New military pension rules need financial advisers to step up and serve

Congress’ latest rewrite of the retirement-savings plan for the military introduces an opportunity for financial advisers, though it remains to be seen whether they will step up and serve this unique market segment that is generally known for lower incomes and smaller account sizes.

By combining a traditional defined benefit pension with a defined contribution plan that includes a 5% matching contribution, the changes in the 2016 National Defense Authorization Act will place increased retirement-planning responsibilities on the shoulders of tens of thousands of active military members.

“This is not just an opportunity, it’s an obligation,” said Scott Spiker, chairman and CEO of First Command Financial Services, a $23.9 billion advisory business that specializes in working with current and former military personnel.

“The new rule is shifting an age-old pension plan to a defined contribution plan for a group of people who are less paid and less prepared to make these kinds of financial decisions,” he added. “We, as a profession, need to take this seriously.”

The so-called blended retirement system for the military alters the military’s 80-year-old defined benefit pension plan for those retiring after 20 years or more of service.

Anyone enlisting after January will be offered a reduced pension along with access to the government’s Thrift Savings Plan that will include a 5% matching contribution.

Current active military with up to12 years of service have the choice of opting for the new blended plan or staying in the traditional pension plan.

From a market-potential perspective, consider that there is approximately $500 billion currently invested through the Thrift Savings Plan, but 90% of the more than 5 million individuals allocating to that plan are represented by non-military federal employees.

“This new plan will make the TSP much bigger,” said Mr. Spiker.

As is currently the case, active duty military can opt out from an automatic 3% annual contribution, but even if they do, starting in January the government will be contributing the equivalent of 1% of their income into their retirement account.

Mr. Spiker said the rule change puts more emphasis on the individuals taking charge of their retirement savings and investing.

“That presents its own challenges, because this is not a group that has historically been at a high level of financial readiness, and we are now putting more risk onto these people,” he said. “If these people are not coached that you never, ever disenroll from this plan they will hurt their retirement savings significantly.”

For financial advisers working with the military, the new rules introduce new planning decisions.

While only about 11% of active-duty military personnel stay in long enough to earn a full pension, the new matching advantages of the TSP increases the risk of people leaving money on the table in a plan that works just like an IRA.

“I can certainly see the opportunity for engagements in working with people on their TSP,” said Curtis Sheldon, owner of CL Sheldon & Co., a $20 million advisory firm that works primarily with people in or near retirement from the military.

“The changes I’m seeing are just like any other change from a defined benefit to a defined contribution plan,” he said. “And I would anticipate a greater need for advisers from younger cohorts in the military.”

It is true that the changes to the military pension plan follow a decades-long trend of moving away from defined benefit plans, but it still represents a new challenge for those serving, and a potential opportunity for those advising.

“The new plan will reduce the benefits from the present system, but they will get a partial pension and even if they don’t retire from the military they will have an opportunity for a matching contribution,” said Skip Fleming, a retired Marine and a fee-only financial adviser at Lodestar Financial Planning.

In addition to the need for increased education on the importance of investing often and early in a retirement plan, those active military members in the window of less than 12 years of service will have a decision to make about choosing the traditional pension or opting for the new blended plan.

According to an analysis by First Command, anyone who plans to stay in through retirement should stay on the old defined benefit plan and then try to max out contributions to the TSP, which will not include matching contributions under that scenario.

But someone planning to get out before the 20-year minimum retirement mark, should opt for the new plan, and take advantage of the matching contributions.

And, as Mr. Spiker pointed out, even though participants have until the end of next year to decide, anyone opting for the matching version should declare that in January to take advantage of the full-year’s benefits.

Of course, that decision is just the most recent financial puzzle that can face members of the military.

The new rules also include a “continuation bonus” at the start of each re-enlistment that can be either rolled directly into the TSP or taken out as cash, minus a 20% penalty.

“That’s money the new blended retirement system is assuming will help people save for retirement,” Mr. Spiker said. “But if they take it and blow it, it’s just gone money.”

Another twist of the new plan is the option to take a cash portion of future retirement income at the end of service, in exchange for a lower pension payout during retirement.

Under the traditional pension, the annual retirement income is equal to 50% of the average of the pay during the last three years of active service.

For those retiring under the blended system, the payout is 40% of the average pay of the last three years of service. But the new plan also allows retirees to take a cash advance in exchange for pension payout as low as 10% of the average three-year income.

“By taking the cash advance, you would be giving away hundreds of thousands, if not a million dollars in exchange for tens of thousands of dollars upfront,” Mr. Spiker said.