If you’re currently serving our country in the armed forces either at home or overseas, you do an important job every day keeping our nation safe. This year, you have a decision to make regarding your personal retirement investments.
Beginning January 1, 2018, the military transitioned from the pension system that was previously in place to something called a blended retirement system. We talked to Carlos Perez, a retired Army colonel and chief operating officer of the American Armed Forces Mutual Aid Association (AAFMAA), a nonprofit provider of financial solutions and advice for service members, veterans and their families, about the difference between the systems and the decision that needs to be made by some service members.
WHAT’S HAPPENING WITH VETERAN RETIREMENT PLANS?
Service members who enrolled in the armed forces on or after January 1 of this year have been automatically enrolled in a new retirement system for veterans called “blended retirement.”
We’ll get into this more below, but it’s blended because it combines the traditional defined benefit pension system with something more typically seen in a 401(k) or another corporate retirement plan.
Service members serving prior to January 1 are grandfathered into the old defined-benefit pension system. Those with 12 or more years of service must remain in that system.
If you have less than 12 years of service, you have a decision to make, and it has to be made prior to December 31 of this year. Do you switch to the new blended retirement system or not?
UNDERSTANDING THE ALTERNATIVES
If you choose not to make a decision one way or the other, you’ll end up in the old defined-benefit pension system. But if you want to decide your destiny, you should know the pros and cons of each system. Before we get to the new one, let’s discuss where we’ve been.
The Legacy Retirement System
We’ll start with what the VA refers to as the legacy retirement because it’s the easiest to explain.
Under the legacy system, if you entered after August 1986, you do have some options, but under one popular option, you would get 2.5% of your base pay for every year of active duty you have up to 30 years as a yearly pension in retirement. How your base pay is determined depends on a decision you make as to how you want things calculated at the time. You can choose to have your base pay calculated at a lower rate in exchange for a bonus after your 15th year in service. There is a good breakdown here of how this works.
The important thing to remember is that under the old system, you don’t get anything unless you stay in the service for 20 years as an active-duty service member. The requirements for the reserves are slightly different and beyond the scope of this article, but it comes out to the equivalent of 20 years of service.
So who is this option right for?
“If you’re in the service and you know without a doubt that you want to serve 20 years until retirement,” said Perez, “what we find, based on some of the calculators that are out there, is that, from a purely financial perspective, the legacy system tends to pay you more over the course of your lifetime.”
The Blended Retirement System
With blended retirement, Congress hoped to solve for two issues with the old system.
“Most service members don’t serve for 20 years,” Perez said. “[And] just like other parts of the economy, a defined-benefit program like what the military had for its retirement was growing increasingly costly.”
In order to solve these problems, they came up with blended retirement, which combines some elements of a 401(k) with a slightly smaller defined benefit.
Under the new system, those on active duty have their retirement savings put in the Thrift Savings Plan (TSP). Service members can choose to invest in government bonds, corporate or mortgage bonds, certain funds tied to national or international stocks, or a combination of these options that will be managed for risk depending on how close the service member is to retirement.
Service members can contribute their own funds and have them matched up to 4% by the service. In addition to the 4% match, the service will contribute the equivalent of 1% of the service member’s base pay to their retirement funds. This isn’t taken out of their base pay.
The service member gets the 1% matching funds from their retirement after they’ve been in the service for at least two years. If the service member leaves the service prior to the two-year mark, they still get access to anything they’ve personally contributed.
Enrolled service members may be eligible for a one-time continuation pay bonus after the eighth year of service in exchange for signing up for four more years of service. It’s a lump-sum payment in the amount of 2.5 to 13 times the base pay of the service member, depending on the need for the specific specialty in their branch of service. If you’re in the reserves, it’s anywhere from 0.5 to six times your base pay.
Finally, if you stay in the service for over 20 years, under the blended system, you get 2% of your base pay per year of service up to 30 years.
This means that if you retire at 20 years, 40% of your base pay becomes your pension. At 30 years, you would get a 60% pension. This is compared to 50% and 75% under the old system. But you do get your other investment dollars from the TSP.
Although Perez says the math will probably work out that you get more money by staying under the old system if you stay in for 20 years or more, it does depend on the performance of your investments, which will be different depending on the funds you choose.
There’s also one more huge advantage of the blended system: You get something if you retire before the 20-year mark. If you choose to stay under the legacy system, that’s not the case.
If you’d like to run your own numbers, the VA does have a calculator you can check out.
As a reminder, you have until December 31 to make a decision on your military retirement plan. Hopefully, this has helped give you the basics you need to make a decision. Just remember that money is only one component of solid retirement planning.