Big Changes Coming to the Military Retirement System

by guest blogger Kimberly Lankford, author of Kiplinger’s Financial Field Manual: A Personal Finance Guide for Military Families

The military retirement system is going to change in 2018. Service members may be able to participate in the new blended retirement system, which changes pension guarantees but also provides matching contributions to the Thrift Savings Plan.

Q. I hear there are going to be big changes to the military retirement system soon. How are the pension and retirement-savings options for service members changing, and do I need to make any decisions now?

A. You’re right—major changes are coming to the military retirement system starting in 2018. You don’t need to make any decisions now, but you should start to assess your options if you joined the military between 2006 and 2017 and have a choice between the old and new systems.

Under the current retirement system, service members who stay in the military for 20 years receive a pension worth 50% of their base pay (or up to 75% if they stay for 30 years), starting as soon as they retire from service, with payouts adjusted annually for inflation. But there is no partial vesting; if you stay for fewer than 20 years, you don’t get anything, and fewer than 18% of service members stay for 20 years.

The new “blended retirement system” reduces the guaranteed income available after 20 years, but it also provides matching contributions to your Thrift Savings Plan (TSP), which you can keep after just two years of service.

Under the new system, if you stay in the service for at least 20 years, you can get a pension worth up to 40% of your base pay (or up to 60% if you stay at least 30 years), with payouts that are adjusted for inflation. You’ll also get extra money in your Thrift Savings Plan: an automatic contribution of 1% of your base pay to the TSP after 60 days of service, and matching contributions for the next 4% of your pay. That’s up to 5% each year in free money that you can keep in your plan after completing two years of service.

If you joined the military from 2006 through 2017, you will have from January 1, 2018, until December 31, 2018, to opt into the new system. (Service members who joined the military before 2006 will still be covered under the old retirement system, and those who join in 2018 or later will automatically be covered under the new system.) If you don’t do anything, you’ll remain in the current retirement system. For more information about the new system, see the Department of Defense’s Blended Retirement System Web page.

How to choose

If you don’t plan to stay in the military for 20 years, you’ll come out ahead with the blended retirement system. If you’re not sure whether you’ll be staying that long, it pays to do the math. Estimate what your monthly income is likely to be under the old and new pension system, and figure out how much you’d need to save in the TSP to make up the difference. Also, be realistic about the possibility that you’ll stay for 20 years. “We’re doing some analysis to understand the probability of retirement and if they can save enough to make up for the gap,” says Josh Andrews, a certified financial planner who is director of military advice for USAA (and a former Air Force pilot).

Making the most of your retirement savings

If you choose the blended retirement system, be sure to contribute at least the 5% needed to get the full TSP match each year; otherwise, you’re giving up free money. Under either system, it helps if you can afford to contribute even more: The more money you contribute when you’re young, the longer the time it has to grow and the less you’ll need to set aside later to reach the same goals. You can contribute up to $18,000 to the TSP in 2016 (the limits remain the same in 2017). If you’re receiving tax-free income while serving in a combat zone, you can contribute up to $53,000 to your TSP for the year—a great way to super-charge your retirement savings, even if you boost your contributions just a little bit when receiving the tax-free income while deployed.

Also decide whether to make traditional or Roth contributions to your TSP. Traditional TSP contributions reduce your taxable income now and grow tax-deferred for retirement, but you’ll have to pay income taxes on the gains when you withdraw the money. With Roth TSP contributions, you forgo the current tax break but can withdraw the earnings tax-free in retirement. Many members of the military are in a lower tax bracket while serving than they are after they leave the service, especially if they’re receiving a tax-free housing allowance and tax-free income while deployed to a combat zone. For them, the Roth TSP is usually the best option, says Patrick Beagle, a certified financial planner in Springfield, Va., and retired Marine helicopter pilot. And if you contribute tax-free income to a Roth TSP while deployed, the money both goes in tax-free and comes out tax-free in retirement.