Funding: In the end, a major aspect of the choice is about whether the new system favors the Service member or the government compared to the current system. In that regard, the Congressional Budget Office determined the new system would generate significant savings to the government over time. There’s only one place that savings can come from: the pockets of career Service members.
Gainers/Losers: A significant aspect of the new system is that it creates a new vesting system whereby members who leave service short of retirement eligibility can take some level of federal money with them in the Thrift Savings Plan (TSP). So Service members who leave before 20 years of service gain under the new system. However, the new system saves the government money overall. So, again, there’s only one place the money for additional benefits for separating members can come from: the pockets of those who stay for a career in uniform.
Key Issues for Decisions Between the New and Old Systems
- Do you plan to stay for a career or separate from service before the 20-year mark? If you‘re pretty sure you’ll get out before 20 years, the decision is a no-brainer – take the new system. If you think the odds are better than 50-50 you’ll continue for 20, you should probably lean toward staying under the current system…but there are others things to think about as well.
- Are you a spender or a saver? This isn’t a joke question. If you have trouble putting money aside for the future, you’ll be at a great disadvantage under the new system, under which you you’ll need to save at least 5% of your basic pay every month to get the full government matching benefit.
Saving can be difficult for many military people, especially in the junior grades. But that’s when it’s most important to start saving, because of the power of compound interest over a number of decades. The later you start to save, the more you lose in long-term compounded savings. If you’re a saver, and you like to plan for the future, you might think about the new system–but you need to analyze some difficult issues, including the following.
- Are you comparing apples to apples? Many comparisons of the two systems (including the DoD education materials) look strictly at the current military retired pay expectation (without the TSP) vs. the reduced retired pay, plus TSP under the new system. But that’s not the comparison to make. Why not?
Because half or more of the money in the TSP will come from your pocket, not the government’s. That’s your money; it’s not part of the government benefit. If you’re going to assume you’ll save 5% or more of your basic pay in the TSP under the new system to get the government match, you should make the same assumption about your own savings for the current system, which also allows TSP contributions (without a government match).
Adding your money on one side of the comparison but not on the other gives a very misleading portrait of what the government itself is providing you for your service. The compounding of TSP amounts over time makes for a particularly misleading comparison if you only include your own TSP savings for the new system side. So in making the comparison, make the same assumption about your own TSP contribution under both the current and new systems, and include the government match on the new system side separately. The only TSP difference between the two should be the money the government contributes.
- If you stay 20 years or more, will you need your retired pay immediately after leaving service or will you be willing to defer part of it until age 67? Under the new system, that decision is made for you. You’ll get about 20% less retired pay upon leaving service, and you won’t be able to access your TSP savings until later.
Here again, there’s an issue of your money vs the government’s money. If upon leaving service you want to defer part of your retired pay, you can already do that under the current system by making annual contributions to a regular or a Roth Individual Retirement Account (IRA). You can also choose to invest part of your higher current-system retired pay in non-IRA accounts to save for the future if you don’t need it immediately. Under the current system, those are your own choices to make.
Under the new system, the government makes it for you by providing 20% less immediate retired pay. Some people are fortunate enough to find good-paying jobs immediately upon retirement. Others struggle for a while to find their second-career niche. Still others use the higher retired pay under the current system to give themselves a financial cushion to let them pursue their (not-necessarily well-paying) dream after service.
- Guaranteed vs. At-Risk Benefits. The current military retirement system is a straightforward statutory formula that provides 2.5% of (highest-3-year-average) basic pay for every year of service. Once you start receiving retired pay, the law requires annual increases to offset the cost of living, so the purchasing power of your retired pay will always be the same as it was the day you retired.
The new retirement system provides 20% less retired pay and depends on four less-certain things to build value over time:
(a) your consistent action to save a significant amount of your pay every month from the beginning of your service;
(b) your avoidance of taking loans against your TSP during times of fiscal difficulty;
(c) an expectation that markets will deliver a certain level of positive returns; and
(d) your constancy in making smart investment decisions.
Unfortunately, (a) and (d) pose particular problems for military age people in their early 20s to mid-40s. Most investors that age are skittish and prone to selling stocks when markets go down and not buying them again until everyone is doing so…which is usually too late. As a result, many younger investors don’t realize the same long-term gains they would have if they stayed the course and kept investing in the stock market even when it went down. Many others choose to make “safe” investments in government bonds rather than stocks. But bonds also can lose value and deliver significantly lower returns over the long term.
So when someone says you can expect to get X% returns over the long term, remember you will only realize long-term returns if you stay the investment course and can handle the ups and downs of the market without changing your investment behavior.
Finally, traditional projections of annual market returns at 8% or higher have been revised in recent years as a result of experience with increased volatility and major market downturns. Most financial experts now say those projections are unrealistic, and cite a 5% to 6% return as a more reasonable expectation.
- Personal Flexibility. This is a big one. Opting for the new system locks you into an immediate savings requirement (if you want the full long-term benefit). It locks you into deferring more of your military retirement benefit for two decades or more after you leave service. But it does give you more flexibility to take some federal retirement benefit with you if you choose to leave service early.
Opting to stay under the current system maximizes your immediate retired pay. This provides greater post-retirement transition flexibility. It also makes more of your military retirement benefit subject to guaranteed inflation protection. Additionally, you benefit from less dependence on market risk. Plus, it still allows you options for personal savings/investment (without federal matching).