In 2016’s National Defense Authorization Act, Congress created a new retirement system for our military. The majority of today’s military service members are eligible to remain in the legacy retirement system or opt into the new Blended Retirement system and have the year of 2018 to make a decision. I broke this article into two parts. In the previous post, I clarified eligibility for BRS and detailed each component. In this second part (Coordinating Instructions), I lay out many of the items that service members must consider when choosing to opt into BRS. The objective is to provide a comprehensive overview to help our service members make an informed decision. In the end, though, everyone has a unique situation and needs to weigh their goals and priorities against the benefits and drawbacks of each system.
For those service members who are eligible for both the legacy system and Blended Retirement System, their decision on which option to pick is one of tradeoffs. Here, I’ll discuss many of the considerations in making the selection. This section will also include additional factors for those who do opt into BRS. To start, I must offer one strong recommendation concerning BRS: service members should make their decision by the end of 2017 and make the opt-in selection at the start of 2018. If someone decides to opt-in, they want to start receiving those matching contributions as early as possible, maximizing time on their side.
Tradeoffs When Taking Market Risk
The first, and most important, consideration for opting into BRS is whether or not the service member plans to serve until their 20-year mark. If they don’t intend to serve for 20 years, then they should select BRS; it’s that simple. For those who are unsure about the length of their career, they may want to choose BRS as well. BRS will give them additional flexibility should they decide to transition out of the service at some future point before reaching the 20-year mark; they will still leave with something. For those eligible for BRS who plan to stay for 20 years or longer, much more analysis is involved. A financial advisor could run several scenarios and help someone determine which option will result in more wealth or a greater chance of reaching financial goals. But the trade-off is psychological, as well. Some service members may be more comfortable knowing that their pension will be higher under the legacy system. Others may enjoy the opportunity for more market-based returns in TSP and the additional wealth they may, but also may not, achieve. Other questions present themselves here, too. Does the service member plan to work after retiring from the military? Is the service member more concerned about retirement finances or the possibility of bequeathing more wealth to their children?
Let’s look at one scenario. Suppose a senior O-3 is at the 10-year mark, is already selected for promotion, and plans to stay until the 20-year mark, retiring at the grade of O-5. Assuming this officer makes the full 5% TSP contribution every month with a 2% annual increase in base pay, the TSP account would hold $98,000 in total contributions at the 20-year mark, with $49,000 coming from the DoD. That amount doesn’t even account for investment returns. An 8% return over that period would result in an account value of over $138,000. On the flipside, the investments could lose value as well. I could go into several iterations of scenarios here, but the point is that the decision to opt-in to BRS may not be as simple as the difference in pension payments under each system. Someone willing to accept volatility in investment returns could end up with a significant amount of in-hand personal wealth upon military retirement with the opportunity for continued, compounding investment returns.
Access to TSP Funds
Members of the FIRE (Financial Independence, Retire Early) movement who plan to retire immediately after completing military service must prepare for the fact that their funds inside TSP have the same restrictions as a 401(k) plan. That is, any withdrawals from TSP prior to age 59.5 will have a 10% penalty applied unless withdrawn under the Substantially Equal Periodic Payments (SEPP) exception. SEPP is an exception that allows early access to funds inside retirement accounts by committing to annual withdrawals based on account value and life expectancy. While still having the pension, early retirees won’t have penalty-free access to all of the market gains earned through BRS until well after beginning their military retirement. This factor may cause some to lean toward the higher pension payments of the legacy system should they need the cash flow.
TSP Investment Options
With the move toward DoD contributions to TSP as a portion of retirement funds, service members are subject to more market risk than they were under the legacy system, ignoring outside savings and investments. This change mimics the civilian transition to 401(k)s from pensions that has been going on for decades and creates the need for more financial management on behalf of service members. The default TSP investment is a lifecycle fund based on the service member’s age. This type of fund adjusts its investment mix to become more conservative nearing retirement. But these lifecycle funds are selected based on retirement at a traditional age, not a possible retirement at a much earlier age. Additionally, many lifecycle funds won’t account for the length of expected retirement at any age and may end up being too conservative to meet a service member’s long-term financial needs. Service members also have the option of directly selecting funds in TSP in which to invest, and this option may be better as part of an overall financial plan.
