An article came out in MilitaryTimes about a month ago, that once again discussed how to tweak military pensions. The latest and greatest ideas are the result of the Military Compensation and Retirement Modernization Commission’s report, which came out on 29 January. As someone who has blogged multiply times about the value of a military pension (here, here and here), I was interested in reading the article. I did not get too far into the article when I started to notice problems with the commission’s suggestions. From the article…..
For example, the charts lay out a comparison for a hypothetical service member who retires as an E-7 after 20 years. The current system would give that member a total retirement benefits package worth $201,282, while the proposed system could offer total assets worth more than $248,000.
The above quote about the current system’s value seemed ridiculous to me. An E7 retiring today (assuming they did not take the REDUX plan), should be receiving a little over $2,000 per month in retirement pension. Using my $23,035.55 estimated value per $100 of pension, gives a retirement benefits package worth $460,711, which is well over twice what the commission is valuing the current retirement benefits package at. Something is definitely off here. To come up with a present value of a pension, there are only a few inputs:
- The dollar amount of the pension. This is not very subjective and I doubt that this is the source of the discrepancy.
- The length of time that the pension is collected. Perhaps the commission is assuming E7s will all die in their 50’s? I doubt if this is the problem, actuary tables are fairly accurate and stable over time.
- The discount rate used to quantify the time-value of money. I bet this is the problem.
Reading further into the article I find another gem…..
the total value of the current retirement benefits for a senior enlisted member was pegged at $201,282 — a small fraction of the $1.1 million figure cited for “lifetime retirement income” for the same hypothetical E-7 retiree in a Defense Department report just last year
This $1.1 million number is just as ridiculous as the commission’s number. This inflated Defense Department figure is the result of not using a discount rate. Basically they are just adding up all of the pension payments and saying this is how much it is worth. This figure is basically a recruiting and retention tool, but at least it is not as nefarious as the commission’s figures. Then the article gets to the meat of the matter….
The data in the commission report also reflects very different discount rates for officers and enlisted members. The commission’s estimate on the value of an enlisted member’s retirement benefit was cropped by 12.7 percent a year. But the estimate of the value of a hypothetical O-5’s retirement benefit was discounted by just 6.4 percent.
Aha! The truth is revealed.
Basically, the bottom line is that enlisted member’s do not properly account for the time-value of money, and would happily trade their pension for a Ford Mustang, a weekend in Las Vegas and a year supply of beer. What is really annoying is the commission’s assumptions regarding “lump-sum” payments and 401K contributions to offset the reduced pension amounts. The commission assumes that the enlisted member, who just-a-second-ago could not grasp the time-value of money, will suddenly make consistently superior financial decisions with the lump-sum payments and 401K plans, and not spend their largess on Mustangs, weekends in Las Vegas and beer. This logic is a tad inconsistent to say the least.