Holding The Line On Military Pensions

Volume V, Number 4 February 25, 1999

Congress and the White House are rushing to repeal the Military Retirement Reform Act of 1986, better known as "Redux." Proponents of repeal claim that Redux, which trimmed pensions for everyone joining the military after July 31, 1986, is causing an exodus of skilled servicemen, and that bigger pensions are needed to boost retention rates and ensure military readiness.

This claim is dubious. Military pensions remain extraordinarily generous, even after Redux. And while falling retention rates are a genuine problem, bigger pensions are not a cost-effective solution. Virtually every expert who has looked at the issue concludes that, to the extent low compensation is responsible for low retention, the culprit is pay, not pensions.

The real attraction of repealing Redux is that it lets political leaders pretend to offer something for nothing. While larger paychecks show up immediately in the budget bottom line, the impact of repealing Redux would be trivial until 2006, the date the first affected servicemen start retiring. All of the large long-term cost--an increase of as much as 18 percent in annual pension outlays, according to the Congressional Research Service--is off the books and over the horizon.

This is not to say that improving retention won't require spending money. Political leaders should take a careful look at all of the options, including pay hikes, targeted bonuses, and, perhaps, a new funded thrift plan. The rush to repeal Redux, however, merely promises to add to government's unfunded liabilities--while sending an unfortunate signal about Washington's ability to make tough choices on entitlements and stick with them.

An Elite among Pensioners

Let's start with the generosity of military pensions. All servicemen who joined the armed forces before August 1, 1986, are entitled to a pension replacing 50 percent of basic pay after twenty years, the minimum term of service required to qualify for military retirement. True, this basic pay does not include cash and in-kind allowances. But it is liberally calculated: on the basis of the final month of pay for servicemen who joined the military before September 8, 1980, and of the highest three years of pay (the "HI-3" method) for those who joined later. If servicemen postpone retirement, their pensions increase by 2.5 percent of pay per year, until, after thirty years in the military, a maximum replacement rate of 75 percent is reached. Each year, pensions receive a COLA equal to 100 percent of the CPI.

So generous are these terms that two out of three officers and nine out of ten enlisted men who stay on for at least twenty years retire before completing twenty-five years. The average retirement age for officers is now 45. For enlisted men, it is 41. The result is that the typical member of the armed forces retiring this year will spend many more years collecting benefits (36 for a man and 41 for a woman) than earning them (21 years).

The extraordinary duration of retirement is the main reason that military pensions are so costly. According to DOD's Office of the Actuary, the "normal cost" of HI-3 pensions for servicemen who joined up before Redux is 33 percent. That's the share of payroll that would have to be set aside annually, throughout their careers, to prefund benefits. By comparison, the normal cost of the typical private-sector pension is just 6 percent. In addition, all servicemen are covered by Social Security. And the vast majority of military retirees pursue second careers, meaning that many become "triple dippers," earning a private (or federal civilian) pension as well.

All of this makes military retirees an elite among pensioners. Families receiving military pensions reported a median income of $60,728 in 1997, compared with $38,930 for families receiving private pensions. Just 8 percent of families with military pensions reported incomes of less than $25,000. For families with private pensions, the share was 22 percent.

A Matter of Perspective

How much will this picture change when servicemen affected by Redux start retiring seven years from now? Not much. Servicemen who joined the armed forces after July 31, 1986, are entitled to a pension replacing 40 percent (rather than 50 percent) of HI-3 pay after twenty years. Beyond twenty years, however, each extra year of service is worth 3.5 percent of pay (rather than 2.5 percent), meaning that the replacement rate after thirty years remains an unchanged 75 percent. Redux also reduced COLAs to the CPI minus 1 percentage point. However, retirees will receive a one-time "catch-up" at age 62, when pension benefits are recalculated using the pre-1986 benefit formula and as though they had always been indexed to 100 percent of the CPI.

