The New World of Retirement Options

Feb. 1, 2000

Air Force Maj. George Lamont, 35, isn’t sure what he’ll decide, but he is thrilled to have the choice. So, too, is SSgt. Rhonda Pelkey, 32. “I think it’s great being in the military and having an option like this,” she said.

A year ago, both Air Force members understood that their retirement plan, called “Redux,” was inferior to the plan provided to peers who had entered military service just a few months earlier.

Now, thanks to the Fiscal 2000 defense authorization act, Lamont and Pelkey not only fall under that more generous retirement plan, known as “High-3,” but they also face an unprecedented choice when they reach 15 years of service: They can stay under High-3, or they can return to Redux, enticed by an immediate $30,000 bonus.

Military members have never seen anything like this option before. While some are anxious about having to make the decision–isn’t the military, after all, supposed to take care of its own?–many more seem both surprised and delighted to have the choice.

“What I like about the option is that, depending on how the stock market is at the time, I could take more control of my future by riding out some more of the bull market,” said Lamont, an information systems officer at Air Combat Command headquarters, Langley AFB, Va. “Making the present value of $30,000 work for me, vs. waiting for it to trickle in through higher future annuities, is attractive.”

Close Call

Pay officials said that, in general, enlisted members with the discipline to invest long term would be better off returning to Redux and taking the cash bonus. It’s less likely, though possible, that an officer would benefit from switching back to Redux.

The first thing the former Redux generation should understand, said Navy Capt. Elliott Bloxom, director of compensation for the Office of the Secretary of Defense, is that they all emerged from 1999 as winners.

Any member who entered service on or after Aug. 1, 1986–about three-quarters of the current active force–saw future retirement benefits climb 12 to 15 percent. Their High-3 benefit package is the same plan available to persons who entered service from Sept. 8, 1980, through July 31, 1986. (Members who entered before Sept. 8, 1980, come under the most generous retirement plan, which is 50 percent of their final basic pay, valued 5 to 7 percent above High-3.)

The second thing new High-3 members should understand, said Bloxom, is that, at the 15-year mark, they will have a choice of retirement plans-and deciding which to take won’t be easy. Disciplined enlisted members could invest well and gain a large return on their $30,000, which represents a larger chunk of their overall retirement benefit than it does for officers.

Additionally, since enlisted income is lower than officer pay, the amount of bonus lost to taxes would be lower than for an officer.

It’s a closer call for officers, but many of them, too, could achieve higher lifetime retirement values with Redux plus $30,000 if they invest wisely and have long military careers.

For members who just stay under High-3, there is a significant gain. By one estimate, the average jump in lifetime retirement benefits in moving to High-3 from Redux is $220,000 for a typical officer, about half that for an enlisted retiree.

However, to put the bonus offer in perspective, members first should understand key features of both the High-3 and Redux retirement plans.

Under High-3, a member who retires with 20 years of service receives an immediate annuity equal to 50 percent of average basic pay over his or her three highest earning years, usually the final three years. For each year served beyond 20, the annuity climbs by 2.5 percent. Therefore, someone who retires after 24 years receives 60 percent and after 30 years the maximum of 75 percent of average basic pay.

High-3 retirees also receive annual Cost-Of-Living Adjustments to match the inflation rate as measured by the government’s Consumer Price Index.

Under Redux, the 20-year retiree gets 40 percent, not 50 percent, of average basic pay over their highest three earning years. The 10-percentage-point annuity gap narrows over time. For each year served beyond 20 under Redux, annuities climb 3.5 percentage points, vs. 2.5 percentage points under High-3. Therefore, a Redux retiree with 24 years of service would draw 54 percent of average basic pay. That’s still lower than 60 percent after 24 years retired under High-3, but the difference has narrowed, from 10 percentage points down to 6.

Equal at 30

The annuity gap continues to narrow with length of career so that at 30 years of service both the Redux and High-3 retiree will draw 75 percent of average basic pay.

Redux also provides less inflation protection, with annual Cost-Of-Living Adjustments capped 1 percentage point below annual inflation. COLAs will match inflation under High-3. The COLA cap accounts for about half of the overall benefit disparity between the two plans.

Again, longer careers soften the blow. A Redux retiree who serves 30 years avoids the impact of the COLA cap for 10 years longer than the 20-year retiree.

When a member reaches age 62, Redux benefits will improve in two ways. The more generous annuity formula used under High-3 will kick in for the first time. Also, Redux retirees will see a one-time catch-up raise to restore purchasing power lost to the COLA cap since retirement. “CPI-minus-one” COLAs begin again for Redux retirees at age 63.

When President Clinton signed the Fiscal 2000 defense authorization bill last Oct. 5, all former Redux members were placed under High-3. The switch solved a benefit disparity that the Joint Chiefs warned was harming morale and endangering the services’ ability to retain enough members.

Replacing Redux ended the equity issue but how to soften the cost? Lawmakers decided to try to woo members back to the cheaper Redux system with a lump-sum bonus. The $30,000 is roughly the difference in cost to the government of a 20-year enlisted member (E-7) retiring under High-3 vs. Redux. The government expects to curb retirement costs with every High-3 member who returns to Redux.

When life-stream earnings are compared, said Bloxom, “the member who takes the $30,000, invests it wisely, and allows compounding [of interest or investment gains] is generally going to be better off than the member who stays under High-3. But it requires not only good financial advice but good financial discipline to not touch that money for any reason. You need to take the long view with the $30,000 to come out ahead.”

