Military Retirement: Possible Changes Merit Further Evaluation (Chapter
Report, 11/15/96, GAO/NSIAD-97-17).

Pursuant to a congressional request, GAO reviewed selected aspects of
the military retirement system, focusing on: (1) military retirement
costs; (2) the role of military retirement in shaping and managing U.S.
forces; and (3) proposed changes to modernize the system and contribute
to more efficient force management.

GAO found that: (1) payments from the miliary retirement fund to
military retirees and their survivors have been rising over several
decades as both the number of military retirees and the average payment
to individual retirees have increased; (2) these payments are expected
to peak at slightly more than $30 billion, in 2007; (3) DOD annual
budgetary costs have declined because of lower benefits for new
entrants, changes in economic and actuarial assumptions to reflect
experience, and recent decreases in force size; (4) the military
retirement system provides an increasing incentive for service members
to stay in the military as they approach 20 years of service and
encourages them to leave thereafter, helping DOD to retain midcareer
personnel and yielding a relatively young force; (5) the system can also
impede effective force management because military personnel with less
than 20 years of service are not entitled to any retirement benefits;
(6) the services have been reluctant to involuntarily separate personnel
with less than 20 years of service, beyond a certain point, due to
financial consequences for service members and their families and the
resulting impact on morale; (7) some analysts belive the military
retirement system is an obstacle to achieving a force of the right size
and composition because the system provides the same career length
incentive for all categories of personnel; (8) proposals to change the
military retirement system range from modifications of various features
of the current system to more fundamental changes to the retirement
system; and (9) earlier vesting of at least a portion of military
retirement benefits is a common feature of proposed changes.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  NSIAD-97-17
     TITLE:  Military Retirement: Possible Changes Merit Further 
             Evaluation
      DATE:  11/15/96
   SUBJECT:  Military personnel
             Government retirement benefits
             Military budgets
             Military cost control
             Reductions in force
             Personnel management
             Service credit
             Military compensation
             Military downsizing
IDENTIFIER:  Civil Service Retirement System
             Federal Employees Retirement System
             Military Retirement System
             Joint Vision 2010
             Military Retirement Fund
             
******************************************************************
** This file contains an ASCII representation of the text of a  **
** GAO report.  Delineations within the text indicating chapter **
** titles, headings, and bullets are preserved.  Major          **
** divisions and subdivisions of the text, such as Chapters,    **
** Sections, and Appendixes, are identified by double and       **
** single lines.  The numbers on the right end of these lines   **
** indicate the position of each of the subsections in the      **
** document outline.  These numbers do NOT correspond with the  **
** page numbers of the printed product.                         **
**                                                              **
** No attempt has been made to display graphic images, although **
** figure captions are reproduced.  Tables are included, but    **
** may not resemble those in the printed version.               **
**                                                              **
** Please see the PDF (Portable Document Format) file, when     **
** available, for a complete electronic file of the printed     **
** document's contents.                                         **
**                                                              **
** A printed copy of this report may be obtained from the GAO   **
** Document Distribution Center.  For further details, please   **
** send an e-mail message to:                                   **
**                                                              **
**                                            **
**                                                              **
** with the message 'info' in the body.                         **
******************************************************************


Cover
================================================================ COVER


Report to the Honorable
Douglas (Pete) Peterson, House of Representatives

November 1996

MILITARY RETIREMENT - POSSIBLE
CHANGES MERIT FURTHER EVALUATION

GAO/NSIAD-97-17

Military Retirement

(703128)


Abbreviations
=============================================================== ABBREV

  CSRS - Civil Service Retirement System
  DOD - Department of Defense
  FERS - Federal Employees Retirement System
  QRMC - Quadrennial Review of Military Compensation
  RDT&E - research, development, test, and evaluation
  SSB - Special Separation Benefits
  TERA - Temporary Early Retirement Authority
  TSP - Thrift Savings Plan
  VSI - Voluntary Separation Incentives

Letter
=============================================================== LETTER


B-275254

November 15, 1996

The Honorable Douglas (Pete) Peterson
House of Representatives

Dear Mr.  Peterson: 

This report responds to your request that we review selected aspects
of the military retirement system.  Specifically, we addressed (1)
military retirement costs, (2) the role of military retirement in
shaping and managing U.S.  forces, and (3) proposed changes to
modernize the system and contribute to more efficient force
management.  As part of our review, we hosted a roundtable discussion
on June 12, 1996, at which several current and former Department of
Defense officials and compensation experts expressed their views on
those aspects of the military retirement system included in our
review. 

