Retirement About-Face?

Retirement About-Face?

For several years, think tanks and commissions have suggested converting the current 20-year, cliff-vested military retirement system to a defined contribution 401(k)-style plan or to a blended system providing lower or deferred retired pay amounts plus a defined contribution element.

The main thrust behind these recommendations centers on the affordability of the current retirement system. Such proposals aren't new. For decades, whenever budgets tighten, analysts, task forces, and commissions propose military retirement cutbacks.

In 2011, the Defense Business Board characterized the current retirement system as “unfair, inflexible, and unaffordable” and recommended adoption of a 401(k)-style plan for all future entrants. Current servicemembers either would remain under the existing system or transition to a hybrid retirement plan.

When troops responded with outrage, defense and congressional leaders disavowed the proposal as detrimental to readiness. But past Defense Secretaries Robert Gates and Leon Panetta and some in Congress have continued to call for reform.

As a result, the FY 2013 National Defense Authorization Act established the Military Compensation and Retirement Modernization Commission (MCRMC) to review the retirement system and make recommendations to modernize it.

According to its charter, the goal of the commission is to ensure the nation can maintain a professional all-volunteer force in both peacetime and war and develop proposals to help guide Congress' future decisions on military compensation, benefits, and retirement.

The president directed the commissioners to review “the full breadth of the systems,” including health care, military family support, and any federal programs that could influence the decision of current or future servicemembers to stay in uniform or leave the service. The guidance also specified all currently serving personnel should be grandfathered under the current system.

Gates particularly criticized the existing 20-year retirement system as being unfair to those who leave service before that point. His successor, Panetta, similarly said, “[Those who leave service before completing 20 years] are not vested in any way. The question that is at least legitimate to ask is, 'Is there a way for those future volunteers to shape this that might give them better protection to be able to have some retirement and take it with them?' ”

However, no would-be reformers envision spending more on military retirement. Any change to provide additional benefits to those leaving before the 20-year point could be funded only by reducing benefits for those who serve longer.

Given the parameters, MOAA anticipates the MCRMC's report - due in February - could recommend significant retirement changes for future service entrants.

The MCRMC could recommend:

  • keeping the current 20-year system as is;
  • changing the retirement calculation (e.g., high-three to high-five or reducing the multiplier);
  • delaying eligibility to receive immediate retired pay (e.g., until age 50 or older);
  • adding a 401(k)-style element requiring member contributions along with some of the changes above with a possible transition payment (similar to the DoD concept paper); or
  • replacing the current system entirely with a 401(k)-style plan.

The early-vesting element of a 401(k)-style plan would appeal to younger personnel who don't expect to complete a military career or who don't understand the value of the military retirement package. It also would cost considerably less for the government to support. Such proposals typically require some level of servicemember contribution and a delay of eligibility for payments until at least age 59½.

Making dramatic retirement changes poses a big readiness question: Would the new system still induce the required numbers of top-quality people to serve a full military career? To help answer that question, it's important to look at some history.

The origins of the 401(k)

Many Americans view the 401(k) plan as the bedrock of retirement planning, but its origins prove to be far more accidental, according to The Surprising Origins of Your 401(k) by Tom Anderson.

In defined benefit plans such as military retirement, retirees receive a monthly annuity defined by a formula involving pay and years of service. These plans are designed to maintain a stable productive workforce as well as ensure employees a financially secure retirement.

For generations, almost every large employer offered a pension as a standard retirement benefit. When Congress enacted the Revenue Act of 1978, its intent was to limit corporate executives from accessing many benefits found in cash-deferred pension plans, but the original 401(k) was established as an additional perk above and beyond existing pensions for senior company executives by providing a tax break on their deferred income.

By the 1980s, defined contribution plans started to become popular when employers and their human resources departments realized offering defined contribution plans to employees in lieu of defined benefit plans could save their companies a lot of money. So since 1980, private employers increasingly have shifted their workers to defined contribution plans - typically 401(k)s.

An individual employee owns and manages a defined contribution plan. Many employers who offer defined contribution plans add company contributions, often matching some level of employee contribution. But no employer contribution is required, and no specific benefit is guaranteed. The employee assumes all investment risk, and the value of the available benefit is always measured by today's market - a stark difference from the predictable and guaranteed defined benefit plan.

Financial blogger John Wasik of Forbes wrote on the history of the defined contribution system: “The 401(k) plan was never meant to be a mainstream pension plan and, from our perspective, is a poor substitute for one. It's a voluntary program that was intended to supplement retirement savings - one of those quirky little options in the byzantine tax code that employers seized upon as a way to save money while pretending that they were doing the right thing by their employees.”

The increasing shift to defined contribution plans in the private sector accelerated after the dot-com bust of the late 1990s, according to Robert Merton's Harvard Business Review article, “The Crisis in Retirement Planning.”

