some retirement benefits when they leave the ranks, rather than only the one in five who stay in uniform for at least 20 years. The new plan would give almost all troops who serve more than two years some benefits upon separation from vested 401(k)-style investments into their Thrift Savings Plan accounts.
Career troops would receive the same 401(k)-style benefits, as well as a traditional pension that is 20 percent smaller than the current one.