All told, Redux reduced the normal cost of military pensions from 33 percent of payroll to 28 percent. For a lieutenant colonel retiring at age 43 with twenty years of service, the cut in lifetime pension benefits, expressed as a lump-sum at the time of retirement, comes to roughly $100,000. Whether that seems like a lot is a matter of perspective. The cut, for example, is more than the present value at age 65 of an average-earning male's total lifetime Social Security benefit. On the other hand, it's just one-seventh of the lump-sum value of the pension received by a lieutenant colonel retiring on January 1, 1998--which is a staggering $681,276.

No Statistically Significant Difference

Redux was enacted in 1986 amid broad bipartisan consensus that the generosity of military pensions was excessive and had to be trimmed. But ironically, it had another purpose as well: to boost retention. By cutting the initial replacement rate (at twenty years) while leaving the ultimate replacement rate unchanged (at thirty years), Redux was explicitly designed to encourage experienced career officers to remain in the armed forces beyond their twentieth year of service.

No one yet knows whether Redux will achieve this objective. But it is already being criticized for something else. Proponents of repeal say that Redux has backfired, and that the lower initial replacement rate is causing large numbers of servicemen who would otherwise have stayed on for twenty years to quit sooner.

Proponents, however, can produce little hard evidence to support this claim. The best data we know of come from a new West Point study, which looks at retention rates among officers commissioned in 1987. This group contains individuals covered under both pension systems, since Redux grandfathered all military cadets and ROTC scholarship students. The study finds no statistically significant difference in retention rates.

In fact, many things besides pension rules have changed since 1986 that might explain falling retention rates. For starters, there's the end of the Cold War. The massive downsizing of the past decade has closed off opportunities for advancement. The number of overseas deployments has also multiplied, adding to the hardship of military life. All of this has hurt morale.

Meanwhile, a booming private economy offers servicemen many more employment alternatives. While studies have consistently shown that military pensions are far more generous than private-sector pensions, they have also found that pay often falls short. And pay is what matters most to servicemen at mid-career--who, after all, are young men and women in their late twenties and early thirties, many busy raising families.

A Cockeyed System

In recent years, Americans have been outraged by reports that many thousands of servicemen are poor enough to qualify for food stamps. How did we ever get such a cockeyed compensation system--one in which young men and women in uniform often serve for near-poverty pay, while retirees barely out of their thirties can collect lavish pensions, inflation-indexed for life?

Not because it is the most equitable system. And not because it is the best at promoting retention. Of all those who ever serve in the military, 79 percent of officers and 92 percent of enlistees quit before becoming eligible for a pension--and this is under the pre-Redux rules that, in the name of retention, Congress and the White House are rushing to reinstate. Rather, we have gotten it for the same reason we have gotten the rest of our entitlement system--because the benefit promises are costless until they come due on someone else's watch.

Yes, there is a military retirement trust fund that ostensibly funds benefits. But the operations of this fund are mere paper transactions having no impact on the budget bottom line. In reality, the entire cost of tomorrow's military pensions will be borne by tomorrow's taxpayers. Repealing Redux is the equivalent of deficit financing--without the bother of issuing formal debt.

There are more efficient ways to improve retention than to channel still more of military compensation to retirees. But if pensions are increased, let's at least fund the benefits. One idea is to set up a supplemental thrift plan similar to that for federal civilian employees. Some will object that thrift plans are portable, and so won't help retention. But this need not be so. Contributions could be personally owned, for instance, but forfeit if servicemen quit before ten, or fifteen, or even twenty years. It's hard to imagine a stronger retention incentive than seeing your own money grow year after year.

Our advice to Congress and the White House is to hold the line. It is doubtful that a repeal of Redux will achieve its stated objective. All that is certain is that it will add to long-term budget costs--and dim the prospects for comprehensive entitlement reform by reversing one of the few tough choices we've already made.


. Last updated: 25 Feb 1999