The Associated Press asks “Are military pensions too generous,” which in terms of precision is a little like asking “How’s your wife?” (In both cases, “compared to what” comes into play.) The AP reports that the Obama administration is thinking of shifting both the form and the generosity of military pensions. A report from the Defense Business Board points out that military pensions are generous relative to the private sector, but that benefits are concentrated in the small percentage of servicemen who stay for 20 years. The Board recommended a shift to the defined contribution Thrift Savings Plan, which the military participates in but does not match employee contributions.
Military pensions require that an individual have 20 years of service before becoming eligible. And, unlike other areas of public service, in the military you need to be promoted to retain your job, meaning that a lot of folks who would be willing to stay 20 years don’t get to do so. This makes military pensions a winners vs. losers game: the 83 percent who leave before 20 years get little or nothing, while those who make it to 20 years receive half pay for life. (Full disclosure: my brother is a career Navy officer with more than 20 years of service, who presumably is looking forward to a life of half-pay leisure…)
The generosity is more difficult to measure due to the differing accounting conventions of defined benefit pensions. What we want to know is the value of what’s called the “normal cost” of the pension, which represents the value of benefits accruing in a given year. If the normal cost is 10 percent of pay, then you would be roughly indifferent between receiving your pension and getting a 10 percent salary increase each year.
The Department of Defense reports a “normal cost” of pensions for full-time workers of 32.7 percent of pay. That’s pretty generous; for ordinary federal employees, the normal cost, including both defined benefit pensions and employer matches to the Thrift Savings Plan, is around 17 percent of pay. So military pensions are more generous than federal civilian pensions, which are themselves far more generous than pensions in the private sector, where the typical employer contribution toward pensions is around 6 percent of salaries.
Moreover, to make defined benefit pensions comparable to defined contribution plans you need to adjust for different accounting conventions. Federal DB pensions assume an interest rate of 5.75 percent, versus the current Treasury yield of around 4 percent. Put another way, federal employees receive a guaranteed return of 5.75 percent on their and their employers’ contributions while a worker with a 401(k) plan could receive a guaranteed return of only around 4 percent. Adjusting for those differences, military pensions are worth around 1.6 times more, or about 52 percent of salaries. Pretty sweet, so long as you make it to 20 years to receive the pension.
How do military pensions compare to those of other high-risk government jobs, such as police and firefighters? For instance, the Florida Retirement System’s Special Risk plan reports a normal cost of 22 percent of pay, but this is based on an assumed 7.75 percent discount rate. Again adjusting to a 4 percent Treasury rate for consistency, that would rise to close to 58 percent of pay. So Florida police and firefighters receive more generous pensions than do members of the military. My guess is that being in the military is a bit tougher — more time away from your family, plus a fair amount of getting shot at — but that demands more analysis.
My gut is that both military pensions and public safety pensions are too generous; that is, the military allocates a greater share of total compensation to retirement benefits than a rational individual would if you simply gave him a single pot of money and let him split it between wages and benefits. My gut also tells me that part of the reason public sector pensions are so generous is that — because no one can figure out exactly what they cost (see my calculations above) — generous pensions and other fringe benefits allow total compensation to rise higher than would be politically sustainable if pay increases came through salaries, the generosity of which are easy for the public to gauge.
Would it make sense for the military (and, for that matter, police and fire) to shift to a DC pension structure? Probably so. It’s fairer to different employees, doesn’t penalize people who want to leave for a different career, and has far more transparent accounting so the risk to government finances and the taxpayer is lower.
