FINANCIAL PLANNING FOR MILITARY RETIREMENT IN NORTHERN COLORADO:

The New Military Retirement System

Whether you are from Loveland, Fort Collins, Berthoud, or Anytown USA, if you or a family member are active duty military or are planning to enlist in the Armed Forces, this post is for you.

This article details the major changes that become effective for active duty military members who begin their service on January 1, 2018 and beyond. I also discuss the options that the current service members will have in 2018 and review some of the factors involved in making wise choices.

For example, a service member retiring after 20 years of active duty service would immediately begin receiving retirement income of 50 percent of their “high three” salary. Under the new program, the 2.5 percent is reduced to 2 percent. Therefore, under the new system, a service member with 20 years of active duty service will receive a retirement pay of 40 percent of their “high three” salary as opposed to the current 50 percent. A service member with 25 years of service will receive 50 percent of their “high three” as opposed to the current 62.5 percent and a service member with 30 years of service will receive 60 percent of their “high three” as opposed to the current 75 percent.

In exchange for the lower benefit structure, the new hybrid system will at least partially offset the resulting shortfalls with matching contributions to the service member’s Federal Thrift Savings Plan (TSP) account. Service members who enter military service in 2018 and after will receive a 1 percent non-elective (meaning it is provided regardless of whether or not the service member elects to contribute a portion of their salary into their TSP account) contribution of their base pay after 60 days of active duty service. In addition to the non-elective contribution, the Department of Defense will match up to 4 percent of a service member’s salary deferral contribution for those who have completed at least two years of service – for a total contribution by the DoD of 5 percent of the service member’s pay.

To bolster participation, the new program utilizes auto enrollment, an employer-based retirement plan default that has grown in popularity over the past 10 years. After completing two years of service, 3 percent of a service member’s base pay is automatically contributed to their TSP account. Of course, participants can elect to opt out of the automatic enrollment, leave the contribution percentage as is, or elect to contribute a higher percentage of their salary.

Under the new hybrid system, 20 years of service is still required in order to be eligible for the defined benefit plan, but anyone with at least two years of service will become vested in the DoD’s contributions to their TSP account (many 401k plans vest the employer contributions over a six-year period). Since 83 percent of active duty military personnel do not serve the requisite 20 years required to receive the monthly defined benefit income, this new retirement pay system significantly broadens the base of beneficiaries.

An additional aspect of the new retirement pay system is a continuation bonus that is received at the 12-year mark of an active duty service member’s military career. The bonus is based on the service member’s specific skill set (AFSC, MOS) and the demand for that skill set at the time of reenlistment. They can receive the bonus by reenlisting for four additional years of active duty service. The bonus ranges anywhere from 2 ½  months to 15 ½ months of their base pay distributed in either a single lump sum or in annual payments stretched out over a period of four years. For those who do not fulfill their term of reenlistment service, the bonus is withdrawn.

The Dates That This New Program Becomes Effective and the Service Members It Impacts

1.  Those entering military service on January 1, 2018 or later will automatically enter the new retirement pay system.
2. Service members who have over 12 years of service as of January 1, 2018 will remain in the old defined benefit retirement pay system.
3. Those with between 0 and 12 years of service as of January 1, 2018 will be the only active duty service members who get to choose which system they will enroll in.

A critical decision awaits the third category of service members. If they plan to serve for at least 20 years, the old 100% defined benefit system is probably their best choice (although each service member should consider their personal circumstances and financial world before making the decision). Given the opportunity to receive up to a 5% match in their TSP accounts, those active duty service members who don’t plan to serve at least 20 years will be better off opting for the new program.

This change to the military retirement system means that service members who are unsure of whether or not they will complete 20 years of service (as is the case with most young recruits) will have to make an informed guess. Since the majority of those active duty service members with less than five years of service are unlikely to serve at least 20 years, they’re better off opting for the new retirement system. The group that will likely have the toughest time determining the potential length of their active duty military service are those who have already completed five to eight years of service. This group is engaged in their second term of commitment but have yet to reach the “10-year hump”, that point in their military career where there’s less time remaining until retirement than back to their initial enlistment. Service members with 9 to 12 years of active duty service are the group most likely to stay for the full 20 and will likely elect to stay in the old 100% defined benefit system. Regardless of the group, each service member should evaluate their retirement income needs prior to making an election.

As was the case when US companies began transitioning away from defined benefit plans to defined contribution plans, these changes will place a tremendous amount of new responsibility on active duty military personnel as their retirement income security becomes far more dependent upon them and less on their employer.

For active duty military personnel, sound financial planning and coaching is essential as they assess their financial world, understand their retirement goals, design plans to align their finances with their goals, and then implement those plans.

Source – The American College of Financial Services

Looking for help with financial planning for military retirement in Northern Colorado? Connect with Tomassi Financial Planning today.