Pelkey, an information management specialist at the Pentagon, entered the Air Force in October 1986, two months after Redux was enacted. Last year Pelkey knew a law had passed that offered her a choice of retirement plans. She knew one was High-3, but she thought the other choice was to accept the bonus and leave service at 15 years with reduced annuities, in which case Pelkey intended to stay under High-3 benefits.

Change of Heart

After learning more, however, Pelkey said she leans toward grabbing the bonus and returning to Redux when she hits 15 years in October 2001. She likes the idea of being able to take the lump sum and still remain on active duty at least five more years.

“I would have those years to adjust my spending habits, or whatever I need to do, and still have some money if I decided to get out” at 20, she said.

Pelkey would use a third of the bonus, after taxes, to pay off bills and to add to a college fund for her seven-year-old daughter. Her family, which now pays rent, might also use some of the money for a down payment on a home. The remainder Pelkey would invest, she said, although she has no investment experience.

Pelkey’s husband, William, is a senior airman with seven years in. If he stays for a career, too, he would face the same retirement choice in eight years, although Congress presumably would need to raise the bonus over time to preserve its value and appeal.

Service members might have good reasons to spend the bonus rather than invest it. Using it for college or to help buy a home could make sense, said Bloxom. What members should avoid, he cautioned, is using the money on “immediate self-gratification.” Buying a sports car or taking an expensive vacation might be fun, but the trade-off would be less financial security in retirement. If a member can’t resist such temptations when money is available, sticking with High-3 might be the better choice, Bloxom suggested.

Are military members sophisticated enough financially to handle the bonus option? “By and large, they are,” said Bloxom. “There’re a lot of people we don’t give enough credit to who are wise to the ways of the financial markets. But there will be some people who may not be savvy. It’s our responsibility to make sure the educational material we put out fits that population as well.”

Defense officials noted, however, that these are not young recruits exercising the option. “These are adults who function in the financial world,” said Tom Tower, a retirement analyst in Bloxom’s office. “They make financial decisions every day, taking out loans, buying houses. This is just one more financial decision to make. Some will do better than others.”

Decision time will start six months before that first group from the former Redux members reaches 15 years of service. That means information packages will be provided and briefings will begin in February 2001. Pay officials plan to provide seminars, counselors, and brochures.

Defense officials already have established a web site at http:// It includes an explanation of the options and typical case illustrations to show relative values. Plans call for it to include an online calculator so members can compare the value of each plan, plugging in their own set of assumptions. Members also will be encouraged to discuss options with family, friends, and personal financial advisors because, for many of them, it will be one of the most important financial decision of their lives.

“If you think you can be savvy with money, the $30,000 is going to be much more attractive to you,” said Tower. “It gives you flexibility–money in your pocket today–and it’s about an equal dollar amount to what you lose by accepting Redux.”

Thrift Savings Plan

One piece of the puzzle still not in place is a military Thrift Savings Plan. Military members, including those who elect the $30,000 bonus and Redux, could shelter 5 percent of their basic pay and any amount of special and incentive pays, up to a maximum of $10,500, if and when the government begins a military TSP.

Congress authorized TSP last year but then delayed its start until the President proposes and Congress enacts legislation to offset the cost to the Treasury from deferral of taxes, about $480 million through 2009.

Another challenge is administrative fees. The Federal Retirement Thrift Investment Board, which administers TSP for federal civilian employees, said in 1997 it could add the military and still keep the administrative fee per participant at 0.06 percent. But it had not anticipated trying to include drilling reservists as the law directs. To do that, the board said, it would need $10 million to accommodate reservists. Without that, it would have to charge individual reservists an 8.4 percent annual fee and 1.5 percent for active duty, according to DoD. Defense officials are weighing options to hold down military TSP fees so they don’t exceed those paid by federal civilian participants.

Whatever is decided, a military TSP won’t start before Oct. 1, 2000, or when offset legislation can be enacted, whichever is later. Bloxom said he doesn’t want members to view TSP as intrinsic to a retirement plan. “The two are separate,” he said. “TSP is a savings vehicle, not a defined contribution part of the member’s retirement.”

No matter how it is perceived, TSP could make the Redux bonus more attractive as an option by deferring taxes on contributed amounts. Any part of the bonus not sheltered will face a federal tax bite, about 15 percent for enlisted and 28 percent for officers.

Congress and defense officials aren’t sure how many members from the Redux generation will exercise the bonus option and return to Redux. “It’s just a unique offering,” said Tower. “Nobody’s had the opportunity to make a similar choice before.”

For budget planning, lawmakers assumed 40 percent of officers and 50 percent of enlisted. Defense pay officials suspect the bonus take rate could be a lot higher. Ironically, officials anticipate some envy among service members who entered before Aug. 1, 1986. So far, they have no choice but to stay under High-3.

“There’s not been a great hue and cry,” said Bloxom, but, he added, “I’ve heard some hard questions from that population.” After all, he said, having a choice “is a desirable capability.” Lamont, who reaches his 15th year of service in February 2002, agreed. “This,” he said, “is just a great opportunity.”

Tom Philpott, the editor of “Military Update,” lives in the Washington area. His most recent article for Air Force Magazine, “With Tricare, Even the Boss Gets Confused,” was published in the September 1999 issue.