Service members who entered the military between Jan. 1, 2006 and Dec. 31, 2017, must decide in 2018 whether to join the blended retirement system or remain under the current system. In an article published in March, we highlighted key changes in the new system; in an article published in June, we tackled the potential differences in the cash value of the two systems. This month, we will address another common question:
Does the new blended retirement system shift the responsibility of saving for retirement from the government to the service member?
Well, no and yes. No, because even a service member who does not want to spend any time on investment decisions will still be taken care of, as we will discuss further. But yes, because in order to obtain the maximum government matching contributions available, the service member must choose to put away more money to obtain the greatest benefit, and he or she also has the opportunity to choose from investment approaches.
In other words, under the previous investment plan, the government gave the same amount of money to savers and non-savers alike, and it made all of the investment choices. Under the new plan, the government gives more money to those who choose to save the most, and it allows — but does not require — participants to choose from a variety of investment options.
As we have stated before, both plans provide for a defined benefit portion of retirement pay in which the service member receives a specific monthly payment. But that defined benefit will be 20 percent lower under the blended retirement system than with the current system. The current defined benefit only applies to those who serve at least 20 years; for those who do not, only the blended system provides money toward retirement.
The blended system, however, also includes a defined contribution component that encourages service members to get involved in making investment decisions. That new component, involving the service members’ Thrift Savings Plan, could make up much, or even all or more of, the 20 percent reduction in defined benefits based on the investment portfolio’s performance.
Under the blended system, all participants will receive a 1 percent automatic contribution from the government to their Thrift Savings Plan – and even more in matching funds when the service member sets aside some of his or her money into the plan, either by requirement or by choice. That is why the amount the service member chooses to save is important in the new plan, and why the new plan will prompt greater participation in the thrift plan. Less than half of service members currently use the plan.
Those automatically enrolled in the blended system after Jan. 1, 2018 will have 3 percent of base pay automatically allocated to their Thrift Savings Plan account after 60 days of service. After two years of service, the government will match that 3 percent contribution on top of the 1 percent automatic contribution. Put another way, the government provides a 1 percent automatic contribution and 3 percent match for a total of 4 percent, while the service member automatically invests 3 percent of his or her basic pay.
Those who must choose to opt into the blended system have a choice as to whether to contribute that 3 percent, or more; there is no mandatory minimum, however. While this is a great start to building a retirement nest egg, we recommend that service members, absent extraordinary circumstances, strive to contribute the full 5 percent. But the government is leaving that decision whether to do so solely up to the service member.
That means that service members in the blended system who choose to contribute at least 5 percent of their base pay to the Thrift Savings Plan will receive a 5 percent government match, which includes the 1 percent automatic contribution.
Consider a few examples of service members, each contributing a full 5 percent of base pay to maximize the government’s match. This will provide an E-6 and O-3 with 10 years of service around $139 and $245 a month, respectively, above the 1 percent automatic government contribution. These matching contributions accumulate quite quickly. Had this system been in place for the past 20 years, an E-7 with 20 years of service at the end of 2017 could have accumulated around $27,000 in additional direct government matching funds, on top of the $7,000 from the government’s automatic contributions. For an O-5, it would amount to $50,000 in additional direct government matching on top of $12,000 in automatic contributions from the government. Of course, the amount available for retirement would be much greater when including the service members’ own contributions.
While contributing an additional 2 percent of base pay to unlock the remaining 1 percent government match might not seem worthwhile instinctively, the difference between saving 7 percent and 10 percent of base pay can result in well over a hundred thousand dollar difference by the time the service member turns 60. For an E-7 fully invested in the TSP C Fund for the last 18 years, this 3 percent would be approximately a $44,500 difference today. Even with no additional contributions to the Thrift Savings Plan, modest market returns cold grow this difference to well over $100,000 by the time the E-7 becomes eligible to make penalty-free withdrawals from the Thrift Savings Plan.
Some readers noted that the military does not train most service members in the art of investing, and that the blended system offers investing options to every soldier, sailor, airman and Marine. But the plan is devised so that, even if the service member remains uninvolved in investment planning, his or her interests are still protected.
For example, the plan for automatic enrollees in the blended system shifts the default fund for savings plan contributions from the current very low-risk G Fund to the most appropriate “life-cycle” fund, which most likely means greater returns without unacceptably greater risk.
Life-cycle funds expose investors to more market risk, and thus offer higher potential returns, during the time when they are young and better able to weather temporary market downturns. As investors age, the funds gradually and automatically switch more assets to lower-risk investment options, like bond funds, with lower expected returns. Put simply, that means that the system itself will automatically help service members make wise investing choices.
Of course, service members have the option of bypassing the default life-cycle option and choosing more or less aggressive funds, which would carry either higher or lower risk and greater or lower potential returns.
But none of the life-cycle funds could be described as wildly risky. For example, the L 2050 Fund, currently the plan’s most aggressive life-cycle fund, still has more than 11 percent of its assets in the G Fund, which consists of short-term U.S. Treasuries with virtually guaranteed returns. In addition, for all of the Thrift Savings Plan funds, the expense ratios — the cost that you are charged for the actual work of investing your money — are among the lowest in the investment industry.
It is true, however, that the different choices made by service members could significantly affect the amount of money that is built up in the defined contributions part of the plan. For example, a service member who invested most of his or her funds in fixed-income assets while the stock market was crashing and then switched to a fund with high levels of stocks before the stock market soared would do very well, while an investor who took the opposite approach would do poorly. A note of caution though. Most investing experts strongly discourage trying to “time” the market to achieve results.
Your own appetite for investment risk is a very personal decision. The default option of life-cycle funds that are aligned with your retirement year is a great hands-off way to invest — and the beauty of it is that service members who choose this route may end up with greater returns than are achieved by their more aggressive colleagues or than even by the most active traders on Wall Street.
THE BIG TAKEAWAY
The blended retirement system does not require service members to have specialized investing skills because it employs a default setting that offers a highly regarded investing approach. But to obtain the maximum amount of governmental matching funds available, service members must choose to contribute more of their own money to retirement savings. The key is to put 5 percent, if possible, into the Thrift Savings Plan – thereby receiving a full 5 percent match from the government. Even greater returns are possible with a variety of investment options available to those who want to go beyond the default investment path.
About the Authors:
Maj. Patrick J. Bell, is a Research Scientist with the Army Cyber Institute and 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(r) 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(tm) 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.
The views expressed are the authors’ own and do not reflect the official policy or position of the United States Military Academy, the United States Army, Department of Defense, or the U.S. Government.