We are probably all aware that military members have some great benefits provided to them, including health, retirement and education support. However, there are some big changes coming to the military retirement system starting the first of the year that will affect almost all personnel currently serving.
Currently most military members are under the “High 36” system if you entered on or after September 8, 1980 or August 1, 1986 and did not elect to receive the career status bonus. The way this retirement benefit is calculated is very straight forward: 2.5% multiplied by the number of years of service. If you have 25 years of service and are in the high-36 system, you would receive 62.5% of the average of your three highest earning years. If you retired making an average of $100,000 for your high 3, your pension benefit would be $62,500 per year. You do have the Thrift Savings Plan available to you, but the money you contribute is unmatched and entirely up to you to manage and allocate. Under this system you may be better off searching for an outside investment manager to help.
Starting in 2018 there will be a new “Blended” retirement system. The new system will bring the military retirement more in line with FERS retirement, civilian 401(k) programs and those that have matching funds for retirement defined contribution plans. Let’s cover the main changes.
1) Matching TSP up to 5%
Starting the first of the year all service members who select the new plan will have up to 5% of their base pay matched dollar for dollar each year they serve. The match will become effective on or after the 3rd year of service. The match is effective up to 5%–if you contribute less, you will receive less of a match. So in other words, 3% contribution receives a 3% match. The match starts on January 1st of the year you are in, so make sure your allocation is where you want it prior to the beginning of the new year.
2) Now the bad news.
The new plan comes at a cost. The basic reasoning for adopting the new plan is to cut down on the retirement costs for pension funding of retirees. If you opt in for the blended retirement rather than having a multiplier of 2.5%, you will be reduced to 2% multiplied by your years of service. The other catch is that the match ends after 26 years of service. This can be a big downfall for those salty “lifers” who want to remain in the military longer than 26 years. In this instance, after the 26th year, you would not be receiving a match but would still have the reduced multiplier of 2%.
3) Where can the match go?
The matching contributions are pre-tax monies and can only be applied to the traditional TSP, not the Roth account. This is by law, not choice so unfortunately, there is no clever way around it.
4) You now get an automatic contribution.
If you are currently serving in the armed forces and opt into the new plan or join next year, you will receive an automatic 1% of your base pay contribution. For new members, this benefit will become effective after 60 days of service and you will be vested after 2 years. As long as you serve 2 years successfully, you are able to move your entire TSP account with you to a new plan or outside account in the event you do not extend your tour or make a career of it.
5) Who needs to be concerned with the new plan?
If you have 12 years or more of service there is nothing for you to do; you will be grandfathered in to the old “High-36” system. There are a few exceptions such as a break in service or a case-by-case basis, but for the vast majority, you will stay where you are at. If you have under 12 years of service, you have a choice to make. You can stay with the old plan or go with the new one.
Let’s look at an example:
Joe has 10 years of service with a high 3 of $88,000. He wants to serve 20 years and retire. If his high 3 moves to $94,000 by the 20-year mark, he would be looking at a pension benefit of $47,000.
If Joe decides to move to the blended system and contributes 5% that is matched for the next 10 years, that would be roughly $90,000 of contributions into his TSP. At a rate of return of 5%, Joe would have a little over $113,000. Obviously, bull and bear markets, corrections and investment choices would all have an impact on this amount. Joe’s pension payment would then be $37,600 per year with the reduced multiplier. Joe would also have the $113,000 in the TSP to re-invest, annuitize or draw from depending on his age.
It is important to note that should you choose the blended plan, there are no backdated TSP contributions, and the entire service time is subject to the reduced multiplier, not just the time under the new system.
Retirement is complicated and your benefits are an integral part of your later years in life. If you are investment savvy and like numbers, great! You probably have this covered. But for the other 95% of people who aren’t CPAs, it would be beneficial to consult with a financial professional who is a licensed fiduciary and obligated to take your best interests in mind. Before making the jump to a new system ask yourself, “how will I benefit from this change” and put pen to paper to work the numbers out.