Retirement benefit policy-how does the military do it? Is it different from how it works in state and local government? Yes-The Congressional Budget Office (CBO)'s new report "Costs of Military Pay and Benefits in the Defense Budget," helps to explain.
(1) Military pensions are cliff vested. Non-disabled service members vest at 20 years, and immediately qualify for a pension worth 50% of the average of their highest three years' basic pay, inflation-protected (reservists have to wait until they're 60 to draw benefits). They also have the option, at 15 years, to take an upfront $30,000 cash payout, and an eventual 40% rate with only partial inflation protection. State and local systems vest much earlier and use more gradual rates of benefit accrual. Only 49% of officers and 17% of enlisted men reach 20 years; all others (except the disabled) get literally nothing in the way of retirement benefits.
(2) The federal government does not really prefund military retirement benefits. Liabilities are calculated and there are, technically, funds set up both for pensions (the Military Retirement Fund) and healthcare for Medicare-eligible retirees (Medicare-Eligible Retiree Health Care Fund). But these funds only invest in "special issue" US Treasuries. Each year, both the Pentagon and Treasury set aside monies for future benefit costs. The pension and retiree healthcare funds then turn around and lend the money to the Treasury department, who will eventually pay it back to Defense.
As the CBO puts it "the balance in the fund...is a measure of the amount that the government has the legal authority to spend on military retirement payments under current law, although it has little relevance in an economic or budgetary sense." The special Treasury bonds are factored into the debt ceiling, but do not cause the government to be any more indebted, since what Treasury recognizes as a debit, Defense recognizes as a credit.
State and local governments of course, invest a wide range of securities, the return on which pays for a substantial portion of the benefits. But as the figure shows, federal taxes are the only source of revenues to pay for military retirement benefits. Military pensions are non-contributory.
(3) The unfunded pension liability is large (almost $1 trillion) and, because the Pentagon "invests" at such a conservative rate, the normal cost (the annual employer contribution for future benefits for active members), is an astronomical 34% of basic pay. That would be sort of like getting a 34% employer match on your 401k, except that only so-called "basic pay" is pensionable. For a service member, basic pay is a relatively small part of total compensation, since housing and food allowances, special tax breaks, special and incentive pay, and other perks and subsidies can boost take home pay by over 100%. But these extras can't be used to spike pensions. Thus, military compensation is much more front loaded than state and local governments', and there is far less incentive for pension fraud.
The military pay system seems more intelligently designed than state and local governments' systems because it gives much more consideration to need and performance. There exist more than 60+ forms of incentive pay for retention bonuses, special skills, hazardous duty, and other functions.
(4) Retiree healthcare is much more expensive for the military than for state and local governments. First, there's very little cost sharing. Active service members pay literally nothing and retirees not much more than nothing. (Healthcare for disabled and combat veterans are a separate case, handled by the Department of Veterans' Affairs). For years, the Pentagon has been trying to increase co-pays and deductibles but Congress has consistently blocked these efforts. Minimal cost sharing has produced a higher cost growth rate for military healthcare than for the nation as a whole and the CBO believes that it has also led to overuse.
Second, because of the 20-year vesting schedule, service members can retire as early as age 37. Their coverage continues into retirement, meaning potentially almost 30 years of coverage before Medicare assumes responsibility for most costs. For state and local retirees, 15 years (in cases of police and fire employees who retire in their early 50s) would be the upper end of pre-Medicare coverage. Pre-Medicare military retirees do have to pay more than active duty members, but the CBO estimates that the total cost for a typical retiree in 2011 was only $880, 18% of what a civilian would pay for a comparable plan. From 1995 to 2011, the boom years of health care cost growth, all pre-Medicare military retirees' healthcare costs were either fixed or reduced.
(6) The one important similarity to note consists in the fact that the legal status of military retiree healthcare is obscure, and has generated controversy. In the 90s, several retirees sued the Pentagon for discontinuing most standard coverage for Medicare-eligible retirees. They claimed that forcing them to pay Medicare's co-pays and deductibles violated an "implied-in-fact contract" of free healthcare for life. The retirees lost the case, because the court ruled that only Congress had the power to grant lifetime healthcare, and this power had never been delegated to Defense. But then it became a non issue because Congress established a special new Medicare supplemental plan for retirees in 2002.