Budget puts military pension plan in cross hairs

Federal budget woes are forcing once-untouchable military pensions onto the cutting board as the Pentagon faces $450 billion in budget cuts over the next decade and an unfunded pension liability expected to hit $2.7 trillion by 2034.

Defense Department officials are playing it close to the vest as the Obama administration prepares to deliver its 2013 budget to Capitol Hill in early February. The budget is not expected to contain wholesale changes for military compensation, but the White House has promised to create a commission to examine the military's retirement system, which had assets of $278.4 billion as of Sept. 30, 2009, according to a 2009 valuation by the DOD Office of the Actuary, the most recent data that could be obtained.

Defense Secretary Leon Panetta, a former White House budget director, stresses that current service members' pensions are off the table for the commission, but has not ruled out changing the retirement program for new entrants.

“The big word is grandfathered,” said Michael F. Hayden, referring to what benefits would be retained for current members and retirees. Mr. Hayden is a retired U.S. Air Force colonel and deputy director for government relations with the Military Officers Association of America in Alexandria, Va. “There is so much rhetoric now, but I think there are going to be changes to the (retirement) formula.”

Right now, the system's 20-year vesting rule means many members of the military walk away with nothing, while those who put in 20 years or more can retire with at least half their salary and other lifetime benefits. In 2010, those payments cost the Department of Defense $50 billion. By 2034, it could balloon to $108 billion, according to the Defense Business Board, a high-level Pentagon advisory panel.

A better approach, DBB members said in a report last year, is tapping into a defined contribution plan like the $291.8 billion Federal Thrift Savings Plan (Pensions & Investments, Sept. 5). That would help shrink that projected $108 billion and stop the meter running on unfunded liabilities, which are now at $1.3 trillion but expected to double by fiscal year 2034.

DBB members don't like the fact that the Military Retirement Trust Fund is legally limited to conservative investments in U.S. Treasuries. The fund relies on investment income for a third of its annual income, plus annual contributions from the services and Treasury. In fiscal 2009, investment income brought in $3 billion, down from $16 billion in fiscal 2008.

The board's biggest complaint is that the current system is simply unfair, considering that 83% of military members don't stay in the services long enough to vest. For those who do stay at least 20 years, it offers 50% of final salary for life, while those with at least 35 years of military service get 87.5% of their final salary. And with life expectancies increasing, that tab is growing more expensive.

But Mr. Hayden cautioned against comparing military pensions to the private sector just on the dollars. “It's more the conditions of service — the hours are kind of crazy, you move 20 or 30 times, and sometimes you're getting shot at.”

Service members not prepared to wait 20 years have led to steady growth in military enrollment in the Uniformed Services section of the TSP, from 280,000 participants in 2002 — the first year they could participate — to 699,000 as of July 2011.

The services also won approval from Congress at the end of 2011 to use a temporary early retirement incentive for members with 15 years or more of service to start trimming pension costs. “We believe that it is a much better tool” than forced layoffs in a weak job market, said Mr. Hayden, a former Air Force budget planner.

With personnel costs one of the fastest-growing areas of the defense budget, and roughly one-third going toward pensions, doing nothing is no longer an option, defense experts say.

Todd Harrison, a senior fellow with the Center for Strategic and Budgetary Assessments, Washington, warns that if total costs, which include pay, retirement and other benefits, continue to rise at 4% annually, “the entire Pentagon budget would go to personnel costs” by 2039. “If you had 25 cents on the dollar go into defined contribution, and you can control investments, that would save a ton of money,” he said.

The idea to change military pensions is hardly new, with proposals stretching back to the end of the draft in the 1970s that focused on improving recruitment. “That's still the case today,” said Mr. Harrison. “Now we have to attract them and give them a retirement system that's flexible and portable and would benefit more people, and it would cost less.”

To find out what current and potential military members value most in retirement and compensation packages, the center is conducting an independent study — the results of which are due in spring — “to understand how we get the best bang for our buck. I suspect that they will find, like the private sector, that they could increase pay and the use of defined contribution plans.”

At the Pentagon, the scope and timeline of the administration's proposed commission remains unclear. Pentagon spokeswoman Eileen M. Lainez said in an e-mail that “no decisions have been made regarding changes to retirement” and stressed that any change will take careful consideration of both current and future work-force needs.