$30,000 Bonus Cuts Military Retirement By $300,000
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, ironically, 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 first group eligible to make the choice entered their decision window in 2001 and most began taking the cash. The Defense Department set up a website to explain plan features and show the dramatic 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 (see www.dod.mil/militarypay/retirement).
The Center for Naval Analyses recently updated its report, “The Retirement Choice,” which all but tells 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.”
CNA suggested that 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.
In the winter issue of “On Watch” magazine, published by the Fleet Reserve Assocation (www.fra.org), Frank Welch, Master Chief Petty Officer of the Coast Guard, said Redux should be renamed “Reduces.” Careerists, he said, need to “do the math.”
The $30,000 is enticing particularly for grades E-5 and E-6 who feel they need the money now for a home, education or to pay off debt.
“They are more concerned about today than tomorrow,” said a pay official.
Officers electing CSB more often want to invest it, believing they can get returns to make up for lower annuities. That’s a significant challenge.
More than 95 percent of bonus takers order a lump sum. Two- to five-year installments also are available to reduce the tax bite or to allow more effective use of tax-deferred options like a Thrift Saving Plan. The TSP for federal civilians has been open to military savers since 2002.
If accepted while the service member is in a combat zone, this and other bonus money is tax-exempt. Even so, said an official who advises on the retirement choice, Redux/CSB usually is the option to avoid.
“You can only tell people, ‘This is not a good deal,'” said a Pentagon pay official. “If they still choose it, well, [in their mind] they’re better off.”
Military Retirement Systems
Three different retirement systems are in effect, depending on the date when you first became a member of the military.
Final Pay System
- Applies to members who first entered active duty before September 8, 1980.
- To calculate retired pay, multiply years of service by 2.5 percent (cannot exceed 75 percent). Multiply the result by your final base pay. Allowances for housing, subsistence or other special pays are not included in any retired pay calculation.
- Under this system, members retiring at 20 years receive 50 percent of their base pay. The amount increases with years of service up to a maximum of 75 percent of base pay for those retiring at 30 or more years.
High-3 Retirement System
- Applies to members who first entered active duty on or after September 8, 1980, but before August 1, 1986.
- Multiply years of service by 2.5 percent, which equals 50 percent at 20 years and 75 percent at 30 years, the same as in the Final Pay System.
- Multiply the result by the average base pay for the highest 36 months of the member’s career, which typically but not always will be the final three years of service.
This is a three-phased retirement program designed to encourage members to remain on active duty past 20 years of service. Although it results in reduced retirement pay, it includes a $30,000 Career Status Bonus at the fifteenth year of active duty.
- Applies to members who first entered active duty on or after August 1, 1986.
- At the fifteenth year of service, these members have two options:
- Take the pre-1986 High-3 Retirement System
- Receive a one-time lump sum Career Status Bonus and have their retired pay calculated under the new System.
If the member chooses the CSB/REDUX option, two levels of multipliers are used to calculate retired pay:
- Each of the first 20 years of service is worth 2.0 percent.
- Each year from 20 to 30 years of service is worth 3.5 percent.
A person retiring at 20 years, for example, will receive only 40 percent of base pay in retirement. But the longer the member remains on active duty, the higher the multiple, until retired pay at 30 years equals 75 percent of base pay, the same as under High-3.
By Tom Philpott