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$30,000 Redux bonus could cost you $427,000

A $30,000 bonus — tax-free if taken in a war zone — has to look attractive to many U.S. troops in times of economic turmoil.

Whether you are upside-down on your mortgage — owing more than the house is worth and possibly facing escalating monthly payments because of an adjustable rate loan — or your spouse has lost a job, or the credit card bills are mounting, many midcareer service members could find good use for the one-time payment offered as they reach the 15-year mark of a military career.

But there’s a huge downside — taking the Redux bonus puts you in a much less generous military retirement plan that will cost you dearly in your post-military life.

“It is easy to see why some people might look at the $30,000 — which is probably $23,000 after taxes — as a pot of money coming at exactly the right time,” said Steve Strobridge, director of government relations for the Military Officers Association of America.

“But this would be a huge mistake,” Strobridge said. “The only time when anybody ought to consider this is when the mafia is holding your parents hostage on their 50th anniversary and demanding $20,000. Taking the Redux bonus is never a good deal.”

Strobridge, a retired colonel and former director of compensation for the Air Force, said he has made it a personal cause to talk people out of taking the bonus whenever possible.

How they work

The $30,000 bonus, officially called the Career Status Bonus, was created by Congress in 1999 and first became available in 2001 as part of an overhaul of military retired pay that gave career service members a choice between immediate or future benefits. The choice, made at the 15-year point of a career, is available to anyone who entered the service since Aug. 1, 1986.

The better pay option computes retired pay for each year of service at 2.5 percent of average basic pay over a member’s three highest-earning years in uniform. For 20 years, that works out to 50 percent of average basic pay over the three highest-earning years.

This plan also has a cost-of-living adjustment each year that matches the increase in the U.S. Consumer Price Index.

The Redux option provides the $30,000 cash and a more complex — and much less generous — formula for retired pay and cost-of-living adjustments.

For the first 20 years of service, a retiree receives 2 percent of average basic pay over the three highest-earning years in uniform. For each year beyond 20, a retiree receives 3.5 percent of the high-three average.

Moreover, annual cost-of-living adjustments under Redux are one percentage point lower than under the better retirement plan each year until a retiree reaches age 62. At that time, a one-time “catch-up” COLA resets the payment at the level it would have been if the member had received full adjustments over all those years. But after that, COLAs under Redux again begin to lag those offered under the other plan by one percentage point per year.

Under both plans, retired pay equals out at 30 years of service, at 75 percent of basic pay — which masks the fact that benefits are lower for anyone who retires with less than 30 years and also does not account for the cumulative effect of cost-of-living adjustments that are perpetually lower than the annual increase in expenses for food, medical care, housing, transportation and the other goods and services that are part of the Consumer Price Index.

And once made, the choice is irrevocable.

The power of compounding

“Some people do not understand the power of compounding,” Strobridge said. “Taking a 10 percent cut right away and a 1 percent cut in cost-of-living adjustments for the rest of your life may not sound like much, but this is a huge difference over a lifetime.”

For E-7s with 20 years of service who retire at age 38, taking the $30,000 bonus and the lower Redux annuities yields a $427,000 reduction in lifetime earnings if they live to age 78.

The loss is even greater for officers than enlisted members because officers receive more in retired pay. And the choice is even more punishing for someone who lives beyond the typical life expectancy, which the Centers for Disease Control and Prevention have calculated to be 77.8 years.

A retired O-5 who lives to age 90, for example, would forfeit a cool $1 million, according to MOAA.

The estimated loss of $427,000 in lifetime retirement earnings for an E-7 who retires at 20 years, arrived at by updating a 2004 earnings comparison from MOAA, is higher than a figure cited by the Center for Naval Analyses.

CNA said in an Oct. 15 analysis for the Marine Corps that E-7s with 20 years of service will have their retired pay reduced by $344,434 if they take the Redux bonus, while O-6s with 26 years of service would lose $339,765.

While the calculations are different, the conclusion of the Alexandria, Va.-based nonprofit research group is the same as Strobridge’s.

