Changes to Military Retirement - An Overview

On November 25th, President Obama signed Defense Authorization Act for 2016. With it comes long anticipated changes to the military retirement system. Over the next several weeks, I’ll dive into some of the details of the changes and how it will affect the financial decision-making of active duty and their families.

First things first, let’s address 8 basic questions to summarize the changes. Please note, this is not a complete breakdown of every detail but just a broad overview of the changes.

1.       What is the main change that was made?

  • The military is shifting the retirement system to be less centered around a pension that was only offered to those who serve at least 20 years and more around 401k style contributions similar to private sector employers.

2.       Why was this change made? Is this just taking away benefits from our troops?

  • While budget reasons certainly play a role in the change, I do think the main reason is to be more equitable in offering retirement benefits to more troops. Since only about 1 in 5 service members make it to 20 years, most were separating from service with no retirement benefits. The changes will allow them to walk away with government funded contributions to a retirement account (Thrift Savings Plan). From a budget standpoint, this shifts more personnel costs into the year they are incurred as opposed to far into the future.

3.       So are they doing away with pensions altogether?

  • No! There will still be a pension for those who serve at least 20 years. It will just be less than it is currently. For example, someone in the new system would receive a pension equivalent to 40% of their base pay at 20 years as opposed to the current amount of 50%.

4.       That doesn’t seem so bad, or is it?

  • It actually surprised me that the reduction in the pension wasn’t more. There is still a strong incentive to stay until 20 years. But over a lifetime, that small reduction adds up to a very large amount of money.

5.       So how is this going to affect retention of our best and brightest?

  • There will be less of an incentive to stay until 20 years but don’t doubt the Pentagon’s ability to find other ways to make adjustments. There have long been retention bonuses based upon in-demand fields and I would expect those to continue and even become more prominent. But for someone set on getting out after a few years on active duty, they will walk away with a government funded retirement benefit that up until this point they didn’t have.

6.       I’m on active duty now. Does this affect me?

  • The short answer is yes and no. No one on active duty will be required to switch to the new system. If you entered service on or after 1/1/06, you will have the option to switch or stay on the old plan. If you entered before that, you will stay on the old plan with a full pension at 20 years with increases for time beyond that.

7.       When would I have to decide?

  • The window to make the change is the calendar year of 2018. So, you have time. But knowing your options could affect your personal and professional plans.

8.       How do I know if I should switch to the new system or stay put?

  • The short answer is: it depends. We’ll dive into more details on this in future posts. Running some preliminary numbers, it looks as if it will virtually always be a better deal to stay on the old plan if you end up serving 20 years. If you are set on separating prior to the 20 year mark, you would likely be better off on the new plan because then you could at least take the government contributions to your TSP account with you (subject to vesting rules). But for many, perhaps you’re unsure if you’ll stay 20 years or not. Then it will come down to what the exact numbers are for your personal situation.