We are sending copies of this report to the Chairmen and Ranking
Minority Members, Senate Committee on Armed Services, House Committee
on National Security, and Senate and House Committees on
Appropriations; the Secretary of Defense; and other appropriate
parties.  We will also make copies available to others on request. 

Please contact me at (202) 512-5140 if you or your staff have any
questions concerning this report.  Major contributors to this report
are listed in appendix IV. 

Sincerely yours,

Mark E.  Gebicke
Director, Military Operations
 and Capabilities Issues


EXECUTIVE SUMMARY
============================================================ Chapter 0


   PURPOSE
---------------------------------------------------------- Chapter 0:1

In recent years, U.S.  armed forces have been affected by substantial
changes, including the end of the Cold War, subsequent downsizing,
and significant technological advances and associated increases in
skill requirements for military personnel.  Also, considerable
changes have been made to the design of many civilian retirement
systems over the past
2 decades.  All of these changes, along with increasing federal
budget pressures, have focused attention on whether the military
retirement system is best designed to efficiently meet the needs of
the Department of Defense (DOD) and members of the military services. 

As requested, GAO reviewed the military retirement system. 
Specifically, GAO addressed (1) military retirement costs, (2) the
role of military retirement in shaping and managing U.S.  forces, and
(3) proposed changes to modernize the system and contribute to more
efficient force management.  As part of its review, GAO hosted a
roundtable discussion on June 12, 1996, at which several current and
former DOD officials, as well as compensation experts, expressed
their views on those aspects of the military retirement system
included in GAO's review. 


   BACKGROUND
---------------------------------------------------------- Chapter 0:2

The basic structure of the current U.S.  military retirement system
was established in legislation over a period of years, ending in the
late 1940s.  The system provides benefits to nondisabled service
members when they retire from active or reserve duty and service
members who retire on disability.  It also provides for optional
survivor coverage.  It is a noncontributory, defined benefit plan
that allows retiring active duty service members with 20 or more
years of service to receive an immediate, lifetime annuity with
cost-of-living adjustments, regardless of age.\1

In 1980 and 1986, the benefit formulas for new entrants to the
military services were changed to reduce costs, and the 1986 changes
provided incentives for longer careers.  Although the basic structure
of the retirement system was left intact, the changes in the benefit
formulas resulted in the three separate versions of the military
retirement system that are currently in effect.\2 Since 1957,
military personnel have paid social security taxes and thus earned
credits toward social security benefits. 


--------------------
\1 In a defined benefit system, employers promise to pay specific
retirement benefits that are generally based on a formula that
considers job tenure and earnings. 

\2 Service members who entered the military before September 8, 1980,
are under one version; those who entered on or after September 8,
1980, and before August 1, 1986, are under a second version; and
those who entered on or after August 1, 1986, are under a third
version. 


   RESULTS IN BRIEF
---------------------------------------------------------- Chapter 0:3

Payments from the military retirement fund to military retirees and
their survivors totaled $29 billion in fiscal year 1996.  These
payments have been rising over several decades as both the number of
military retirees and the average payment to individual retirees have
increased.  These payments are expected to peak at slightly more than
$30 billion (in fiscal year 1995 dollars) in 2007.  Since fiscal year
1985, the "accrual accounting" concept has been used to reflect the
cost of future retirement payments for current service members in
DOD's military personnel budget.  These annual DOD budgetary costs
have declined for several reasons, including lower benefits for new
entrants, changes in economic and actuarial assumptions to reflect
experience, and recent decreases in force size.  These costs--about
$11 billion in fiscal year 1996--constitute approximately 4 percent
of DOD's budget. 

The military retirement system strongly influences the broad shape of
the force.  The retirement system provides an increasing incentive
for service members to stay in the military as they approach 20 years
of service and encourages them to leave thereafter, helping DOD to
retain midcareer personnel and yielding a relatively young force. 
However, the system can also impede effective force management. 
Because military personnel are not entitled to any retirement
benefits unless they have served 20 years, the services have been
reluctant to involuntarily separate personnel with less than 20 years
of service beyond a certain point due to the financial consequences
for service members and their families and the resulting impact on
morale.  Moreover, some analysts, including several of GAO's
roundtable participants, believe the military retirement system is an
obstacle to achieving a force of the right size and composition
because the system provides the same career length incentive for all
categories of personnel.  These analysts maintain that 20 years may
not be the optimal career length for all military personnel. 

