Recently, I sat down with someone who asked me whether she should take the military’s Blended Retirement System (BRS). As most people know, the BRS is the military’s attempt to slowly move away from a defined benefit pension to a defined contribution pension. So her question was, “Should I take some money now, in exchange for a lower pension later?”
As a member of the military community, I’ve seen this discussion a lot. There are any number of opinions across the spectrum. As a financial planner, though, I’ve seen less discussion. However, from my experience, personal finance is more personal than finance. In other words, it’s not just crunching the numbers.
Immediately, these thoughts came to my mind. Granted, this is not for the majority of people who only stay for their initial obligated service (enlistment or officer obligation). Nor is this for those who truly don’t plan to stay in for at least 20 years. However, if there is even an inkling that you might, you should consider these thoughts:
1. To make a truly informed decision, you should have a good idea about on your career prospects.
If you’re relatively junior, you probably don’t know whether you’re going to stick around for 20 years. No promotion is ever guaranteed, and the best plans can go by the wayside. However, once you reach 8, 10, or 12 years of service, you at least have some handle on:
- Promotion prospects within your occupation or specialty. Highly in-demand jobs will probably command more money in terms of retention bonuses, incentive pays, and other compensation. Also, those jobs will also come with a higher probably of making it to 20 years (or more). Finally, you’ve probably seen what your terminal paygrade might look like. The higher your community’s promotion prospects, the more likely the numbers will swing in favor of the High-3 retirement system. However, if your community is throwing a lot of money at you in terms of incentive pays, you might want to run the numbers.
- Your promotion prospects. If you’re at the mid-point of your career, you should also have a mapped out plan (or rough idea) for what your promotion probabilities are. This depends not just your community, but on your competitiveness within your community. For example, you’ve been the command superstar everywhere you go, you probably have a lot of potential. If you’re wondering why everyone seems to get good fitness reports, you might want to take a closer look at how you can become more competitive. If you don’t know, you probably can talk to a mentor, one who will give you the hard truth.
2. The older you currently are, the more likely it is that the High-3 retirement system is better for you.
This does come down to basic numbers. The more time you have to allow the government to match contributions, the better for you. This relates to both the time value of money & compounding interest as well as the number of years the government actually contributes to your account. Conversely, the fewer years you have the government match your TSP contribution, the less beneficial that will be.
3. Matching contributions are at your present (or near future paygrade). The reduction in your retirement pension is based upon 20% of your final paygrade. Unless you plan to retire at your current paygrade (or lower), there will be a HUGE difference.
The person I was talking with was a current O-4. Under the BRS, she would receive O-4 matching contributions. She would also go from a 50% pension (at 20 years) to a 40% pension. She expects to make O-5 before she retires, if not O-6. If that were to happen, BRS would be a 20% reduction of her pension at O-5 pay, not at O-4 pay. In other words, you get matching contributions at the lower paygrade, and the government gets to reduce your pension at your final (most likely highest) paygrade. Anyone who expects to make it to 20 years should keep this in mind.
4. The difference in pensions doesn’t stop at your final pay. The result is compounded with each COLA increase.
Don’t believe it? Let’s do this hypothetical exercise, where the traditional pension is $5,000 per month, and the BRS is $4,000 per month. Also, imagine a 3% annual COLA increase under each pension system. Let’s see where this goes:
|1||$ 4,000.00||$ 5,000.00|
|2||$ 4,120.00||$ 5,150.00|
|3||$ 4,243.60||$ 5,304.50|
|4||$ 4,370.91||$ 5,463.64|
|5||$ 4,502.04||$ 5,627.54|
|6||$ 4,637.10||$ 5,796.37|
|7||$ 4,776.21||$ 5,970.26|
|8||$ 4,919.50||$ 6,149.37|
|9||$ 5,067.08||$ 6,333.85|
|10||$ 5,219.09||$ 6,523.87|
As you can see, it takes the reduced pension 9 years to reach the point that the regular pension starts at in Year 1! The other thing is that the BRS pension is now over $1,300 less than the High Three pension. Such is the power of compounding interest. When you’re running the numbers on how much larger your TSP account will be, you might want to account for the growing difference in your pension over time.
At least Congress eliminated the reduced COLA increase in the 2016 NDAA. This could have been worse.
5. The more senior you become, the more likely it is that the legacy retirement system is for you.
To take the previous point to an extreme, think about this: someone who is currently an O-1 will become the Army’s Chief of Staff. Someone will become the Chairman of the Joint Chiefs. Tomorrow’s senior enlisted leaders will come from today’s sergeants. While no one knows whether they’re going to be tapped on the shoulder for those responsibilities, someone will. And if that future O-10 or E-9 selects the BRS today, they’ll have done much more than a service to their country. They’ll have put a lot of money back in the taxpayer’s pocket at their expense.