A 2014 Forbes article, “Companies Prepare To Dump Pension Plans,” further explains the shift: “U.S. pension plans sponsored by S&P 500 companies were fully funded (meaning they had enough banked to meet future obligations to retirees) but got hammered in the Great Recession of 2007 when stock values dropped and interest rates declined. There are two big cost factors to keeping pensions that are motivating employers to consider dropping them. First, there's a dramatic rise in Pension Benefit Guaranty Corporation (PBGC) premiums on the horizon starting in 2015; employers have to pay a premium into the PBGC pot for each plan participant each year. Second, longevity is a factor: New IRS [Internal Revenue Service]-mandated mortality tables will make keeping pensions on the books more costly.”

These shifts in investment strategy reflect a conscious shifting of a company's liability for an employee's future security onto the worker. As a result, employees have shown decreasing levels of company loyalty ever since. The Bureau of Labor Statistics has found today's average worker in the U.S. will hold somewhere between seven and 11 jobs in his or her lifetime. This is a marked shift in employment mentality of earlier generations, who often stayed with an employer for decades.

One of the reasons for diminishing company loyalty in the private sector was the Great Recession, which led to mass company layoffs regardless of tenure, an erosion of company benefits, a lack of training opportunities to fill critical skills gaps, and a lack of promotion opportunity for employees who remained.

However, military recruitment and retention levels tend to be counter-cyclical to that of the private sector. While opportunities in the private sector were eroding, retention rates in the military were strong. Many servicemembers weren't willing to separate and enter an uncertain job market. As the economy shows signs of recovery, servicemembers are more apt to take their skills elsewhere and enter the job market.

Although the portability of a 401(k) plan might be appealing to many young people, the adoption of a 401(k) plan might not be in the best interest of servicemembers and, ultimately, of our national defense.

A key strength of the current retirement system is its predictability. A 401(k) system would gravely impede servicemembers' ability to identify and quantify the annuities they could expect for the potentially unlimited sacrifice of service. It simultaneously makes servicemembers bear the entire brunt of any miscalculation about variable benefits and the performance of the stock market.

The services could suffer from a mass exodus of highly trained personnel when they face tough career decisions, such as choosing another deployment away from their homes and families.

Responding to system criticism

Criticism of the retirement system is not new; allegations of the retirement system being unaffordable and unsustainable have been around for decades. A 1978 report of the President's Commission on Military Compensation included the following extract from the minority report of then-Commissioner Lt. Gen. Benjamin O. Davis Jr., USAF (Ret):

“Unfortunately, the commission has embraced the myth that retirement costs will soon rise so high - from $10 billion this year to $30 billion in the year 2000 - as to become an unacceptable and unfair burden on the American taxpayer. Such assertions fail to point out that by using the same assumptions, today's average family income of $10,000 will be $36,000 in the year 2000. The average cost of a home will be $171,000; a compact automobile will cost $17,000; and the overall U.S. budget will have increased from $500 billion to some amount in the trillions.”

Such numbers might appear quaint today, but they make two telling points. First, long-term projections that sound dire today often prove far less ominous as years pass. Second, after budget-driven retirement cuts in 1986 seriously damaged retention, Congress restored the current system in 1999, finding it more affordable than continued retention and readiness shortfalls.

The Military Retirement Trust Fund, which is run by the DoD Board of Actuaries, manages military retirement contributions, and the funds' viability is certified on an annual basis.

In 2012 testimony before Congress, Dr. Jo Ann Rooney, principal deputy undersecretary of defense for personnel and readiness, testified the current military retirement system is “neither unaffordable nor spiraling out of control,” noting retirement costs as a percentage of pay have remained reasonably constant.

The Defense Business Board and others have criticized the current military retirement system, with its 20-year cliff-vesting feature, as being unfair.

As stated in DoD's November 2011 Military Compensation Background Papers, the military retirement system “was designed to retain a young, viable force and to provide a choice of career service … some measure of economic security … [for] members after retirement … and … a pool of experienced personnel subject to recall … [in] a national emergency.”

Its fundamental purpose is to induce the required number of top-quality people to serve a multi-decade career in uniform. It must exert a strong retention pull despite imposing an array of demands and sacrifices so extraordinary that few Americans are willing to endure them for one term of service, let alone 20 or 30 years.

Never has this career pull been more essential to force retention than over the past 13 years of repeated wartime deployments.

The military retirement system is fundamentally DoD's primary career force management tool.

Servicemembers understand very early in their careers that qualifying for a military retirement requires a commitment of at least 20 years of arduous service. Moreover, retaining all who join is not a goal. Hazardous duty, frequent moves, extended family separations, overseas service, long hours of overtime without extra pay, forfeiture of many personal freedoms most civilians take for granted, and an “up-or-out” promotion system result in high attrition rates. Less than 1 in 5 servicemembers end up qualifying for retirement. It, therefore, requires a unique retirement system to reflect those career challenges.

This reflects both the arduousness of extended military service and the services' needs to selectively retain the best-qualified candidates in progressively smaller numbers as they assume positions of ever-greater leadership responsibility.