Proposals to change the military retirement system range from
modifications of various features of the current system to complete
alternatives.  Those proposals are intended to improve efficiency and
flexibility in managing the force, increase fairness or
attractiveness to service members, and reduce costs.  Earlier vesting
of at least a portion of military retirement benefits is a common
feature of proposed changes.\3 Cost estimates done by the DOD
Actuary, at GAO's request, suggest that some type of earlier vesting
could be offered with little or no increase to DOD's retirement
costs.  The total impact on DOD's budget of the proposed changes
depends on their effect on retention and force composition.  Some
analysts, including several of GAO's roundtable participants, have
called for more fundamental changes to the retirement system,
possibly with other changes in compensation and personnel policy, to
accommodate different career lengths for different personnel.  These
changes could increase effectiveness or reduce costs by yielding a
force of a different composition and size than today's force. 


--------------------
\3 In this report, the term vesting refers to a service member's
right to receive some retirement benefit, regardless of whether the
benefit is paid immediately or deferred. 


   PRINCIPAL FINDINGS
---------------------------------------------------------- Chapter 0:4


      MILITARY RETIREMENT COSTS
-------------------------------------------------------- Chapter 0:4.1

Pressures to reduce the federal budget deficit have focused attention
on the level of payments to current military retirees.  These
payments, which totaled $29 billion in fiscal year 1996, have been
rising for several decades as the retiree population has grown and as
average payments to individual retirees have increased.  They are
expected to peak, in fiscal year 1995 dollars, at about $30 billion
in 2007. 

Since 1985, DOD's budget has reflected the estimated amount of money
that would have to be set aside in that year to cover the future
retirement costs of current service members.\4 Those costs, $11
billion in fiscal year 1996, have declined over the past decade due
to reduced benefits for new entrants, changes to the DOD Actuary's
economic and actuarial assumptions, and reductions in the size of the
force. 

Even with the reductions to military retirement benefits resulting
from the changes in benefit formulas in 1980 and 1986, some observers
question whether military retirement benefits have the right weight
in overall military compensation.  These observers maintain that the
appropriate indicator of the level of retirement benefits is how well
they contribute to the services being able to build and maintain the
force they need. 


--------------------
\4 Funds appropriated in DOD's budget to cover future retirement
costs are recorded as payments to the Military Retirement Fund.  The
fund's assets are nonmarketable, special-issue Treasury securities,
which constitute a promise on the part of the U.S.  government to pay
based on the government's power to collect taxes.  Thus, the military
retirement system actually continues to be financed on a
pay-as-you-go basis, as do the retirement systems for most federal
civilian employees, Social Security, and the rest of the federal
government. 


      MILITARY RETIREMENT'S ROLE
      IN SHAPING AND MANAGING THE
      FORCE
-------------------------------------------------------- Chapter 0:4.2

The retirement system is widely viewed as a substantial influence on
the broad shape of the force.  With its combination of 20-year
vesting and the payment of an immediate annuity at any age after 20
years of service, the system is designed to foster a relatively young
force and ensure a flow of experienced personnel through encouraging
those with 20 or more years of service to retire.  The system
generally serves as a very strong retention tool, pulling personnel
after a certain career point to stay at least 20 years.  It has thus
been valuable as a force stabilizer.  Although recent historical
experience has shown that about 15 percent of entering enlisted
personnel and 48 percent of entering officers become eligible for
retirement, the percentage of personnel with 10 years of service who
reach retirement eligibility has been about 70 percent for enlisted
personnel and over 90 percent for officers. 

The retirement system contributes to the difficulty of changing the
size or composition of the force.  The services are reluctant to
involuntarily separate personnel, with less than 20 years of service,
past the midcareer point because of the financial consequences for
service members and their families and the resulting impact on
morale.  This situation was highlighted by the need for temporary
measures to induce separations or compensate involuntarily separated
members with less than 20 years of service during the recent
drawdown. 

Some analysts maintain that today's military needs many service
members for less than 20 to 30 years and may want to retain others
for longer.  By offering the same career length incentives to all
personnel, the retirement system can impede effective force
management.  For example, although some military combat specialties
require youth and vigor, experience may be of greater value in
occupations such as systems acquisition or intelligence analysis. 
One roundtable participant advocated lengthening careers for senior
officers and shortening them for other officers partly because of the
increased requirements senior officers face for both formal education
and joint operational experience. 

