MBA Student Analyzes Military's Overhauled Retirement System

Monday, November 16, 2020

Compass needle points towards the word "retirement"
begin quoteIn 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.

Sometimes a school assignment can become a highlight on your resume. That’s exactly what happened to Zach Denison, a Part-Time MBA student at the University of San Diego School of Business. His professor, Adjunct Clinical Professor Steven Levkoff, describes Zach as a “top performer” so perhaps it should be no surprise that his class paper was published by the U.S. Naval Institute. Professor Levkoff had assigned students in his Economics in a Global Environment class to write an analytical paper that identifies a source of market failure or inefficiency, why the inefficiency occurs and how to improve the market outcome. As a member of the U.S. Navy, Zach chose to write his paper about the U.S. military’s overhauled retirement system.

Read Zach’s article below.

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...