Calculating Military Retirement

Before describing how the military retirement pay for a retiree is calculated, it is important to know that there have been numerous changes to the system over the past 30 years and there is understandably a lot of misunderstandings about the various systems currently in place.  As a career Navy Sailor, I lived through all these changes and routinely counseled Sailors and Marines about the differences between the three plans in effect.  The three plans all rely on the Date of Initial Entry into Military Service or DIEMS to determine which plan is applicable to a service member.  While the examples shown here use a maximum of 30 years of service, since 2007 any service beyond 30 years also earns retirement credit at a rate of 2.5 percent for each year of service.  This means that a 40 year career will earn a military retiree a 100 percent of base pay pension subject to the individual programs described below.

High Pay – DIEMS Prior to September 8, 1980

While the number of those service members who are in this group is rapidly shrinking as most services have a 30 year maximum service limit except for Flag and General officers (Admirals and Generals), there are a few.  This plan is the most straightforward of the three plans and is the easiest to calculate.  As long as the service member has at least 20 years, the calculation is final pay times 2.5 percent (0.025) times years of service.  This means that a retiree with 20 years gets 50 percent of final pay, one with 26 years gets 65 percent of pay and a 30 year retiree gets 75 percent.

High 3 Average – DIEMS prior to July 31, 1986 but After September 8, 1980

This group of retirees has it almost as good but it does require more planning to get the most retirement.  This group too is rapidly shrinking as most military personnel retire after they reach 20 years of service.  For this group the same formula is used but with a slight difference.  Instead of using final pay, an average of the last 36 months of pay is used.  This reduces the amount of the pension or retirement pay (it was in fact a cost cutting measure by Congress) due to the annual cost of living adjustment to pay that military members receive each year.  Another aspect of the high three average plan is that if a service member gets a promotion, they will need to serve three years at the new pay grade in order to get the full benefit of the promotion in their retirement pay. 

REDUX/High-3 Options – DIEMS after August 1, 1986

The most recent plan is known as REDUX and it is the most complex of all the retirement plans and the one that can also have the most negative impact on a military retiree’s financial future.  The key aspect of this plan is that the service member can choose to either take the high-3 average plan or take a reduced retirement in exchange for a cash bonus.  In either case, the decision must be made at the 15 year point and it is an irrevocable decision.  In other words, whatever choice a service member makes, it is forever and cannot be changed.

The easiest option is to take the High 3 Average option and go with the plan provides 2.5 percent per year and makes a 20 year career in the military worth 50 percent of base pay (averaged over the last 36 months).

The more complex option and one where the cash up front is not worth the cost to the retirement plan (in this author’s humble opinion).  If the service member decides to take the $30,000 lump sum cash payment, that is subject to taxes and reduces the take home to about $22,000, then the service member is committed to having a retirement that is only 40 percent of the high three average for a 20 year career.  Additionally, the annual cost of living adjustment (COLA) that retirees receive will be reduced by 1 percent each year until age 62.  At age 62, retirement pay is adjusted to an amount that it would be if the COLAs had not been reduced (but there is not back pay awarded) and the COLA reduction begins again for the rest of the retiree’s life. 

For service beyond 20 years, the effective formula is that each year beyond 20 and up to 30 is worth 3.5 percent of pay so that a person who takes the cash bonus and serves 30 years will get 75 percent of pay (at the high 3 average) but they will also see a 1 percent reduction in their COLA each year with the readjustment done at age 62.  Another adjustment that takes place at age 62 is that the percentage that the retiree would have earned under the high-3 average is restored so that a person who completed 20 years of service sees their percentage go up from 40 percent to 50 percent.

To put this in perspective, an E-6 who retires at 20 years in 2010 under high 3 has a retirement pay of about $1700 per month.  If this same E-6 had elected to take the $30,000 cash bonus the E-6’s retirement pay would be about $1350 per month.  This works out to $4200 per year and as the COLA is reduced in each subsequent year the amount grows to an even larger figure.  While the easy solution would be to serve longer than 20 years in order to make up the difference, each service has limits on how long a person can serve.  For enlisted personnel, only an E-9 can serve to 30 years without a waiver and officers also have limits on their length of service.  Making this decision at the 15 year point can have long term consequences and since most people who retire with 20 years of service are about 40 they can expect to draw a retirement check for about 30 years.  This means that the initial $4200 per year works out to a reduction of over $92,000 until age 62 in return for a $30,000 cash bonus that is only $22,000 after taxes.

The three military retirement plans are essential knowledge that every military service member should know so that they can plan their retirement’s financial situation.  Making the right decision for those who have a choice is essential so that the future will be what the retiree desires it to be.  Keep in mind that all retirement plans are based on base pay only and that any special pay and allowances, along with the housing allowance, are not included in the calculation of retirement pay.

Once decided, there is no going back.  Choose wisely!