Two views were expressed at GAO's roundtable regarding the
information necessary to justify fundamental retirement system
changes.  One view was that designing the right types of management
policies, including the retirement system, required first determining
what kind of force DOD is trying to build for the future.  The other
view was that such foresight was unlikely and a retirement system
that could accommodate changes in circumstances was needed. 


      OPTIONS FOR MODIFYING THE
      MILITARY RETIREMENT SYSTEM
-------------------------------------------------------- Chapter 0:4.3

Various proposals to modify the military retirement system have
sought to increase force management efficiency or flexibility,
increase fairness or attractiveness to members, and reduce costs. 
These proposals include modifications or additions to the current
system as well as complete alternatives.  A common feature of many
proposals, generally supported by GAO's roundtable participants, is
that service members be vested earlier in some type of retirement
benefit.  At GAO's request, the DOD Actuary estimated the impact on
retirement accrual costs of (1) three changes to the system that
provide earlier vesting in a benefit that could be paid either as a
deferred annuity or a lump-sum payment upon separation and (2) a
tax-deferred savings option (with and without government matching)
for military personnel.  According to the Actuary's cost estimates,
DOD may be able to provide some earlier vesting of retirement
benefits with little increase in retirement costs.  For example, the
cost estimate for a deferred annuity adjusted for inflation would
increase the current military retirement system cost by less than 1
percent of basic pay.  Predicted total cost impacts depend in part on
the extent to which particular changes result in significantly
different retention behavior and yield a more junior (or senior)
force.  Some analysts have called for major changes to the retirement
system, often along with other changes in compensation and personnel
policy.  One alternative proposed at GAO's roundtable discussion was
to create a two-part system for military personnel.  Service members
in occupations requiring youth and vigor would be under the current
system (modified to vest earlier), and others would be under a system
similar to the Federal Employees Retirement System (FERS). 

In general, the greater the change to the military retirement system,
the greater the uncertainty surrounding predicted impacts. 
Predicting cost and other impacts of retirement system changes is
difficult partly because of uncertainty about retention impacts.  For
example, a recent RAND analysis of placing military personnel under a
FERS-type system concluded that the change would reduce retirement
costs but that maintaining the current size and quality force would
require a pay increase and a system of separation payments.  The
analysis predicted the change would result in net cost savings to
DOD.  If changes in retirement and other aspects of personnel policy
allow military objectives to be achieved with a smaller, more
efficient force, cost savings could be greater.  The most
sophisticated analysis may be a poor predictor of substantial
retirement system changes, according to several of GAO's roundtable
participants.  They noted that impacts of the 1980 and 1986 changes
to the retirement system are not yet known.  Characteristics of the
desired future force are important in evaluating the risks and
benefits of retirement system changes. 


   RECOMMENDATIONS
---------------------------------------------------------- Chapter 0:5

GAO is not making any recommendations in this report. 


   AGENCY COMMENTS
---------------------------------------------------------- Chapter 0:6

DOD provided written comments on a draft of this report.  DOD stated
that it did not object to the overall thrust of the report but did,
however, express concern that the report's discussion of potential
changes to the retirement system could be taken to suggest a
consensus on specific shortcomings of the system.  DOD emphasized the
overall effectiveness of the retirement system in providing the
military with needed personnel and stated that the impact of 1980 and
1986 changes to the system should be fully assessed before further
changes are made.  DOD's specific comments appear in appendix III. 


INTRODUCTION
============================================================ Chapter 1

The basic structure of the U.S.  military retirement system was
established in legislation over a period of years, ending in the late
1940s.  The system provides benefits to nondisabled service members
when they retire from active or reserve duty and service members who
retire on disability.  It also provides for optional survivor
coverage.\1 It is a noncontributory, defined benefit plan that allows
retiring active duty service members with 20 or more years of service
to receive an immediate lifetime annuity with cost-of-living
adjustments, regardless of age.\2 In 1980 and 1986, benefit formulas
for new entrants were changed to reduce costs and, in 1986, provide
incentives for longer careers, but the basic structure of the system
was left intact. 

In recent years, U.S.  armed forces have been affected by substantial
changes, including the end of the Cold War, subsequent downsizing of
U.S.  forces, and significant technological advances and associated
increases in skill requirements for military personnel.  These
changes, along with increasing federal budget pressures, have focused
attention on whether the military retirement system is best designed
to efficiently meet the needs of the Department of Defense (DOD) and
service members. 


--------------------
\1 Since 1953, military personnel have had the option to receive
reduced retired pay to provide survivor benefits for spouses and
children. 

\2 In a defined benefit plan, employers promise to pay specific
retirement benefits that are generally based on a formula that
considers job tenure and earnings. 