6. You can put your money into the Roth TSP account all you want. Don’t expect the government to put matching contributions anywhere but your traditional account.
Military.com posted an interview with media personality Suze Orman. In her interview, she says, “If you’re smart and let me teach you, I can show you how you can have more money [with BRS] than with the legacy system.” She then outlines four basic steps:
- Contribute a full 5 percent of basic pay to TSP to maximize government matching;
- Use only the Roth IRA option inside TSP so contributions are taxed in the year made but will be withdrawn tax free after age 59-and-a-half;
- Invest only in stock index funds which provide the highest return over time.
- Don’t get spooked when markets correct and decide to move into more conservative funds.
In concept, this sounds great. However, don’t think that your matching contributions will go into the Roth account as well. According to the BRS website, “All government contributions are deposited into the service member’s traditional account.” Nothing wrong with this, but just keep that in mind when you’re running the numbers for yourself…you’ll have to account for taxes on the government contribution side. You don’t get the TSP match tax-free…just tax-deferred.
7. The BRS is the government’s attempt to shift the risk of funding your retirement back onto you.
Like it or not, that’s the way it is. It’s just a little more palatable than the REDUX plan, where they tried to throw $30,000 at service members to take a similar cut in pension. The primary difference is that it’s open to everyone, not just people at 15 years. Also, for those who are looking to retire, there’s a little more confusion about how much money you’ll receive in exchange for downsizing your pension. It’s not as clear cut as trying to decide if $30,000 is enough to buy out part of your pension.
8. Peace of mind matters.
This discussion is similar to the one surrounding whether one would be better off by participating in the Survivor Benefit Plan or buying a term life insurance policy. The SBP vs. term insurance debate is an ongoing, because there’s an emotional aspect to it. Even though OSD’s Actuarial Office annually publishes a calculator to help run the numbers, there are many people who prefer the peace of mind of knowing the government is responsible for protecting their pension.
And yet, I wonder how many people who think similarly are also in favor of the BRS for people who plan to stay in for 20 years. I see these as two similar (yet slightly different) problems. Each situation contains:
- A lump sum vs. annuity (or combination of each in the case of BRS) problem. You have to fill in assumptions about things that happen in the future, such as investment return, inflation (or COLA), etc. However, the numbers will be different in each person’s case. It’s incumbent upon everyone to make sure the numbers reflect their reality, regardless of how many government or investment company calculators exist.
- A decision on whether the government maintains the risk of protecting future income, or whether you choose to accept that risk. In the SBP/term insurance debate, the question is really about whether your premium dollars should go to the government to manage future cash flow or towards an insurance policy for you to manage. In the BRS discussion, the question is really about how much money you would be willing to consider taking so that the government shoulders less of your future pension.
It would seem that if you’re in favor of SBP (and protecting your income against longevity risk), you’d probably also be in favor of retiring to the High-3 pension plan. That way, you’d protect as much of that pension as possible. For as long as possible. I could be wrong…there could be people who would want to participate in SBP, but also take part in the BRS. In that case, I guess SBP would be cheaper, because there would be less pension income to protect.
Regardless of your position, one thing is for sure: peace of mind matters. There are multiple dimensions of this, though. For one person, peace of mind could mean never outliving your pension. In another instance, it could be being able to pay off a mortgage with insurance proceeds. For the pension discussion, peace of mind could mean 100% portability in case you decide to change careers midstream. Or it could mean ensuring that you don’t have to take on more risk than you feel is necessary to protect your retirement income. Or, it could mean that you have access to your pension right away.
9. Timing matters.
Having the government contribute to your TSP can be a great thing, even if there are restrictions on when you can withdraw from it. So is being able to receive a retirement check from the government at age 42. It’s all a matter of perspective, and how you draw up your post-military life. Whichever way you decide, you’ll want to make sure that this decision goes hand-in-hand with your personal financial philosophy.
10. Investment companies have a stake here.
Despite the DOL Fiduciary rule, which protects clients’ best interests regarding retirement plan advice, there are incentives at play. Investment & insurance companies can’t really monetize a government pension. However, people can definitely give you advice about your TSP, especially when you’re looking to diversify your investment options.
For example, USAA has an online BRS calculator. It’s a great customer service tool, with a purpose. That purpose is to help bring in new business.
There might not be anything underhanded about an investment company that helps you explore options beyond TSP. However, there are incentives for someone, somewhere, to take advantage of people who are not on their guard. Even though you’re talking TSP, someone else might be talking “Rollover IRA.”
Which may, or may not, be in your best interest. But if the online calculator is going to make any assumptions, I’ll guess they’re going to be in the company’s favor.
To be honest, I have no idea which direction the person I talked with will go. We had a pleasant conversation, and I told her that it’s a tough decision for everyone to make. However, I’d like to think that we discussed some things that weren’t obvious in the DoD training or the resources that you can find online. In that regard, I do hope she makes a decision that complements her life goals.