Retirement And The U.S. Military

by: Kyle Gunn

Summary

Defense Secretary Ash Carter has introduced a new retirement system for the US Military that will begin January 1, 2018.

The system will phase out then replace entirely the current system and will impact hundreds of thousands of those currently serving.

Under the new system, service members will be able to contribute to a 401(k) style system with employee match up to 5%.

There are many pros and cons to this update and many individuals will have to decide which is best for them.

I walk through the different plans taking a look at a service member who will have to choose.

The retirement system for the military is changing. Since August of 1986, we have been working with the same two options in the military. After Final Pay was phased out we were left with High 36 and Career Status Bonus/REDUX. This is a big deal and will affect hundreds of thousands of Americans and their families who find themselves wearing a uniform today.

The two aforementioned retirement options must be decided upon once the individual reaches their 15-year mark in the service. If you elect not to choose, you are automatically enrolled in the High 36 program.

The High 36 is structured as such: After 20 years service, you receive 50% of the average of your highest 36 months base pay. For every year after 20 you served, you get an additional 2.5% on top. Cost of Living Adjustment is calculated using the Consumer Price Index and is issued annually and of course healthcare is provided through retirement via Tricare.

The CSB/REDUX is very similar to the High 36 with some changes. After 20 years, you receive 40% of your highest 36 months average base pay plus 3.5% added on for each year after 20 and 2.5% for each year between 30 and 40 total served. If you elect this system at 15 years, you also receive $30,000 that is subject to taxation. COLA for the REDUX is determined using the CPI minus 1% and is also issued annually. Healthcare is provided through Tricare as well.

Those that joined the military before December 31, 2005 will remain under the current system. Those who joined between January 1, 2006 and December 31, 2017 will be able to choose which system they fall under. Everybody after that date will be under the new system.

The new system, referred to as the Blended System, is actually not much different. After 20 years, you will receive 40% of your base pay like the REDUX program but only an additional 2% for each year after 20. At 12 years, you will receive a bonus of 2.5 months of base pay after agreeing to serve another four years.

Where the plan takes a drastic shift is that the government will also contribute 1% of your base pay to a TSP and after 24 months of service, they will match dollar-for-dollar the first 3% and $.50 to the dollar for the next 2% the individual contributes. This is where it becomes difficult to decide.

Service members who need to make a choice have a lot to consider. The amount of years they are at now, their current health, pay grade, and a host of other issues must be taken into consideration. Personally, I fall into the camp that must choose and so I set about figuring it out for myself.

I went about creating a spreadsheet which can be found here that has all three retirement systems included. (If you have issues downloading it please contact me here and I will email it to you.) If you care to follow along I highly recommend you utilize the spreadsheet. It is free to use, and I only ask that if you are using it to help a service member out, you do not profit from it.

Our Case Study

For the sake of argument, let's get introduced to Staff Sergeant Mays. He joined the Marine Corps on January 1, 2007 and intends to retire at 20 years exactly which will set his date for January 1, 2027. On January 1, 2024, he picked up Master Sergeant for a pay grade of E8 and will fall under the 18-year or more pay scale at time of retirement.

Currently, that is at $4,878.00 base pay each month. If we assume that will increase by 1.6% every year for the next 10 years until he retires that will be a base pay of $5,717.14 a month. Since he was promoted on January 1, 2014, he would have held that rank for three years, so his 36-month average would be $5,627.33 when adjusted for each year.

Under High 36, he would receive $2,813 a month for a total of $33,763.98 annually. If we assume that COLA is increased by 1.25% a year after 20 years, his total compensation would be $761,815.96. Seeing as how there is no bonus paid, there is nothing else to consider for High 36.

Under REDUX he would receive $2,250.93 a month for a total of $27,011.18 annually. Using the same assumption for COLA at 20 years, his total compensation would be $639,452.67 including the $30,000 bonus he was paid at 15 years. This is where individual variables will come into play. After taxes that would be about $21,000 and where this Marine places that money can drastically change the benefit of the REDUX.

If he pays down all high-interest credit cards which miraculously totals $21,000 that return could be as high as 25% depending on his APR. He could pay the remaining balance of his mortgage which is also at $21,000 and has a rate of 4.25%. Depending on how smart the individual is with this payout, it can change their quality of life in retirement.

Under the Blended Plan he would still receive $2,250.93 a month and $27,011.18 annually. The 20-year total would adjust slightly because there is no $30,000 bonus. At 12 years, he will still be a Staff Sergeant and has agreed to serve four more years thereby qualifying for the 12- year bonus of 2.5 months pay which would be about $9,320.00.

This brings total 20-year compensation to $618,384.72. We must also consider what he did with the $9,300 bonus eight years ago and hope he was smart with it. Another variable we must consider is the TSP contributions.

The TSP has six funds inside of it and they can be found here. Staff Sergeant Mays didn't start contributing to his TSP until January 1, 2018 when the government began to match his contributions. This gives him nine years of contributions into his TSP at his retirement. He has elected to contribute 5% of his base pay to his TSP and participates in the C Fund to track the S&P 500 (NYSEARCA:SPY).

With dividends reinvested, the average rate of return since 1924 has been just over 7%, so we will assume he earns 7% a year while contributing to the TSP. The numbers start to get murky here. As his time in the service increases triggering raises, his pay grade increases with his promotions and the annual raises will hit his base pay thus increasing contributions every year.

To keep it simple, we will assume he contributes $4,000 annually or $185.20 of his own check each month and the government chips in $148.16; this figure will remain unchanged for the nine years. His total after nine years would be $48,846.57 inside his TSP which he is now free to transfer to a new employer upon retirement. The government has contributed $16,001.28 over these years as well so his overall retirement compensation at 20 years is now $634,386.

This is pretty close to the REDUX. I will add that it is likely the contributions would be much higher into the TSP and as his base pay increases so does the government match. If he elects to contribute nothing, the government will still throw in 1% of his base pay if he chooses to go with the Blended Plan.

When looking at the three plans, I tend to favor the Blended Plan. Though on the surface it looks like High 36 is the winner based on total compensation at 20 years retired, you are on a fixed income and COLA isn't always going to be dished out. One must consider their earnings potential after the military and if you work after your 20 years, you can also transfer your TSP to your new employer's 401(k) if they offer one and continue to compound on that amount.

Individuals must also take into account what serving beyond 20 years would do to their total. As more time is served, all the plans of course become more increasingly attractive and REDUX looks like the winner based on the 3.5% increase for anything between 20-30 years. On the other hand, they must also consider what would happen if they were not able to make it to 20 years served at which point they would not receive anything under the High 36 or REDUX options but would still walk away with whatever is in their TSP under the Blended Plan.

At this point, the military hasn't begun discussing this with their typical mass briefings and PowerPoint murderfests but I know it is coming. If you or someone you are close to is in the military and will be impacted by this change please get ahead of it. Making a snap decision because of misinformation or no information at all can be costly.

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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.