Editor's note: The following is a guest commentary by two active-duty economics professors from the U.S. Military Academy. This is the second in a reoccurring series to educate service members on the new Blended Retirement System; the first is linked below.
Last month, we wrote aboutfive key considerations about the new Blended Retirement System, which will be provided to active-duty service members who join the military beginning in January 2018, and is optional for those who have entered since January 1, 2006, or who will enter through the end of this year. For next year's newcomers, the new system may provide, overall, the same, or less, or more retirement income than the current system does, depending on the choices service members make and their investment returns.
But for those who must choose whether to stick with the current system or switch to the blended system, the question is more complicated. Some members of this group who read our first article were skeptical of the blended plan's benefits, and raised several concerns. This month we will address the most common question we encountered: Will the blended system provide me with less retirement money than the current plan?
Definitely not, if you serve fewer than 20 years in the military. Maybe not, if you serve at least 20. Those with the least time served before opting in are most likely to come out better with the new system.
For the first group, there is little debate: The blended system allows those who do not plan to stay 20 years a chance to build up savings that can be used for retirement, partly through the accumulation of matching Thrift Savings Plan contributions and investment returns. That money can be put aside for use when the decision to retire — from whatever job — is made. Or it could be spent before retirement as well, with various limitations.
Across all services, only 17 percent of service members — 13 percent of all enlisted and 43 percent of all officers — stay for 20 years or more. For those who will stay 20 years, or more, the question is more complicated. The size of the pension itself would be reduced, by 20 percent over the current plan, but that loss could be offset by the value of the government's matching contributions to the TSP and investment returns.
The uncertainty of a 20-year retirement and the hedge against being left with no retirement savings at all is the primary benefit of the Blended Retirement System. But the switch to the blended system could also mean more money for a service member, if the combination of his or her reduced pension with the returns on the contributions to a TSP account adds up to more than would be received by the current pension. However, the closer a service member is currently to retirement, the less likely that is to be true.
Another important consideration, especially for those who entered the military closer to 2006 than 2017, is that matching TSP contributions will cease at 26 years of service. That makes it harder to bridge the gap between the two systems. In addition, service members should remember to consider the value of their 12-year continuation bonus, available only under the BRS, when making the decision on which plan to choose.
Some numbers to consider: Using current long-term U.S. Treasury yields, the value of 30 year pensions for an E-7 and O-5 with 20 years of service are worth approximately $519,000 and $985,000, respectively. Under the blended system, the value of the enlisted service member’s pension is reduced by $104,000 and the officer’s by $197,000. To put these differences into perspective, had these service members received a 5 percent match in their respective TSPs for the past 18 years, they would have received roughly $33,500 and $62,000 in matching funds.
This, combined with the most conservative estimate for the 12 year continuation pay (2.5 times the monthly base pay, taxed immediately at 25 percent), brings their total retirement compensation to approximately $41,000 and $74,000.
In order for these matching funds to compensate for the full value lost, by the time of retirement, the service members would have needed average annual returns of between 11 and 12 percent, nearly twice the actual average annual return of the S&P 500 over the same time period. It is important to note, however, that the value of the TSP account can continue to grow each year after leaving the military because of market returns.
"All-or-nothing" vs. "Most and/or something"
The best way to summarize the difference between the two retirement plans may be as follows: The current system could be described as "all-or-nothing," while the blended system could be called "most and/or something."
With the current plan, service members need to stay in 20 years or they will receive no pension payments at all.
The blended plan pays, to those staying in 20 years, 80 percent of the pension paid out by the current system, while providing matching funds toward a defined contribution plan for all service members, whether or not they qualify for a pension. Those who serve fewer than 20 years will absolutely benefit more under the blended system.
The decision whether to opt in is certainly not a simple one. For current service members who plan on serving 20 or more years, opting into the new system makes sense only if they can earn more from returns on TSP matching, the automatic contributions, and the continuation pay bonus than the gap in value between the two pensions.As we said before, this becomes increasingly difficult the closer one is to retirement when opting in.
We realize the calculations involved in this decision are far from one-size-fits all, but we hope to continue to help you, your family and your subordinates make the best personal decision.
The views expressed are those of the authors and do not reflect the position of the U.S. Military Academy, the Department of the Army or the Defense Department.
Maj. Patrick J. Bell and Maj. Evan R. Davies
About the Authors
About the Authors: MAJ Patrick J. Bell, is an Assistant Professor of Economics in the Department of Social Sciences at the United States Military Academy at West Point. He is a Military Intelligence Officer with experience in unmanned aerial systems, cybersecurity, and advising foreign militaries, including two combat tours to Iraq. He holds a B.S. in Political Science and Sociology from the United States Military Academy and an MBA with Specializations in Finance, Economics, and Global Business from Leonard N. Stern School of Business at New York University.
MAJ Evan R. Davies, CFP® is an Assistant Professor of Economics in the Department of Social Sciences at the United States Military Academy at West Point and a CERTIFIED FINANCIAL PLANNER™practitioner. He was commissioned as an Armor Officer and served in a variety of positions within the 3rd Infantry Division including two combat tours to Iraq.He holds a B.S. in Economics from the United States Military Academy, a M.S. in Personal Financial Planning from the College for Financial Planning and a MBA from Harvard Business School.