New military retirement lump sum payout option: What you need to know

The military retirement system has long been considered one of the best retirement offerings around. Unlike most of us who “hope” to retire in our 60s, after 20 years of service, military personnel are entitled to their pensions, which means they could be collecting their benefits before they reach the age of 40.

The Defense Department says the lump sum feature of the new Blended Retirement System (BRS) offers service members more financial choices at retirement, but according to analysis of the program by financial planning firm First Command Financial Services, those who sign up for the cash buyout may pay a high price.

Scott Spiker, CEO and chairman of the Board for First Command Financial Services, discussed with FOX Business the new Blended Retirement System and his firm’s analysis regarding the lump sum payout option.

Boomer: What are the requirements for military personnel to be eligible for retirement?

Spiker: Under the current system, a service member reaching at least 20 years of service is eligible for retirement pay. That pay is arrived at by calculating their average pay from their three highest paying years of service (typically the most recent three) and applying a multiplier of 2.5% for each year served. A person serving 20 years receives 50% (2.5% times 20) of their “high three” average monthly pay. That pay begins immediately upon retirement and lasts for life, with annual cost of living increases.

BRS takes that system and slashes the multiplier from 2.5% to 2.0%, resulting in a huge 20% reduction in the multiplier and subsequent annuity.

The reduction in annuity is replaced with two components: First, automatic and matching contributions to the Thrift Savings Plan (TSP), a defined contribution plan for federal employees and the military offered by the federal government. To earn the full TSP match, service members must contribute 5% of their pay. And second, a continuation bonus to be awarded between the eighth and 12th year of service. The continuation bonus (intended to manage retention) will be 2.5 or more months of pay.

Proponents praise the new program as a valuable benefit that will give our men and women in uniform new opportunities to control their own financial futures. For those who don’t stay long enough to earn the traditional retirement pension (generally 20 years), BRS looks like a fair trade. It will put new dollars in the pockets of service members who today leave the military with no retirement benefits. But for the next generation of 20-year career military families, BRS trades good things for risks that could turn out bad.

Boomer: What is the lump sum feature of the new Blended Retirement System?

Spiker: The lump sum feature of the new Blended Retirement System is a cash buyout of the traditional pension. It offers retiring service members the opportunity to receive upfront dollars by forfeiting an additional portion of their working-age retirement pay (either 25% or 50% of the monthly payment). In other words, their remaining annuity payment would either be 30% or 20% of their “high three” average pay, respectively.

Boomer: How will the lump sum payouts be determined?

Spiker: Retirees can choose to take the lump sum as a single payment or in four equal annual installments. Either way, their monthly retired pay will remain at the reduced level until age 67 and then returns to the full amount. Lump sum amounts will be determined using the Government Discount Rate, which is an annually approved rate that is currently 6.99%.

Boomer: What is the negative side of taking the lump sum payout? The positive?

Spiker: Based  on a detailed analysis of the future finances of two hypothetical career military members (one enlisted, one officer) who retire at age 42, First Command projects that lump sum amounts calculated at the 6.99% Government Discount Rate would total less than half of all the monthly payments forfeited over a 25-year period.

For the hypothetical officer example, First Command based its projections on a pay grade of O-5, an assumed retired pay of $3,410 per month and annual cost of living adjustments of 3%. The 25% option produces a lump sum of $157,250. That’s a significant benefit. It is the positive side of taking the payout. However, it pales beside the $372,978 in total monthly payments forfeited over the 25-year period. By taking the lump sum option, the service member sees the value of their retirement package shrink by $215,728.

Enlisted personnel face similar challenges. For the hypothetical enlisted example, First Command assumed a pay grade of E-7, retired pay of $1,770 per month and annual cost of living adjustments of 3%. The 25% option produces a lump sum of $81,622. The monthly payments forfeited over the 25-year period totaled $193,600. The value of the service member’s retirement package shrinks by $111,978.

In both cases, the dollar amounts received, and the payments forfeited would be double if they elected the 50% option.

These hypothetical examples suggest that service members who select the lump sum payments could put themselves at risk of a significant drop in the lifetime value of their own retirement package. The promise of a lump sum that could total in the six figures will surely appeal to many service members. In fact, the assumption that many will elect to take the lump sum is what drives the projections for an overall reduction in military retirement pay. They may choose to take the upfront dollars with good intentions, but there are no guarantees.

Instead of investing the money for retirement, they may use it for other purposes. They may sink it into a business that fails, use it to help out a relative or just spend it. Years later, when these retirees are attempting to turn their accumulated assets into income streams, they could have fewer dollars to deploy.