MILITARY UPDATE
Switching retirement plans can cut benefits by more than $300,000
By Tom Philpott
Career counselors advise against it. Financial experts say it's a poor deal. Economists estimate that a typical enlisted member with 20 years of service will cut the lifetime value of his or her retirement by $309,000.
Yet about half of military careerists, as they enter their 15th year of service, have been drawn to a $30,000 cash bonus and voluntarily trade away a far more valuable slice of future retirement benefits.
They do so by electing to shift retirement plans, from High-3 to the less generous Redux formula with its side offer of instant cash.
If a business scammed military people this way, Congress would hold hearings and force executives to end their sting operation. But it was Congress that designed this scheme. And considering the goal to save billions of dollars that otherwise would go to a new generation of retirees — the scheme is brilliant.
Most pay experts can't say enough bad things about Redux and the Career Status Bonus (CSB). Military leaders are more constrained. After all, the honey trap is legal. Also, for many careerists, the typical $22,000 (after taxes) is so timely for buying a home or paying off crushing debt, that it just feels right. There often are better alternatives, however.
Congress devised CSB, while doing a great favor for the same service members it entices, those who entered after July 31, 1986. These members got stuck under Redux, a cheaper retirement plan passed during the Reagan administration. By 1999, fearing lesser benefits would cause retention and morale problems, Congress moved these members, and future entrants, under High-3, a far more generous plan.
For a 20-year career, High-3 pays an annuity equal to 50 percent of average basic pay over the member's three highest earning years. Redux pays only 40 percent of the three year average after 20 years service.
High-3 protects annuities with annual cost-of-living adjustments that match inflation. Redux COLAs are a full percentage point below inflation with a one-time catch up at age 62 but then COLA caps resume.
Worried about the cost of shifting all future retirees to High-3, Congress borrowed an incentive idea used successfully in the post-Cold War drawdown. It would offer former Redux careerists, in their 15th year of service, a cash bonus payable immediately to shift back to Redux.
The Defense Department set up a Web site to explain plan features and show the differences in lifetime benefits. Calculators there allow comparison of early and lifetime benefits under both plans, by plugging in assumptions about inflation and return on investment (www.dod.mil/militarypay/retirement.)
The Center for Naval Analyses recently updated its report, The Retirement Choice, which all but tells careerists not to accept the Redux/CSB offer. An E-7 who retired at age 38 would see retired pay reduced by $309,000 under Redux, even with the bonus, CNA said. An O-6 who retired at 50 after 26 years would lose almost $312,000.
"We're hopeful that, by providing information on how much this cash-out will cost in smaller, future retirement income, we can help service members make more informed decisions about which plan to select," the report said.
CNA suggested the $30,000 be viewed as a kind of nightmare loan, far more damaging to fiscal health than a mortgage, car loan or even credit card debt.
"The $30,000 has a rather peculiar payback scheme," the report said. "The service member pays nothing until retirement, pays quite a bit from the beginning of retirement until age 62, and then continues to pay back smaller amounts over the rest of his or her lifetime."
Despite all the warnings, $30,000 remains a powerful lure.
From July 2001 through December 2003, almost 11,000 Air Force members entered their 15th year of service under High-3. Sixty-percent of them came out with cash but stuck under Redux. The "take rate" has been 63 percent for Air Force enlisted, 33 percent for officers.
Forty-five percent of sailors and 12 percent of Navy officers have shifted to Redux. The Marine Corps take rate has been 20 percent for officers, 43 percent enlisted. A third of eligible Coast Guard members are electing Redux and the bonus. Army data were not available.
Officers electing CSB more often want to invest it, believing they can get returns to make up for lower annuities. But that's not an easy thing to do.
Questions, comments and suggestions are welcomed. Write to Military Update, P.O. Box 231111, Centreville, VA 20120-1111, or send e-mail to: milupdate@aol.com. Or visit Tom Philpott's Web site.
