Military Retirement Compensation System Can Be Improved to Cut Costs and Improve Equity

The U.S. Department of Defense can change its retirement system in ways that will save substantial amounts of money, while extending benefits to more veterans and maintaining its attraction as a recruiting tool, according to a new RAND Corporation study.

The proposed changes, which include allowing service members to become vested sooner than 20 years, could generate cost savings of between $1.8 billion and $4.4 billion a year, according to the study. The changes can be made while allowing the military to maintain the personnel level and experience mix it needs in the armed forces.

In September 2011, the Office of the Secretary of Defense convened a working group of senior department representatives to conduct a comprehensive review of retirement compensation.

Researchers from RAND, a nonprofit research organization, worked closely with the group and, using a new version of RAND's Dynamic Retention Model — a tool able to assess the effect of alternative compensation proposals on active and reserve component retention both in the long term and in the transition years — assessed many proposals that led the group to identify two broad concept designs.

RAND found that both design concepts retain the positive aspects of the current system while improving fairness and the department's ability to sustain funding of the plan, as well as providing the potential for more management flexibility.

The current military retirement system has existed in its basic form for nearly 70 years. The system is a defined benefit plan, where the amount of the benefit is defined by a formula based on basic pay, years of service and a multiplier. Service members are vested at 20 years of service, and in the case of active duty service members, receive an immediate annuity once they leave the military.

Study groups and commissions have criticized the current system as being inequitable, inefficient and inflexible. Only 34 percent of officers and 14 percent of the enlisted force serve long enough to receive benefits. In contrast, most civilian retirement plans are defined-contribution plans with nearer-term vesting standards — with vesting occurring after three to six years of employment.

The RAND study says the current military system is inefficient because it places too much compensation in the form of deferred payments, despite the fact that the typical service member is young and would prefer to receive higher pay as they serve, rather than a higher annuity once they complete 20 years of service. As a result, compensation costs are higher than necessary.

The system is considered inflexible because it results in retention profiles that are similar across occupations despite differences in training cost, learning curve and value of experience.

The RAND study found that creating a hybrid plan could address the criticisms. The hybrid plan would include both a defined benefit and a defined contribution plan, and it would have retention incentives in mid-career and a transition pay at separation to sustain the size and experience mix of the military force.

Such an approach has been recommended by prior studies, including the Tenth Quadrennial Review of Military Compensation. A hybrid system could provide both a predictable source of income for old age and a benefit that is available immediately upon separation from the military, which would ease the transition from military service to a second career.

The defined contribution plan would enable more service members to become vested, thus improving equity. Although the defined retirement benefit would be somewhat smaller, this would be offset by the retention incentives and transition pay. Also, shifting pay from future years to current years would save cost and make the system more efficient. The military services would be able to add to the retention incentives and transition pay, allowing them flexibility to shape retention by occupation, according to the RAND study.

If the retirement system were reformed, members under the current retirement system would likely be grandfathered. RAND found that giving grandfathered members the option to switch to the hybrid plan would accelerate cost savings to the Department of Defense.

The study, “Toward Meaningful Compensation Reform: Research in Support of DoD's Review of Military Compensation,” can be found at www.rand.org. The authors are Beth J. Asch, James R. Hosek and Michael G. Mattock.

Research for the study was conducted within the Forces and Resources Policy Center of the RAND National Defense Research Institute, a federally funded research and development center sponsored by the Office of the Secretary of Defense, the Joint Staff, the Unified Combatant Commands, the Navy, the Marine Corps, the defense agencies and the defense intelligence community.