Saturday, September 23, 2017

Thrifty Thinking: Military retirees who choose DoD’s lump sum buyout will likely pay a high price

The Defense Department is casting the lump sum feature of the new Blended Retirement System as a way to give service members new financial choices at retirement, but a detailed analysis of the program reveals that those who sign up for the cash buyout will likely pay a high price.

The lump sum program offers retiring service members the opportunity to receive upfront dollars by forfeiting a portion of their working-age retirement pay (either 25 percent or 50 percent of the monthly payment). 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 percent. 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 Financial Services, Inc. projects that lump sum amounts calculated at the 6.99 percent 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 percent. The 25 percent option produces a lump sum of $157,250. That’s a significant benefit, but 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 percent. The 25 percent 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 are double for the 50 percent option.

The Blended Retirement System, which goes into effect on Jan. 1, 2018, calls for a 20 percent reduction in current retirement pay in exchange for a defined contribution program of automatic and matching Thrift Savings Plan contributions, a mid-career continuation pay bonus and the lump sum buyout option. The program will apply to all new service members starting next year, but current military members with 12 years or less of service are eligible to opt in to the new program.

When the first wave of eligible service members who opted into the Blended Retirement System start to retire in 2026, they’ll likely be dealing with a different Government Discount Rate but the challenges promise to be the same.


Highlights of First Command’s analysis of lump sum payment options

Officer examples

Pay grade O-5 taking a 25% reduction in pension in exchange for a lump sum
Assumptions
  • Retirement pay for BRS of $3,410, or $40,920 first year
  • 3.0% post-retirement COLA
  • Retirement pension started at age 42
  • Discount Rate of 6.99%
  • discounted pension lasted through age 66
Results
  • Reduced pension for the first year would be $30,690
  • First year reduction was $10,230
  • Total of the reductions over the 25 years prior to FRA at age 67 totaled $372,978
  • Lump sum at retirement in exchange for the reduced pension using the Discount Rate of 6.99% totaled $157,250

Pay grade O-5 taking a 50% reduction in pension in exchange for a lump sum
Assumptions
  • Retirement pay for BRS of $3,410, or $40,920 first year
  • 3.0% post-retirement COLA
  • Retirement pension started at age 42
  • Discount Rate of 6.99%
  • Discounted pension lasted through age 66
Results
  • Reduced pension for the first year would be $20,460
  • First year reduction was $20,460
  • Total of the reductions over the 25 years prior to FRA at age 67 totaled $745,987
  • Lump sum at retirement in exchange for the reduced pension using the Discount Rate of 6.99% totaled $314,500

Enlisted examples

Pay grade E-7 taking a 25% reduction in pension in exchange for a lump sum
Assumptions
  • Retirement pay for BRS of $1,770, or $21,240 first year
  • 3.0% post-retirement COLA
  • Retirement pension started at age 42
  • Discount Rate of 6.99%
  • Discounted pension lasted through age 66
Results
  • Reduced pension for the first year would be $15,930
  • First year reduction was $5,310
  • Total of the reductions over the 25 years prior to FRA at age 67 totaled $193,600
  • Lump sum at retirement in exchange for the reduced pension using the Discount Rate of 6.99% totaled $81,622


Pay grade E-7 taking a 50% reduction in pension in exchange for a lump sum
Assumptions
  • Retirement pay for BRS of $1,770, or $21,240 first year
  • 3.0% post-retirement COLA
  • Retirement pension started at age 42
  • Discount Rate of 6.99%
  • Discounted pension lasted through age 66
Results
  • Reduced pension for the first year would be $10,620
  • First year reduction was $10,620
  • Total of the reductions over the 25 years prior to FRA at age 67 totaled $387,197
  • Lump sum at retirement in exchange for the reduced pension using the Discount Rate of 6.99% totaled $163,245

About First Command
First Command Financial Services and its subsidiaries, including First Command Financial Planning and First Command Bank, coach our Nation’s military families in their pursuit of financial security. Since 1958, First Command Financial Advisors have been shaping positive financial behaviors through face-to-face coaching with hundreds of thousands of client families.

First Command Financial Services, Inc., is the parent of First Command Financial Planning, Inc. (Member SIPCFINRA), First Command Advisory Services, Inc., First Command Insurance Services, Inc. and First Command Bank. Financial planning services and investment products, including securities, are offered by First Command Financial Planning, Inc. , a broker-dealer. Financial planning and investment advisory services are offered by First Command Advisory Services, Inc., an investment adviser. Insurance products and services are offered by First Command Insurance Services, Inc., in all states except Montana, where as required by law, insurance products and services are offered by First Command Financial Services, Inc. (a separate Montana domestic corporation). Banking products and services are offered by First Command Bank. In certain states, as required by law, First Command Insurance Services, Inc. does business as a separate domestic corporation. Securities products are not FDIC insured, have no bank guarantee and may lose value. A financial plan, by itself, cannot assure that retirement or other financial goals will be met. First Command Financial Services, Inc. and its related entities are not affiliated with, authorized to sell or represent on behalf of or otherwise endorsed by any federal employee benefits programs referenced, by the U.S. government, or the U.S. armed forces.

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