Navy

What Happened When the Military Overhauled Its Retirement System?

In the military, I have observed a culture of continuous evaluation where we expect constant debriefs, after-action reports, and revolving cycles of lessons learned. At all levels, from a small division to an entire fleet, we expect our performance to be evaluated and to receive honest feedback from a more experienced assessor or a leader in our chain of command. Eventually, we might even begin to crave this feedback and feel as though something is missing if the debrief is overlooked. When the military retirement system was changed dramatically in 2018, I anticipated some form of feedback. After all, this shift took more than three years from the announcement to implementation and represented one of the largest changes to military benefits in the 21st century. For these reasons, the retirement shift seemed to be worthy of an in-depth debrief. There were specific questions I was hoping would be answered after the retirement shift: How did the government switch from defined benefit to defined contributions? How did military members respond to the switch to the 401(k) system? What is the current state of retirement readiness for service members? Who are the winners and losers from this shift? While I do not have the authority to request this type of feedback and analysis, I set out in search of specific answers and to share lessons learned.

In shifting from a pension system to a 401(k) system (defined benefit vs. defined contribution), approximately 40 percent of military members did not respond to market incentives to maximize their employee-sponsored retirement benefits to reach a social optimum point—or the point where we should strive to be in terms of social welfare. After requesting data related to the military retirement shift through a Freedom of Information Act (FOIA) request, I found service members missed their claim to approximately $138 million in available retirement contributions in 2019. On an individual level, eligible service members missed their opportunity to receive $300, on average, in employee-sponsored retirement contributions. In total, approximately 800,000 service members are not expected to be eligible for retirement (serving at least 20 years) and are not currently maximizing government sponsored retirement benefits.

The Federal Retirement Thrift Investment Board (FRTIB), the government 401(k) manager, appeared to recognize this widespread failure to properly allocate resources to reach a social optimum. The FRTIB later changed the default individual contributions to push the employee demand for retirement benefits toward the social optimum point from its sub-optimum equilibrium.

How did the entire military overhaul its retirement system?

In 2015, the National Defense Authorization Act (NDAA) announced the government’s plan to shift from a traditional pension plan to a modified Blended Retirement System (BRS), which combines a traditional pension plan for eligible personnel (serving 20 years or greater) and a 401(k) plan for all new service members and some current service members who met eligible criteria. The high percentage of service members (81 percent) who left the military without receiving any employee-sponsored retirement benefits was a primary reason to introduce the BRS. Historically, only service members who served 20 years or more (19 percent of all service members) received retirement benefits (defined benefit or pension). The new BRS provided all new service members with some retirement benefits (1 percent government contribution of base pay) and the opportunity to match contributions up to 5 percent (see table below). New service members in the BRS can still receive a pension (although with a slightly reduced multiplier 2.0 percent versus 2.5 percent) if they serve at least 20 years.

The next step in implementation was the opt-in window. During calendar year 2018, current service members with less than 12 years of service could opt-in to the blended retirement system or stay with the traditional pension plan. In 2019, all new service members were automatically enrolled in the BRS and existing service members remained with either the traditional pension system or their new system, leaving four different categories of retirement plans for active military members. These four categories are relevant in understanding the data obtained through the FOIA request in late 2019:

  1. Military members (more than 12 years of service) remaining in the Traditional Defined Benefit (High 3, Pension)
  2. Existing military members (less than 12 years of service) who chose to remain in the Defined Benefit plan
  3. Existing Military members (less than 12 years of service) who opted into the Blended Retirement System with no default employee contributions
  4. New military members (less than 1 year of service) who were in the Blended Retirement System by default with no default employee contributions

 How did service members respond?

In 2018, eligible service members with less than 12 years of service were required to complete online training to educate themselves before making their decision to opt-in to the Blended Retirement System. The following Google trends graph shows that search interest in the new Blended Retirement System peaked around December 2017 and January 2018 (max:100) at the beginning of the opt-in window, and then later surged to half the level of interest (approximately 50) at the end of the opt-in window around December 2018. Certainly, service members did their homework to make an informed decision about shifting to the new BRS or to stay with the traditional retirement plan. I have not found “Blended Retirement System” used widely to describe any other retirement systems, meaning the Google trends graphic should be an accurate representation of relevant interest for military members and/or their family members.

In an effort to paint a more complete picture of military retirement and explore how service members responded to the retirement overhaul, I submitted a FOIA request to the Defense Finance and Accounting Service (DFAS) in October 2019. In my request, I asked for information related to how members of the military service have changed their Thrift Savings Plan (TSP) contributions within the context of the new BRS. The Thrift Savings Plan (TSP) is the retirement and savings plan, administered by the FRTIB, for uniformed service members similar to a corporation’s 401(k) manager. The information from DFAS would be insightful in studying trends and data related to how service members changed their behavior related to retirement contributions and provide analysis to paint a more complete picture of the military retirement.

After receiving a positive response in November 2019 (including data relevant to my inquiry), I calculated how many service members were maximizing the possible government retirement benefits by electing to contribute at least 5 percent of their own base pay toward a retirement fund. I discovered that none of the service branches experienced more than 67 percent of BRS participants contributing 5 percent or greater (see table below).