   THE THREE VERSIONS OF THE
   RETIREMENT SYSTEM
---------------------------------------------------------- Chapter 1:1

Currently, members are covered by three separate versions of the
nondisability retirement system based on when they entered military
service.\3 Retired active duty personnel who entered the service
before September 8, 1980 (known as pre-1980), receive a benefit equal
to a percentage of their final basic pay,\4 calculated by multiplying
their years of service by 2.5 percent.  The benefit is 50 percent of
basic pay for 20 years of service and reaches a maximum of 75 percent
of basic pay for 30 years of service.  For members who entered
military service on or after September 8, 1980, and before August 1,
1986 (known as 1980-86), the accrual percentage is the same, but an
average of the highest 3 years of basic pay, rather than the final
level of basic pay, is used in the calculation.  For members who
entered the service on or after August 1, 1986 (known as post-1986),
the accrual percentage for benefits before age 62 is lower for
members with less than 30 years of service.  Retirement pay is 40
percent of the average of the highest 3 years of basic pay for 20
years of service, gradually increasing to 75 percent for 30 years of
service.  Benefits for this last group are not fully protected
against inflation, whereas benefits for the first two groups are
fully protected.  Table 1.1 shows details of the benefits for the
three military retirement systems. 



                               Table 1.1
                
                   Military Retirement System Benefit
                                Formulas

Plan            Description
--------------  ------------------------------------------------------
Pre-1980        2.5 percent for each year of service up to a maximum
                of
                75 percent of final basic pay. Retired pay is adjusted
                annually by the increase in the consumer price index.

1980-86         2.5 percent for each year of service up to a maximum
                of
                75 percent of the average of the highest 3 years of
                annual basic pay (known as the high three). Retired
                pay is adjusted annually by the increase in the
                consumer price index.

Post-1986       Same as the 1980-86 benefit formula, except benefit is
                reduced by 1 percentage point for each year of service
                less than 30. At age 62, the retired pay is recomputed
                with the penalty removed. Retired pay is adjusted
                annually by 1 percentage point less than the increase
                in the consumer price index, with a one-time restoral
                in purchasing power at age 62.
----------------------------------------------------------------------
Source:  DOD Actuary. 


--------------------
\3 Since 1957, military personnel have paid social security taxes and
thus earned credits toward social security benefits. 

\4 Basic pay averages about 72 percent of regular military
compensation, which also includes housing and subsistence allowances. 


   ACCOUNTING FOR MILITARY
   RETIREMENT COSTS
---------------------------------------------------------- Chapter 1:2

The DOD Authorization Act of 1984 established the Military Retirement
Fund, which became effective on October 1, l984.  With the
establishment of the fund, the military retirement system went from
pay-as-you-go accounting and budgeting to accrual-based accounting
and budgeting.  At that time, payments to individuals who had already
retired began to show up in the federal budget as disbursements from
the Military Retirement Fund and not as payments from DOD's military
budget. 

Under accrual-based accounting, the Secretary of Defense is required
to allocate a percentage of annual military basic pay costs to the
fund to meet future retirement obligations for current service
members.  This amount is paid from DOD's military personnel account
and is based on actuarial and economic assumptions.  This payment is
called the "normal cost" payment, or the retirement accrual charge. 

When the fund was established, the unfunded costs of retirement
benefits already accrued became apparent.  The initial unfunded
liability as of September 30, 1984, was $528.7 billion ($751.8
billion in fiscal year 1995 dollars).  The unfunded liability is
being amortized over a period of
50 years with payments to be made to the Military Retirement Fund
from the Treasury Department.  Changes in the amount of the unfunded
liability "owed" to the fund can occur due to changes in economic
assumptions, changes in the benefit formula for retired pay, or
differences between anticipated accounting gains or losses in the
fund and actual experience.  The value of the unfunded liability as
of September 30, 1995, was $500.8 billion. 

In addition to normal cost payments from DOD's military personnel
account and unfunded liability amortization payments from the
Treasury, the Military Retirement Fund receives income from interest
earnings on investments in nonmarketable, special-issue Treasury
securities.  All three of these payments are intragovernmental
transfers consisting of debits from one government account and
credits to another.  In addition to making payments to military
retirees and their survivors, the fund purchases the special-issue
Treasury securities, another intragovernmental transfer.  The
adoption of accrual-based accounting caused future retirement outlays
to be recognized as a future liability and thus made the total cost
of current personnel decisions evident.  However, the military
retirement system continues to be financed on a pay-as-you-go basis,
as are the federal retirement systems for most civilian workers and
Social Security, in that benefits paid each year are financed by
federal revenues received that year. 