Should you take the lump sum?
As I mentioned in Part 1 of this post, upon entering retirement, service members under BRS will have the option to trade 25% or 50% of their pension payments until age 67 for a lump sum payment at the beginning of retirement. The value of the lump sum offered is based on three primary factors: the retiree’s age, base pay, and discount rate. It will be difficult to plan for an exact lump sum far in advance due to the discount rate varying from year to year, but we can make some estimates. An excellent article on Stripes.com details lump sum payment estimates based on a 7.3% discount rate. Using the report’s analysis, a 20-year E-7 taking the 50% lump sum option would get a $174,454 one-time payment while forgoing monthly payments valued at $488,363 over the next 29 years.
That tradeoff may seem like a bad deal, and I wouldn’t recommend anyone take the lump sum just for spending money; the tradeoff in that case is poor. Should a retiree need the money for something else like paying off debt or funding higher education for their children, then the lump sum may make sense. The cash could be used to start a business, too. Additionally, in the same vein as BRS in general, the lump sum provides an opportunity for retirees to take more market risk to earn investment returns significantly higher than the pension would pay them. A retiree could invest that same $174,454 lump sum in equities; 29 years later it could be worth $945,259 at a conservative 6% compounded return. At 8%, the value would be $1,625,435. Those values are significantly higher than the foregone pension payments, and the retiree could pass the wealth to subsequent generations, whereas a pension cannot.
Taking the lump sum offers incredible wealth generation opportunities for retiring service members under BRS given the right circumstances. The retiree must be in a position to forego the higher pension payments through small cash flow needs or starting a second career. A disciplined investment strategy is a must as well.
I’ve spent most of this article explaining BRS from the perspective of our active duty service members. BRS is an option for our national guard and reserve service members, too. For those who qualify for BRS, the benefits are primarily the same. However, qualifying for retirement is based on completing 20 “good years,” defined as earning 50 retirement points per year, and the pension payments only begin at age 60 even if a person retires earlier. DoD contributions to TSP will be smaller in absolute value unless a person is called to active duty. For many guard or reserve service members who are eligible for both retirement programs, BRS may be of great benefit due to the delay in pension payments until age 60 in both systems.
Some Comments on Continuation Pay
Since I published the first part of my BRS analysis, most services (minus the Air Force) have published their 2018 guidance on continuation pay. All services elected to make the minimum payment options, basically targeting the year groups that will least likely select BRS in the first place. A cynical move? Maybe. For any financial calcualtions regarding the opt-in to BRS, I would only account for a service paying the minimum multiple. That way, any additional benefit is a bonus.
Command and Signal
To wrap up, anyone considering BRS must look at their situation, needs, and goals. BRS provides significant improvements in opportunity and flexibility through continuation pay, matching TSP contributions, and lump sum payments of pension benefits but at the cost of reduced benefit guarantees. Generally, for those who have the option to move to BRS, the opportunities are greater for those who are younger and farther from military retirement.
- If you aren’t sure about remaining in the service until at least the 20-year mark, opt into BRS.
- As a pure math problem, the legacy pension system generally wins out over BRS. Congress didn’t develop this system to spend more money on veterans’ retirement. The breakeven point for selecting BRS, depending on assumptions, trends toward service members who are only a few years into their career.
- BRS increases career flexibility. We’ve all heard the phrase “I’ve done 10, might as well do 20.” Selecting BRS allows service members to change their mind and end their service earlier than originally planned and take some employer provided benefits with them.
- With increased flexibility comes the need to plan and invest diligently. Additionally, regardless of one’s choice, investments beyond the pension and the TSP match rate are critical to achieving one’s goals.
- The official military BRS page: http://militarypay.defense.gov/BlendedRetirement/
- Great article discussing some of the drawbacks of BRS: https://www.stripes.com/blended-retirement-s-lump-sum-feature-is-enticing-but-is-it-fair-1.463389#.Wcl8QkyZOA0
- DoD BRS Calculator: http://militarypay.defense.gov/Calculators/BRS/
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