03-13-2017 07:40 AM
Content provided courtesy of USAA.
By J.J. Montanaro
There are some big changes coming to military retirement planning.
The 2016 Defense Authorization Act will transform the military’s traditional, 20-year retirement system to a new blended system. The blend mixes the old — a defined pension — with the new — a new Defense Department matching contribution to the military’s version of a 401(k), the Thrift Savings Plan.
What does that mean? Service members will need to take a more active role in deciding how they finance their retirement, and those in the gap between the old and new plans have to decide which plan suits them better.
No sooner than the ink had dried on my first pass at this article and the DoD had already proposed changes to three of the four components of the new system. The blended plan begins in 2018 and, as of now, will feature these changes:
- Retirement pay (pension). Service members will be eligible for a retirement benefit after 20 years of service. Smaller than the current benefit, it will be calculated using a 2% multiplier instead of the current 2.5%. (Multiply your years of service by 2%. That number is the percentage of your High-36 average base pay that you’ll receive in retirement).
- Matching contributions. Service members will receive an automatic 1% Defense Department contribution to their Thrift Savings Plan after 60 days of service. At the beginning of their third year of service, service members who contribute at least 5% on their own will receive up to 4% in matching TSP contributions.
- Continuation pay. After 12 years in the military, service members will receive continuation pay if they commit to serving four more years. This one-time retention bonus will be worth at least two and a half months of basic pay for active-duty personnel and at least half a month’s basic pay for reservists. The amount could be higher for in-demand positions.
- Partial lump-sum option. Retirees can choose to receive a full retirement annuity each month, or they may be able to opt for a smaller pension along with a lump sum payment. Details are still being worked out, so it’s unclear how this will be calculated and what this would mean from a tax standpoint.
With any change, there are positives and negatives.
The positive: The new plan will benefit a lot more service members. The overhaul aims to provide some retirement funding to about 85% of service members. Plus, the design should encourage service members to save for retirement on their own since they’ll need to make a personal contribution of 5% to get the full match. Being better prepared for retirement is always a positive.
The negative: Retirees will probably get less. Under the new system, that could equate to a six figure difference over their lifetime. That’s based on someone entering the service in 2016, opting for the new system, receiving the minimum continuation payment and serving 20 years. However, it’s worth noting that today less than 20% serve long enough to qualify for full military retirement.
The new plan doesn’t take effect for two years, so what should you do now?
If you entered the military before 2006: Carry on. You’re locked into the current retirement plan.
If you’re entering service in 2018 or later: You automatically fall under the new plan. Make sure you contribute enough to your TSP to get the match and put in more if you can.
If you entered between 2006 and 2017: You’ll have a choice to make in 2018 — the old plan or the new one. Crunch the numbers and consult your financial advisor. If you’re committed to and anticipate serving at least 20 years, opting to stay in the old system may make sense. If you’re uncertain about your plans in the military or have only served a few years, the new blended plan could be best.