   OBJECTIVES, SCOPE, AND
   METHODOLOGY
---------------------------------------------------------- Chapter 1:3

As requested, we reviewed selected aspects of the military retirement
system.  Specifically, we addressed (1) military retirement costs,
(2) the role of military retirement in shaping and managing U.S. 
forces, and (3) proposed changes to modernize the system and
contribute to more efficient force management.  As part of our
review, we hosted a roundtable discussion on June 12, 1996, at which
several current and former DOD officials, as well as compensation
experts, expressed their views on those aspects of the military
retirement system included in our review.  A summary of the
discussion and a list of roundtable participants appear in appendix
I. 

We focused our review on the nondisability active duty military
retirement system.  We identified and reviewed studies and data
concerning the military retirement system and proposed changes.  We
interviewed military personnel, compensation, and force management
officials from the Army, the Navy, and the Air Force.  We also spoke
with officials from the Office of the Secretary of Defense; Retired
Officers Association; Retired Enlisted Association; Congressional
Research Service; Congressional Budget Office; Office of Management
and Budget; Office of Personnel Management; Brookings Institution;
Employee Benefits Research Institute; Hay-Huggins Management
Consultants; ICF Kaiser International, Inc.; KPMG Peat Marwick; and
RAND. 

We reviewed historical data and the current projections of future
retirement costs from the DOD Actuary.  At our request, the Actuary
also provided retirement cost estimates for selected proposals for
change.  We did not validate or verify the Actuary's results, and the
estimates only reflected retirement costs, not the total cost impacts
to DOD.  The four proposals we selected represent past proposals and
suggestions from roundtable participants.  Each proposal retains the
basic feature of allowing retirement with an immediate annuity after
20 years.  In addition, we collected and analyzed data on costs of
civilian retirement systems and compared these costs with those of
the military retirement system. 

We conducted our review from December 1995 to September 1996 in
accordance with generally accepted government auditing standards. 


MILITARY RETIREMENT COSTS
============================================================ Chapter 2

The cost of military retirement can be measured in a number of ways. 
For understanding military retirement cost as a portion of total
federal government outlays and its impact on the current budget
deficit, outlays to existing retirees are the appropriate measure. 
However, these outlays represent obligations already incurred.  For
evaluating military retirement as an aspect of current government and
DOD policy, the accrual costs in DOD's budget, which reflect future
retirement outlays for individuals now serving in the military, are
the relevant measure. 


   FEDERAL OUTLAYS FOR MILITARY
   RETIREES
---------------------------------------------------------- Chapter 2:1

In fiscal year 1996, the United States paid $29 billion to military
retirees and their survivors.\1 Figure 2.1 shows historical and
projected federal government outlays for military retirement.  The
outlays are projected to increase to slightly more than $30 billion
(in fiscal year 1995 dollars) by the year 2007, after which they will
decline, in inflation-adjusted terms. 

   Figure 2.1:  Military
   Retirement Outlays, Historical
   (1950-95) and Projected
   (1996-2030)

   (See figure in printed
   edition.)

Source:  DOD Actuary. 

Military retirement outlays have increased in constant dollars since
1960 due to the increase in the number of retirees, average retired
pay, and survivor benefits.  For example, from 1960 to 1995, the
number of retirees grew sixfold--from 254,000 to 1,603,000--due
primarily to the rise in the proportion of service members reaching
retirement and somewhat to higher life expectancy.  Over the same
period, average annual inflation-adjusted pay per retiree rose by
about 11 percent as military basic pay, on which retired pay is
based, grew faster than inflation.  Also, the percentage of retirees
electing survivor benefits increased from 15 to 60, and the
population of survivors receiving payments went from a few thousand
in 1960 to 213,000 in 1995. 

Federal budget pressures have heightened interest in opportunities to
reduce spending both in the near and long term.  Efforts to reduce
near-term spending have resulted in several initiatives to achieve
savings through trimming payments to existing retirees.\2 One
initiative was a fiscal year 1996 budget resolution proposal to
reduce outlays for those who entered the military before September
1980 by computing benefits on an average of the final year of basic
pay instead of the final basic pay.  (This initiative was removed
from both the House and Senate versions of the reconciliation bill.)
Other initiatives included a proposal to reduce inflation adjustments
for all nondisabled retirees and a bipartisan plan to reduce
inflation adjustments and the retired pay computation formula for
retirees under age 50. 

