2008/08/12 00:00:00
By Tom Philpott
A new military retirement plan devised by a Pentagon study group assumes piles of cash — offered at critical career points and paired with a much reduced “defined” retirement benefit — can be more effective in shaping a career force than the current 20-year retirement system.
How a more complex, more fluid retirement offer will be received by the military, which has relied for 60 years on a straightforward and generous plan, remains a big unknown.
That is why the 10th Quadrennial Review of Military Compensation (QRMC) recommends, sensibly, that its plan be tested for at least five years on a sampling of military volunteers. A test could verify if servicemembers react to the plan’s major features as the computer model predicts they will.
In an interview, QRMC’s director, retired Air Force Brig. Gen. Jan “Denny” Eakle, said the current retirement system is inequitable, inflexible, and inefficient — criticisms made by many previous studies. Fewer than half of officers and 15 percent of enlisted personnel serve long enough to draw benefits.
Also, the rigidness of the current system, with no benefits offered before 20 years, encourages the services to keep too many people they don’t need, while too many members with critical skills retire early.
Eakle said the QRMC proposal “will answer the needs of individual servicemembers,” allowing about 25 percent to leave with some retirement benefits. It would also give the services greater flexibility to shape their force, perhaps lengthening careers and lowering recruiting and training costs. And the plan would provide “best value to the taxpayer,” Eakle said.
The plan, which would apply to both active and reserve component servicemembers, has four major features.
The defined benefit annuity uses a familiar formula: 2.5 percent of average annual basic pay for a servicemember’s highest three years, times the total number of years served. Servicemembers would be vested after just 10 years’ service, but payments couldn’t begin until age 60 or 57 for servicemembers who complete 20 years or more. Taking an immediate annuity option would cut the benefit severely, by 5 percent for each year it was paid before age 60 (or 57).
A defined contribution would be a government-funded Thrift Savings Plan (TSP) account with no matching required of the servicemember. Contributions would begin in year two at 2 percent of basic pay, followed by 3 percent in the third and fourth years, 4 percent in the fifth, and 5 percent of basic pay each year after. Servicemembers would be vested in this TSP after 10 years.
The plan’s final two features are gate pays and separation pay. The first would be used to entice servicemembers to stay through career milestones. The second would be used to entice servicemembers to leave. Use and timing of these two pays would be left to service discretion and would vary by job skill and years of service.
Eakle noted, for example, that the Army could maintain its current force profile by setting gate pays equal to 15 percent of annual basic pay at 12 and 18 years of service and by offering separation pay equal to a year’s basic pay to servicemembers who retire between 20 to 26 years of service.
This “flexible” plan is an economist’s dream, relying heavily on computer modeling informed by personal discount rates for military populations going back to 1990. Discount rates tell economists how individuals are willing to trade current dollars for future dollars. The QRMC model, developed by RAND, assumes a servicemember discount rate of 15 percent, which means $100 paid now will be as attractive as $115 next year.
Much was learned from discount rates measured during the post-Cold War drawdown. Given the choice of accepting a lump-sum cash payment or an annuity that would last twice the length of their time in service, 90 percent of careerists chose the lump sum, even though its cost to the government was a mere fraction of the annuity option.
Similarly, thousands of servicemembers today, as they enter their 15th year of service, are accepting a $30,000 bonus to shift voluntarily under the less generous Redux retirement plan. In pocketing the cash, they cut the lifetime value of their retirement by an average of more than $300,000.
The bad choice people make when offered near-term cash drives cost efficiencies behind the QRMC proposal. Its computer model shows that an E-7 with 20 years of service under high-3 retirement assigns a cash value to his lifetime retirement benefit of only $120,000.
In other words, the E-7 is likely to accept $120,000 and forfeit his or her right to a lifetime annuity equal to 50 percent of high-3 basic pay plus annual COLAs. The same E-7, the computer indicates, would value QRMC’s four-part retirement plan, with its immediate annuity option, at $138,000, or more attractive than the current system.
The government stands to save money on that choice, because it must fund retirement using values undistorted by emotion, impulse, or immediate needs. The government pegs the lump-sum equivalent value of high-3 retirement for an E-7 with 20 years at $502,000 — four times the value that servicemembers assign to their own benefit, the QRMC says.
