BLENDED RETIREMENT’S LUMP-SUM FEATURE ENTICING BUT IS IT FAIR?
When the first wave of active duty personnel who opt into the new Blended Retirement System (BRS) next year start to retire a decade later, they will face a decision on retired pay so unusual that the Department of Defense Board of Actuaries has called it inappropriate and asked Congress to rescind the choice.
The decision they will face might be explained like this:
Congratulations on your pending retirement. Do you want your full immediate annuity? Or do you prefer to get part of its value in a discounted lump sum at retirement, in return for forfeiting either one half or one quarter of your retired pay until age 67, when you would see full annuities restored?
Lump-sum buyouts of pension obligations are common in the corporate world but not the formula Congress has prescribed for setting military lump sums. The amounts offered will be too large to ignore for many retirees seeking to get out of debt, buy a home or start a business. But the lump sum choice also will have members lowering the lifetime value of their own retirement packages significantly.
Most disturbing to actuaries and other critics of BRS is that Congress ordered lump sums calculated using “personal discounts rates,” a concept that pension guardians don’t recognize as actuarially sound or perhaps even fair. Personal discount rates measure an individual’s preference for current dollars over promised future dollars. The higher the discount rate assumed for folks being offered lump sums in exchange for reduced annuities, the greater the savings realized by the retirement plan’s designers, in this case the U.S. government.
In January Defense officials announced the formula to be used for setting an aggregate personal discount rate for enlisted and officer retirees. It will combine an inflation-adjusted, 7-year average of the Department of Treasury High-Quality Market (HQM) Corporate Bond Spot Rate Yield Curve at a 23-year maturity with an adjustment factor of 4.28 percentage points. That last factor seeks to capture some of what past studies have learned about military personal discount rates.
It’s a formula incomprehensible to most of us. But Air Force Capt. Daniel Kopp, who has an economics degree from Purdue, is studying to be a financial planner and operates a financial advice blog called militarylifeplanning.com, has it figured out. He said that if adopted today the formula would support applying a discount rate of 7.3 percent in calculating lump sum amounts under the BLS.
What sort of dollars are we talking about? Defense officials will not announce the actual personal discount rate to be used to illustrate lump sum values until June 1. But here are calculations Kopp made that actuaries have deemed as reasonable.
If a 38-year-old E-7, completing a 20-year career, could retire today under the BRS formula, the lump sum offer would be $174,454 in return for forfeiting 50 percent of retired pay until age 67, when this generation also reaches full retirement age for Social Security. The second lump sum option for the same E-7, payable for accepting a 25-percent annuity cut until old age, would be $87,277.
Kopp looked at a 42-year-old officer retiring after 20 years in the rank of O-5. The lump sum offer would be $309,132 to take a 50 percent retired pay cut until age 67, and $154,566 to accept a 25 percent annuity cut for 25 years.
Kopp also calculated total retirement dollars these retirees would forfeit to accept lump sums. From age 38 to 67, the E-7 who accepted a 50 percent cut in retired pay would get total retired pay of $488,363 – and would forfeit an equal amount to accept a lump sum of $174,454 at retirement. The E-7 who accepted the 25 percent cut until 67 would forfeit $244,182 to receive $87,277 at retirement.
To allow these calculations Kopp assumed retired pay cost-of-living adjustments of 3 percent to match annual inflation. He also plugged in that personal discount rate of 7.3 percent for both officers and enlisted retirees.
The BLS plan enacted for new entrants starting in 2018, with opt-in option for current members having fewer than 12 years’ service by then, is the vision of the Military Compensation and Retirement Modernization Commission. Besides a lump sum to attract a 50 percent annuity cut, the commission proposed one big enough to entice new retirees to suspend any retired pay until age 67.
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