Reactions to these initiatives demonstrated that proposals to change
retirement benefits for service members already retired are likely to
meet strong opposition.  For example, in expressing DOD's view of the
fiscal year 1996 budget proposal, the Secretary of Defense said he
would do everything he could to ".  .  .  drive a stake through the
heart of this idea." One reason cited for the defense community's
opposition to this proposal is that retroactive changes constitute a
breach of promise to service members, which could undermine DOD's
credibility.  This position is consistent with the views of DOD
officials and some analysts that changes to the military retirement
system should apply only to new entrants so that the changes do not
affect the terms under which a service member began his or her
career. 

There is, however, tension regarding the disparity between benefits
to current retirees and service members under the more generous
systems, on one hand, and those members covered by a less generous
system, on the other.  Moreover, one of our roundtable participants
observed that lifetime benefits to personnel currently retired will
generally exceed expectations due to longer lifetimes.  Participants
also noted that all of society will have to make adjustments as the
country's budgetary strains continue to grow. 


--------------------
\1 This amount represents payments from the Military Retirement Fund
and does not include social security payments to military retirees. 

\2 One of our roundtable participants put the magnitude of military
retirement current and projected outlays in context by comparing them
with those under the broadest federal entitlement programs, such as
Medicare and Social Security.  Medicare spending in fiscal year 2000
is projected to be about $200 billion, and outlays for Social
Security are projected to be about $369 billion (both in fiscal year
1995 dollars).  Even though those programs, which apply to huge
proportions of the population, can make almost any category of
federal spending appear small, they are provided as examples to
illustrate that the deficit will not be dramatically affected by
adjustments in payments to current military retirees. 


   MILITARY RETIREMENT COST AS A
   DEFENSE BUDGET ITEM
---------------------------------------------------------- Chapter 2:2

Military retirement accrual cost for active duty personnel was an $11
billion DOD budget item in fiscal year 1996.  DOD paid this amount
into the Military Retirement Fund to reflect the future retirement
obligations being generated by current personnel.  Trends in DOD
budget costs, called retirement accruals or normal costs, are shown
as a percent of basic pay in figure 2.2.  Normal cost payments,
expressed in dollar amounts instead of as a percent of basic pay,
show a similar pattern over the period. 

   Figure 2.2:  Military
   Retirement Normal Costs as a
   Percent of Current Service
   Members' Basic Pay (1985-2030)

   (See figure in printed
   edition.)

Source:  DOD Actuary. 

Military retirement normal cost percentages have declined sharply
since the inception of accrual accounting in fiscal year 1985.  This
decline is due to more service members being under less generous
retirement plans and changes made in actuarial assumptions to reflect
experience.  However, as shown in figure 2.3, military retirement
normal costs remain a significant DOD budgetary item.  They comprised
nearly 16 percent of DOD's $70.7 billion personnel costs in fiscal
year 1995 and 4.3 percent of DOD's fiscal year 1995 $257.8 billion
budget. 

   Figure 2.3:  Military
   Retirement Normal Costs
   Compared With Personnel Costs
   and Other DOD Budget Categories

   (See figure in printed
   edition.)

Note:  RDT&E, research, development, test, and evaluation. 

Source:  DOD. 

Analysts, including some of our roundtable participants, have
advocated that the DOD Actuary be instructed to calculate separate
normal cost percentages for each service and for officers and
enlisted personnel to improve the use of the information for force
management purposes.  Although they are not reported separately,
actual normal cost percentages are significantly different for each
service and for officers and enlisted personnel.  These differences
exist because the services have varying percentages of personnel
staying to retirement and a greater proportion of officers stay to
retirement than enlisted personnel.  The DOD Retirement Board of
Actuaries is directed under law (10 U.S.C.  1465 and 1466) to
calculate a single normal cost percentage for active duty service
members,\3 which is used in figuring retirement costs into each
service's personnel budget. 

Military retirement has historically been considered more generous
and costly than most other retirement systems, including federal
civilian retirement systems.  However, comparisons are complicated by
the need to consider total compensation packages and conditions and
risks that are unique to military life.  Even with the 1980s
reductions, some observers question whether military retirement
benefits have the right weight in overall military compensation.  The
Federal Employees Retirement System (FERS) covers most federal
civilian employees who entered service after December 31, 1983.  FERS
is a three-part pension program that includes social security
benefits, an additional defined benefit, and a tax-deferred savings
plan with government matching of contributions.\4 It differs
significantly from the Civil Service Retirement System (CSRS), a
stand-alone defined benefit system that covers most federal employees
hired before 1984.  Both the FERS and the CSRS systems have distinct
provisions for law enforcement officers and firefighters (referred to
in this report as protective service employees).  Table 2.1 shows the
normal cost percentage incurred by the government and the percentage
contribution of the individual for the three military retirement
systems in effect and for the different plans under FERS. 



