Would an E-6 careerist nearing retirement accept a $30,000 car loan if forced to pay back a total of $390,000 in principal and interest?
Would an E-7 accept a $30,000 loan to make a down payment on a home or to wipe out credit card debt if the lifetime cost of that decision were $386,000 in lost retired pay?
The answer to both questions, regrettably, is: You bet.
Hundreds of career service members every month make a comparable choice while in their 15th year of service. That’s when, in return for an immediate cash bonus of $30,000, they make an irrevocable decision to opt out of “High-3” retirement and accept the less generous “Redux” plan.
The loan shark here is the federal government, the same Congress and Department of Defense that like to get tough with payday lenders outside of military bases who prey on young or naïve enlisted members. Meanwhile, they offer their own rotten deal, which every year gets a little worse, say economists at the defense think tank CNA.
Under contract to the Marine Corps, CNA in late September sounded anew its periodic alarm over the Redux retirement option and its onerous $30,000 Career Status Bonus, in a report titled “Retirement Choice 2014.”
Applying current military pay tables and fresh assumptions about the lifetime value of military retirement options, CNA spells out in blunt terms the penalties careerists impose on themselves when they take the $30,000 bonus while five years from initial retirement eligibility.
For those who elect Redux, retire at 20 years and live until age 79, which is average life expectancy for their generation, E-6s among them will reduce lifetime retired pay by $335,529. E-7s will lose $391,600. CWO-3s will lose $451,303. An O-4, who presumably retires at age 44 rather than 38 for enlisted, would see lifetime pay cut by $382,522, CNA says.
“The best way to think about this is to consider Redux’s $30,000 Career Status Bonus as an early cash-out” of part of a member’s retirement. “We can calculate how much this cash-out costs…by thinking of it as a ‘loan’ to be paid back later in the form of lower retirement checks,” CNA says.
While car loans and mortgages have fixed loan periods, often five years for cars and 30 for mortgages, the Redux bonus “has a rather peculiar payback scheme.” The member “pays nothing until retirement, pays quite a bit from the beginning of retirement until age 62, and then continues to pay back smaller amounts over the rest of his or her lifetime.”
To fully grasp the effect, careerists eyeing the bonus must consider how retired pay is calculated under High-3 versus Redux. Both plans provide an immediate annuity after 20 or more years of service computed on a base amount of their highest three years of basic pay. But rather than 50 percent base pay after 20 under High-3, retirees under Redux receive 40 percent.
That disparity narrows gradually for every year served beyond 20 so that after 30 years of service both the Redux and the High-3 retiree will draw 75 percent of their base amount.
What never disappears is the disparity in plan with inflation protection. High-3 retirees get annual cost-of-living adjustments or COLAs to match inflation. Redux COLAs are set a percentage point below inflation. There is a one-time catch under Redux to restore lost purchasing power temporarily at age 62 but then the COLA-minus-one formula resumes.
EFFECT LASTS A LIFETIME
Redux retirees feel the effect for a lifetime and so do their surviving spouses if they are covered under the military’s Survivor Benefit Plan. Unless Redux retirees elect to pay a higher SBP premium, survivor payments too are impacted by COLA-minus-one.
Congress first approved Redux for new entrants in 1986 in hopes of saving billions of dollars in retirement costs. It repealed it in 2000 on worries that it was compromising career retention rates. But to hold down some pension costs, Congress voted for a scheme that entices some members back into Redux voluntarily with the $30,000 bonus at the 15-year mark.
Anita Hattiangadi, director of the Marine Corps Manpower Team at CNA and co-author of the retirement choice report, said that comparing the Redux bonus to a loan retirees must “pay back forever” helps careerists conceptualize the full effect of their decision.
“Another thing we do is to talk about the very high break-even interest rate you would have to earn” for the bonus to make any sense, she said.
Two main reasons given for taking Redux and the bonus is members want or need the money now, or they think they can do better than under High-3 retirement if they invest that $30,000 wisely and watch it grow.
“Neither of these reasons should justify the Redux/bonus choice,” the report concludes. “Service members who want or need the money now should look into other ways to obtain the required funds.”
Even members who draw their Redux bonus tax free while serving in a combat area, or who shelter the money in their federal Thrift Savings Plan accounts, would almost certainly be better off financially in the long run by sticking with High-3 retirement, the reports argue in considerable detail.
Congress hasn’t raised the bonus since it first was offered in 2001. Aline Quester, another co-author and principal research scientist at CNA, said military folks should be grateful because fewer careerists every year are being enticed to accept Redux. Marine Corps “take rate” has fallen from 56 percent in 2001 to 12 percent today. That’s still too high, the report argues.
“My big worry,” said Quester in an interview, “is that Congress will decide that instead of $30,000 we should give them $50,000 or $60,000 which would still be a terrible deal but more people would take it. So I’m very content to have it get to be a worse and worse and worse deal because, I think, the take rates are going to keep falling.”
CNA has briefing slides and an online calculator for careerists to use to compare lifetime values of Redux and High-3 for them. These along with the full report are available at: www.cna.org/news/releases/2014-09-29.