The initial findings were surprising considering the individual research and mandatory training related to the Blended Retirement System. The number of eligible individuals maximizing their government sponsored benefits is a starting point, but only applies to two of the four categories (mentioned earlier) of retirement plan participants in 2019. These two categories consider only the pool of service members in BRS (34.33 percent of all active service members). We need to examine the larger state of the military retirement to provide greater context to the BRS data. As stated previously, we expect around 19 percent of active service members to retire with a pension after serving 20 years. The problem is that we do not know which service members will serve 20 years: are they currently in the BRS or not? If we use the data constructed in the previous table (service members maximizing retirement benefit) and assume 19 percent of all total service members will retire then we can construct the following graph:

For simplicity, I assumed these two groups are mutually exclusive (which they are not) to see the best-case scenario for service members in retirement. The best-case scenario is that the greatest number of service members would either retire with a pension or actively contribute to their retirement (more than 4 percent) and therefore maximize employee-sponsored contributions. There is a substantial gap for all services: a significant percentage of service members are not expected to retire or have not maximized their employee sponsored retirement benefit. It was alarming to see that even in the most optimistic scenario 808,660 service members (60.39 percent) would not be expected to receive a pension and were not maximizing their employee-sponsored retirement benefits (see table below).

Economic Impact due to Sub-optimal Participation

While the gathered information is valuable in providing insights to greater trends, it does not provide economic data to describe the overall impact of this inefficiency. In analyzing the data for BRS participants, I calculated that the overall demand (or average savings for BRS participants) for contributions by service members was approximately 4.1 percent. The breakdown by service is: Army 3.83 percent; Navy 4.37 percent; Air Force 4.4 percent, and Marine Corps 4.05 percent. We could also describe this as the average savings rate for BRS participants because demand for employee-sponsored retirement benefits correlates with individual saving rates up to 5%. By taking the difference between the actual savings and the optimal savings (5 percent), we can estimate the total government savings and the total amount that service members missed by not electing to maximize their employee-sponsored contributions. I took the difference in these percentages (approximately 1 percent) and multiplied it by the annual base salary for expected BRS participants. I used paygrades that I would expect to be eligible (less than 12 years of service) for BRS and distributed the BRS participants throughout the eligible paygrades related to their relative weighting in the service. (Percent the paygrade comprises of the entire branch.[i]) See the following chart for how this breaks down in the Navy.

With a .632 percent difference between the average demand (4.37 percent) and optimal demand (5 percent) multiplied by the annual base salary for 107,488 Navy BRS participants, it appears that Navy BRS participants left about $24 million in unclaimed retirement benefits or $226 per BRS participant.

Applying the same calculations to the other three services, I estimated a total government savings of $138 million in 2019 due to service members not maximizing their employee sponsored contributions, or about $302 per BRS participant.

Winners and Losers in the Market Failure

This data has greater implications when comparing the relative impacts to the winners and losers of the inefficiency. The government saved approximately $138 million, which equates to about .019 percent of the $686 billion defense budget for 2019, because service members did not maximize their benefits. Individual service members missed out on about 1 percent of available retirement benefits. The TSP—the 401(k) manager—also missed the opportunity to grow its balance sheet of investments by approximately $138 million (not including government matching contributions), which is a tiny fraction of its $558 billion assets under management. The winner appears to be the federal government, with its estimated savings of $138 million in retirement contributions; this inefficiency amounted to missed opportunities for the individual service members and the 401(k) manager, both of whom benefit from maximizing possible contributions.

Will the market failure go unresolved?

The TSP announced in the summer of 2019 that all new BRS participants after October 2020 would have 5 percent set as their default individual contributions. With this new default, we need to create a fifth category of potential retirement situations for service members in 2021: new military members (joining in 2021, less than 1 year of service) who are in the Blended Retirement System by default with a 5 percent default employee contribution amount.

The new default would push the previous 4 percent demand for retirement benefits (or savings rate) slowly toward the social optimum of 5 percent. The new default should shrink the $138 million estimate for unclaimed retirement benefits as the percentage of BRS participants with a 5 percent default contribution (meaning no missed employee-sponsored retirement benefits) account for a greater percentage of the total force each year. In theory, the current estimate of 808,660 current military members not expected to retire and not maximizing retirement benefits would become fewer every year as well. 

Recommendations

The decision-making process demonstrates the two economic tools available to push toward a social optimum or desired state: market-based incentives and command-and-control policies. First, the government incentivized service members to save and contribute to their retirement by offering matching contributions. This proved inefficient and created a surplus where the amount of retirement benefits supplied exceeded the employee demand. The TSP then moved to the command-and-control policy to minimize this efficiency by changing the default contribution to 5 percent for new BRS participants. This inefficiency should also be minimized more rapidly with increased financial education to allow greater understanding of service member’s personal retirement benefits. Department of Defense (DOD) leadership should strongly consider producing year-over-year data to closely track trends for service member engagement in maximizing retirement benefits. These statistical trends will enable the DOD to provide recurring feedback to service branches related to the effectiveness of their financial education programs.

Endnotes

[i] To protect Personally Identifiable Information (PII), DFAS did not provide a specific breakdown of BRS participants by paygrade. These numbers are an estimate based on the weight that each rank comprises of total service branch.

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