If the military’s new Blended Retirement System (BRS) lump sum option confuses you, you’re among friends. I get a lot of questions from members asking if taking the lump sum is a good deal. Before we go there, let’s talk about what the lump sum option is — and how it’s calculated.
With the lump sum option, the retiring military member can elect to receive a smaller monthly pension — reduced by either 25% or 50% — in exchange for a cash payment. This reduced pension returns to 100% at the normal Social Security retirement age: Today that’s 67.
The Department of Defense uses what’s called a “discount rate” to calculate the lump sum amount. That rate changes from year to year, depending on factors like inflation and interest rates. For 2018, the discount rate is around 6.99%. While a 6.99% discount rate may not sound like a lot, it’s quite a bit higher than the discount rate civilian corporations are legally required to use when they calculate lump sum payouts. And while bigger is normally better in the world of personal finance, a higher discount rate means a smaller lump sum payout.
To better grasp this topic, let’s look at three estimated numbers:
- The cumulative value of the pension pay you forfeit if you take the lump sum.
- The approximate BRS lump sum value using the current DOD personal discount rate.
- The approximate BRS lump sum value using the civilian corporation discount rate.
The charts below show estimated numbers for an active duty and Guard/Reserve O-5 and E-7, calculated as if they were retiring at 20 years of service under BRS on January 1, 2018.
To better understand these numbers, let’s look at Sally, an active-duty E-7 retiring under BRS. If Sally chooses the 25% lump sum option, she would receive a cash payment of around $62,000, and her monthly military retirement check would be reduced by 25% or $430/month. If we assume a 2.75% cost-of-living adjustment, Sally is giving up a total of over $200,000 in income between age 41 (the age she retires from the military) and 67 (the age her pension is restored to 100%) in exchange for that lump sum payment. That equates to a loss of more than $138,000 over the 26-year period.
Now, let’s compare what the military is providing in a lump sum ($62,000) versus what they would have to provide if they used the same discount rate a civilian corporation is required to use ($122,000). That’s nearly 50% less, which is a big deal.
Looking at the Guard/Reserve numbers, you quickly notice the difference between “lump sum” and “pension payments forfeited” is much smaller than for their active-duty counterparts. The reason? Active-duty retirees receive their monthly pension upon military retirement, while most Guard/Reserve members must wait until age 60. Therefore, a Guard/Reserve pension would only be reduced 25% or 50% for seven years before returning to 100%, while an active-duty pension could be reduced for 25-plus years, depending on age at military retirement.
Now that we are done with today’s math lesson, let’s look at the #1 key takeaway:
However, each person should carefully analyze his or her own financial situation before deciding. For example, if you are preparing to launch a business, a cash influx of $62,000 might enable you to get started, while having an extra $430/month in your military pension might not accomplish the same goal.
Of course, there are other factors to consider as you ponder taking the lump sum. Taxes could significantly reduce what is ultimately available for you to use, and the decision to take a lump sum could affect your VA benefits. I’ll explore those issues in more detail later.
Need to know if BRS is right for you? Visit Usaa.com/BRS and run our Military Retirement Comparison Tool.
The Department of Defense will release more details of the plan before 2018. Details of the plan are subject to change pending National Defense Authorization Act (NDAA) approval.
Information is accurate as of January 2017 and is intended for use by USAA, its members, and prospects.
The contents of this document are not intended to be, and are not, legal or tax advice. The applicable tax law is complex, the penalties for non-compliance are severe, and the applicable tax law of your state may differ from federal tax law. Therefore, you should consult your tax and legal advisers regarding your specific situation.
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