“If Marines select the Redux retirement plan and the $30,000 bonus, they are effectively borrowing against their retirement pensions,” CNA says. “Virtually all Marines who elect the $30,000 will lose about $300,000 or more in retirement monies over the course of a normal lifespan.”

Strobridge said the lifetime differences are so large that any service member considering taking the bonus needs to stop and think hard about what they would be giving up.

Someone who opted for the Redux bonus and had to pay taxes on it — everyone outside designated combat zones — would take home about $22,500.

Making up for the loss in lifetime annuities would require investing that money in ways that yielded a 20.5 percent annual return for the average enlisted member and a 28.5 percent annual return for the average officer, Strobridge said.

“I don’t know anyone who can do that, especially not today,” he said.

By the time people who retire at 20 years of service reach age 60, their annuities are one-third less than those of 20-year retirees who choose the more generous plan, according to MOAA.

Not all bad?

Not everyone believes taking the Redux bonus is the wrong move.

Retird Army Col. Charles Abell, a former senior Pentagon personnel official and the chief architect of the $30,000 bonus option, said some service members may find a cash payment at 15 years of service fits into their plans pretty well.

“Career people are adults, and this is a decision to be made by them,” said Abell. “I have always said some families need capital right now, and that is what the option offers.”

Abell, a Vietnam veteran, was a staff member on the Senate Armed Services Committee when he pushed the idea of creating a $30,000 bonus option as part of a military retirement reform plan that restored the option of full cost-of-living allowances to troops who had entered service after Aug. 1, 1986.

His plan, which became law, helped to undo an earlier retirement-cutting law that senior military leaders feared would lead to an exodus of experienced midcareer people who would no longer be drawn to stay in the military for 20 years.

Offering the option of a big cash bonus at 15 years of service in return for a promise to serve to 20 years was seen as a sweetener to get people to stay in the ranks.

The bonus, Abell said, “could be used to buy a new Camaro, it could pay for a spouse to go to college or the money could help with a down payment on the house a couple has always wanted.”

“I don’t think what they do with the money is our concern,” he said. “Our obligation is to explain the options to them, and let them decide.”

Retired Lt. Gen. Theodore Stroup Jr., a former Army personnel chief and now vice president of the Association of the U.S. Army, said he is reluctant to tell anyone to take or reject the bonus.

“I really don’t think any of us can second-guess a person or family’s financial choices,” Stroup said. “If someone approached me and asked, I would want to know the circumstances that makes them think taking the bonus is good for them. I would ask what they plan to do with the money, and if there was another way to get it. I would not automatically say it is always bad.”

Abell and Stroup agree with Strobridge that troops making a decision about retirement options need more information than they often get from the services.

The Pentagon has a Web site explaining the options, and includes a calculator to show the differences, but it’s not well-publicized, Strobridge said.

“The two retirement plans provide service members with a choice; which is best is dependent upon the individual member’s unique situation,” Pentagon spokeswoman Eileen Lainez said.

She said the Web site with facts about the two plans and a calculator to check differences in payments can be found at www.defenselink.mil/militarypay/retirement/ad/05_retirementchoice.html.

In most cases, Strobridge said, a midcareer service member has other, better options than taking the $30,000 bonus.

For example, he said, someone with problems keeping up on their mortgage should talk with the lender about refinancing or renegotiating payments.

“Saving your house is important if you are behind on your mortgage, but $23,000 is not going to save it,” Strobridge said. “Most people in trouble owe a lot more than that. If all you owe is $23,000, get down to your bank or credit union and get a loan.”

Temporary financial problems from lost jobs or large debts also do not justify taking a lifetime loss in a pension, Strobridge said.

“I understand times get tough, but you are never going to be able to make up the difference it will cost you,” Strobridge said.

Another reason sometimes suggested for taking the bonus is to provide seed money to start a business. But Strobridge said that even there, other options are available, noting that the Small Business Administration has programs to help veterans get loans that could allow them to avoid raiding their retirement pay.

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DISCUSS:

Have you considered using the Redux bonus?