Saturday, June 13, 2015

A bad plan for many reasons

 I've held fire on the new DoD retirement plan, waiting for some details rather than analyze the rumors and half-truths.  We now have some definition.  The new plan would have:

- Members contribute to TSP with DoD matching.
- Mid-career you'll get a bonus.
- If you stay to 20 years, you get a reduced per month amount (40% vs. 50% base pay).

While it has some advantages, some are touting it as more fair.  From everything I see, it's worse in almost all respects.

TSP matching is delayed.  You don't get a TSP account right get it after 2 years of service.

DoD will establish for each Service member a TSP account and automatically contribute an amount equal to 1% of a Service member’s basic pay (or Inactive Duty Pay for a Selected Reserve member) into that account upon entry into the service until separation or retirement. Vesting would occur upon completion of 2 YOS.

For the average E-1, what does that mean?  E-2 pay is 1,734 a month, so that's 17 dollars per month, or 408 dollars in 2 years.  If you wait until your 65, assuming 7% return, you'll have a grand total of ~8,800 dollars.

But wait!  That's the minimum you say, we'll actually get more with DoD matching!  Yeah, at 4 years of service:

DoD matching contributions to TSP. DoD will match service member contributions up to 5% of their basic pay. DoD matching would start upon completion of 4 YOS and continue to separation or retirement.

Not as great a deal.  Plus, remember that every dollar you put away takes a dollar from your pay.  So we'll probably have a lot of people that will opt out.

TSP member enrollment. Service members will be automatically enrolled in TSP upon entry, with 3% of their basic pay going into their account. Service members will be able to reduce their contributions or disenroll from TSP only after completion of financial literacy training at their first permanent duty station.

So yes, you're getting choices...but many of them will be forced on you.  The whole "first permanent duty station" could be as far out as 1-2 years for many servicemembers.

OK, but what about that mid career bonus?  That'll be a nice change right?

CP multiplier (months of basic pay).  The Services will each determine when, to whom, and how much continuation pay is offered, and the additional service obligation required.  The maximum CP multiplier shall be 22 for AC, 11 for RC; the minimum required additional service obligation shall be 1 year.

Read carefully...the services will determine when and to whom the bonus is offered.  As I read it, it's not a guarantee.  Is your rate overmanned?  Potentially no bonus.  This seems a bit ripe for abuse.

In the end, does it stack up financially?  I used a calculator at Bankrate to figure out what your TSP would be.  Keep in mind I'm not a financial planner, so you could do better or worse.  Let's assume that you enlist now and retire at 20 years as a chief.  I couldn't find a year-by-year calculator, so I averaged out what you would make over a 20 year career, assuming you make chief by around year ten (yeah, fairly generous).  I didn't account for any sort of inflation...sorry, not a math major.

A Chief's compensation
So let's assume you don't contribute anything, do twenty years and get the bare 1% a year.  On average, you're getting $413 dollars a year entered in.  Paltry!  And in the end, you'd only have $145,488 by age 65.  Assuming you can draw out 4% a year safely, you get 5,819 dollars from your IRA plus a 40% High-3 pay of 79,315 dollars, for a grand total of $85,134.  Under the old plan, you make $99,144 a year (look at year 2062, which is when this theoretical chief is 65 years old).

Average of 1% over a 20 year career.
But that's totally small.  Let's assume that our theoretical chief socks away 5% for the first four years, then gets matching.  Now we make some real money...over one million by the time we're 65!  We can draw 47,688 dollars a year from this, plus our High-3 pay of 79,315 dollars gives us 127,003...way larger than the 99,144 from High-3.

10% matching at Year 4, Hypothetical Chief 
So yes, you can absolutely beat the system as a 20-year Navy Chief, assuming you sock away money regularly and the market stays constant at 7% return.

What if you're a 20 year LCDR?  Assuming a normal progression, you look like this:
LCDR, by the numbers
Under the old system, by 2062 you're making $170,760 a year, or 136,608 under the new one.  A 1% IRA gives you only ~194K, which adds 7,760 dollars a year to your pay.  A 10% matching maxes out the calculator, so assuming you max out at 5500, you'll have ~1.6 million at the end, giving you an extra 65K a year, for a total of 201,608 a year.

None of this takes into account that you'll draw money between when you leave the service and when you reach 65 years of age.  

Yes, the new system can, given the right circumstances, beat the old one.  This assumes that you never hit a depression that wipes out your IRA.  It also takes money out of your bank account, which is hard to do early on in life, especially for young families.  Even worse, the government doesn't kick in money early in your career, negating the whole point of compounding interest.

I don't see the advantages for the user.  With this new retirement, the deck is stacked against you.  The only positive (if you can call this positive) would be you could take the money and walk away, whereas renouncing your citizenship or working for a foreign government means you lose your retired pay.  Although it's good to have options, arguing that this plan is better without discussing the pitfalls is dangerous.

In general, the new retirement shifts the risk to the uniformed member for investing and managing their own money.  While that may be OK for some people, most military members don't have the financial background to do this, and don't have the time between deployments to learn.  If anything, this gives servicemembers more incentive to leave at the 5-10 year point, which is exactly what we shouldn't be doing.

There is one advantage though:

Savings (steady state, 4% match).  DoD’s proposal will achieve real tangible savings to DoD over 10 years ($8.1B, FY17-26) and $14.1B in annual mandatory outlay savings in steady state (i.e., in 2118).  Annual DoD budget savings in steady state (2048) are projected to be $1.19B.