In January 2014, Vice Chairman of the Joint Chiefs of Staff Adm. James Winnefeld Jr., USN, testified before the Senate Armed Services Committee, saying, “I think it gets back to the variables that are inherent in any retirement plan. I think one that has been discussed the most is the vesting time, the piece about you have to wait until 20 years before you receive any retirement benefits. That actually helps us a great deal right now in the profiling of our force. We want to have a young force that's going to stay to a certain point and then, frankly, we need a number of them to move on so that we can bring fresh new faces in.”

With the creation of the all-volunteer force in 1973, military professionalism has grown exponentially. According to the 2006 RAND Corp. study “The Evolution of the All-Volunteer Force,” “The AVF [all-volunteer force] has dramatically increased the number of career personnel and increased the proficiency and professionalism of the force.”

MOAA couldn't agree more. The vast majority who exit military service do so with less than six years of service - large numbers with fewer than the five years required by many employers to vest for retirement benefits.

Those employing the “vesting unfairness” argument imply separatees leave the military with no benefits, but that's hardly the case.

To the extent they have participated in the military Thrift Savings Plan, they retain the same rollover rights for tax-deferred savings plans as any civilian job-changer.

In addition, those who complete at least one term of service qualify for an extraordinarily generous GI bill benefit that far exceeds any education benefit offered by almost all other employers.

Depending on the circumstances of their separation from service, many servicemembers receive substantial separation allowances.

And perhaps most important, veterans reap the military's investment in their valuable occupational skills and team-oriented training, plus a history of job and leadership responsibilities that are often well beyond those experienced by civilians of comparable age.

All of these are tangible, portable benefits supporting veterans' reintegration into the civilian sector.

Past military retirement changes

This is hardly the first initiative to reform military retirement. Many changes, large and small, have been introduced over the past 35 years, and the degree of success has been inversely proportional to the magnitude of the change.

A law change in 1980 resulted in the “high-3” model, where retired pay calculations are based on the highest 36 months' average basic pay amount for subsequent service entrants. Retired pay for earlier entrants was grandfathered based on the servicemember's basic pay amount upon retirement.

Then in 1986, Congress enacted the more radical REDUX model that, for post-1986 service entrants, reduced lifetime retired pay value by more than 20 percent.

Then-Defense Secretary Caspar Weinberger strongly opposed the change, warning it inevitably would harm long-term readiness. His warning proved all too accurate a decade later, and Congress repealed REDUX in 1999 after the Joint Chiefs of Staff testified it was causing worrisome career retention problems.

There can be no clearer demonstration of the adverse effect on readiness of major retirement cuts - and no clearer demonstration that grandfathering the current force while imposing major retirement cuts on future entrants doesn't change the adverse effect but only delays it.

The all-volunteer force has proven to be the cornerstone of America's national defense through decades of hot and cold wars, despite pundits' and bean counters' continual gloom-and-doom predictions that retirement costs are spiraling out of control.

The adoption of a 401(k)-style retirement would be a far more severe change than REDUX and almost certainly will prove to be a retention-killer, regardless of any grandfather clause for the current force. It is not hard to imagine a future mid-career servicemember, faced with a third or fourth deployment, choosing to leave the service when he or she can walk away with a 401(k) in hand. That choice would be made far easier if Congress also cuts benefits for completing a career - as envisioned by every vesting proposal offered to date.

In the end, claims that the current system is unfair to early separatees are a red herring, designed to mask the shift of the cost of retirement away from the government and onto the backs of servicemembers - the one weapon system that has never failed our nation.

The powerful pull of the 20-year retirement system is the main reason retention hasn't imploded over the past 13 years of unprecedented wartime strains on troops and families.

After the Great Recession of 2007, when the market significantly dropped, more and more workers who were looking to retire on their 401(k)s found themselves remaining in the workplace for several more years until their portfolios recovered from a 30 to 50 percent drop. Servicemembers who stay two to three decades need and deserve predictability in retirement and should not be subject to market fluctuations.

The crucial element to sustaining a high-quality, career military force is establishing a strong bond of reciprocal commitment between the servicemember and the government (i.e., loyalty). If this reciprocity is unfulfilled, or if faith is broken with those who serve, retention and readiness inevitably will suffer.

So what have we learned?

It's well documented that 401(k)-style plans undermine employer-employee loyalty and discourage long-term retention.

  • Past military retirement cuts far less dramatic than those now being proposed have generated unacceptable readiness problems, regardless of grandfathering provisions.
  • Cutting rewards for serving an arduous military career while increasing rewards for separation is not a viable formula for retention of a high-quality career force.
  • If our nation is willing to impose unlimited sacrifices on servicemembers and their families over the course of a military career, it must not simultaneously reduce its responsibility to protect career servicemembers' and families' welfare.

The most critical element to the all-volunteer force is the well-trained, seasoned mid-grade NCO and officer corps. From our foxhole, the cliff-vested retirement system remains the most important benefit to sustaining the career force.