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Trade-Offs in Military's Restructured Retirement Plan

The portability of the new system is a plus, but it's not a fit for everyone.

My article about the Thrift Savings Plan for government workers focused on the investment lineup; I noted a few spots where the otherwise-excellent plan could improve.

What the article didn't discuss is that big changes are already afoot in the retirement plan system for some military personnel--not on the investment front, but with the basic framework of the plan. Active-duty military personnel who joined after Jan. 1, 2018, will be automatically enrolled in the Blended Retirement System, or BRS. That system combines the existing retirement program, which allows military personnel who retire after 20 years of service to receive a lifetime annuity, with the Thrift Savings Plan, or TSP--a 401(k) equivalent for government workers. In essence, the BRS is a pension/401(k) plan hybrid.

The change has the biggest implications for service members who entered the military after Jan. 1, 2018; for such individuals, the BRS is the only retirement plan on offer. Meanwhile, all military personnel who were serving as of the end of 2017 will be grandfathered into the legacy system. However, military personnel who started before 2018 but have served fewer than 12 years will have the option to choose between the legacy pension system and the BRS by the end of 2018.

Blended Plan Features Trade-Offs To understand the BRS, it's worthwhile to take a look at the military's legacy retirement pension plan as well as the TSP, because BRS melds the two.

Under the legacy retirement system, military personnel who have served 20 years receive an annuity in retirement; the percentage of salary received is calculated by taking the average of the service member's highest consecutive 36 months of basic pay times 2.5% times his or her years of service. Using this formula, someone who has served 20 years is eligible for an annuity payment equal to 50% of his or her peak salary.

The TSP, on the other hand, is a 401(k)-type plan. Participants make their own contributions and, in the case of the BRS, the government steers additional contributions into the account. (The higher participant contribution, the higher the matching contributions.) Participants can make their own investment elections. TSP participants can also choose whether they'd like to make pretax (traditional) contributions or Roth contributions; assets in traditional accounts enjoy tax-deferred compounding but are taxed upon withdrawal, whereas Roth assets are tax-free upon withdrawal in retirement.

The BRS brings together the two types of plans: Personnel covered by the BRS will be able to invest in the TSP and receive matching contributions; they'll also receive lifetime annuity payments in retirement, provided they serve 20 years.

So what's the catch? The BRS ratchets down the benefit received under the legacy plan by tweaking the formula. Whereas the legacy formula to determine an annuity benefit takes the average of the service member's highest 36 months of basic pay times 2.5% times the years of service, annuity payments under the BRS are determined by taking the average of the service member's highest 36 months of basic pay times 2% times his or her years of service. That's a 20% reduction, and means that the largest annuity benefit available through the BRS is equal to 40% of an individual's peak salary, down from 50% under the legacy plan.

To help offset the reduction in the annuity benefit associated with the BRS, the government will begin contributing 1% of pay to the TSP accounts of military personnel after 60 days of enrollment; that 1% contribution is available whether or not BRS participants make their own contributions. Matching contributions of up to 4% of pay--in addition to the 1% automatic contribution--are also available after two years of service. At the high end, military personnel can steer 10% of their pay into the TSP per year--their 1% automatic contribution, their own 5% contribution, and a 4% match available to individuals contributing at the 5% level. (Military service members covered by the legacy retirement plan can contribute to the TSP, too, but they don't receive matching contributions.)

Another feature of the BRS is that those covered by the program will be eligible for continuation pay--a onetime midcareer cash bonus for military personnel who have served between eight and 12 years and agree to serve an additional three years. (Here are some frequently asked questions and answers about continuation pay.)

Portability an Advantage At first blush, the BRS appears designed to reduce the government's outlay for retirement benefits. Just as many private firms have switched workers over to 401(k) plans and away from pensions as a way to cut costs, the BRS has the potential to move some of the onus for funding retirement from the employer (in this case, the U.S. government) to employees.

But a great motivating factor behind the change is that many military personnel walk away with no retirement benefits because they don't remain in the service for the required 20 years to earn a lifetime annuity under the legacy plan. According to U.S. Department of Defense data, only 19% of active-duty military personnel and 14% of reservists remain in the military long enough to qualify to receive annuity retirement benefits from their service. The TSP, on the other hand, is portable; those who leave military service before 20 years still own their assets (subject to vesting requirements).

How to Choose For military personnel who have served longer than 12 years, the introduction of the BRS is a nonevent; they'll be grandfathered into the legacy pension plan, and they can also contribute to the TSP, albeit without the matching scheme of the BRS. At the other end of the spectrum, new military personnel will automatically be opted into the BRS.

The cohort that needs to make a decision is military personnel who aren't newly enlisted but have served fewer than 12 years; they'll have to decide whether to stick with the legacy system, which promises a higher annuity benefit, provided they stay in the military for 20 years, or opt into the BRS, which lowers the annuity benefit but provides portability and the potential for market-related growth.

Here are some of the key factors that should factor into the decision-making.

Remaining Time in the Military: By far the biggest swing factor in whether to stick with the legacy plan or enroll in the BRS is expected time in the military. Those who expect to stick it out the full 20 years should give serious consideration to the legacy system, while the BRS is a no-brainer for those who expect to leave prior to 20 years fo service, in that it ensures they won't leave empty-handed.

Savings Rate: Personnel who are able to kick in their own contributions at a higher rate receive higher matching contributions and are better able to harness market appreciation to their advantage. Higher contributions to the TSP--and an enlarged balance down the line--help offset the reduction in the annuity income that comes along with BRS versus the legacy plan. Of course, higher contributions also mean a reduction in current spending. Military personnel whose budgets don't allow a penny to spare will obviously benefit less from the TSP feature of the BRS, though it's hard to find a more painless way to save than pretax contributions deducted directly from payroll.

Asset Allocation of TSP Assets: Expected investment mix in the TSP also plays a role; TSP investors who are able to tolerate a more aggressive, stock-heavy investment mix are apt to amass a higher account value over a long time frame (say, 10 years or longer) than those who stick with a more timid asset mix.

Presence of Other Lifetime Income Sources: The trade-off of opting into the BRS is a reduced lifetime annuity benefit. Military personnel who will have significant lifetime benefits other than their military pensions--such as a pension from another job and/or Social Security--have less to lose from opting for the BRS than is the case for personnel who will rely heavily on their military pension for lifetime income.

To help guide decision-making using hard numbers and a service member's own data, the Department of Defense has developed a Blended Retirement Comparison Calculator. The tool factors in an individual's expected years of service, grade, expected retirement date, expected TSP contribution, and longevity, among other factors, to depict when TSP savings amassed via the BRS beats the legacy retirement system.

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