                               Table 2.1
                
                Costs of Selected Retirement Systems as
                        a Percent of Pay (1995)


                                                  From    From
                                                employ  employ
Retirement plan                                     er      ee   Total
----------------------------------------------  ------  ------  ------
Average military                                  33.3       0    33.3
Pre-1980                                          39.3       0    39.3
1980-86                                           35.0       0    35.0
Post-1986                                         29.7       0    29.7
FERS without TSP                                  11.4     0.8    12.2
FERS protective service without TSP               24.3     1.3    25.6
FERS with TSP                                     15.3     6.8    22.1
FERS protective service with TSP\b                28.2     7.3    35.5
----------------------------------------------------------------------
Note:  All employees pay social security taxes of 6.2 percent on the
first $62,700 of earnings, and their employers make matching
contributions. 

\a Normal costs for the military systems are shown as a percent of
basic pay.  Since basic pay averages about 72 percent of regular
military compensation, normal cost as a percent of regular military
compensation is lower than the percentage shown, averaging, for
example, about 24 percent for the three military retirement systems. 

\b These figures assume the same TSP participation rate as the
average for all FERS employees. 

Source:  DOD and Office of Personnel Management Actuaries. 


--------------------
\3 This category includes about 65,000 active National Guard and
Reserve members. 

\4 The tax-deferred savings plan is a type of defined contribution
plan.  In these plans, an individual account is established for each
participating employee, and benefits are based on contributions to
and investment earnings for that account.  No exact benefit is
promised at retirement.  Over the past
2 decades, defined contribution retirement systems have become more
prevalent in the private sector, often as supplemental plans to
established defined benefit systems.  The Thrift Savings Plan (TSP)
is the supplementary defined contribution portion of federal employee
retirement plans.  Such plans are known as 403(B) plans in the state
and local government and nonprofit sectors and 401(K) plans in the
private sector. 


MILITARY RETIREMENT'S ROLE IN
SHAPING AND MANAGING THE FORCE
============================================================ Chapter 3

The military retirement system strongly influences the broad shape of
the force.  The retirement system provides an increasing incentive
for service members to stay in the military as they approach 20 years
of service and encourages them to leave thereafter, helping DOD to
retain midcareer personnel and yielding a relatively young force. 
However, the system can also impede effective force management. 
Because military personnel are not entitled to any retirement
benefits unless they have served 20 years, the services have been
reluctant to involuntarily separate personnel with less than 20 years
of service beyond a certain point.  Moreover, some analysts,
including several roundtable participants, believe the military
retirement system is an obstacle to achieving a force of the right
size and composition because it provides the same strong career
length incentive to all categories of personnel.  These analysts
maintain that 20 years may not be the optimal career length for all
military personnel. 


   FORCE MANAGEMENT OBJECTIVES OF
   THE MILITARY RETIREMENT SYSTEM
---------------------------------------------------------- Chapter 3:1

The present practice of allowing normal nondisability retirement on
an immediate annuity after 20 years of service evolved from a program
designed to aid retention of naval enlisted members to a program
covering all of the armed services.  Officers and enlisted members of
each service were brought under the 20-year retirement umbrella by
separate pieces of legislation between 1915 and 1948.  The
legislative history of these actions shows that Congress established
the 20-year retirement to encourage more enlisted personnel to remain
in the service longer and eliminate older officers from the service
to lessen promotion stagnation problems. 

The 5th Quadrennial Review of Military Compensation (QRMC)\1 in 1984
specified the following military personnel management needs that the
retirement system promotes: 

  -- a young and vigorous force, with a continuing flow of officers
     and enlisted personnel through the system;

  -- military careers that are reasonably competitive with other
     alternatives; and

  -- a mobilization base to be called up during a war or an
     emergency. 

This QRMC also identified several principles of military compensation
with relevance for evaluating the retirement system, including
economic and military efficiency, equity, flexibility, and
integration with force management. 


--------------------
\1 Mandated by 37 U.S.C.  1008(b), the QRMC is a complete review,
every 4 years, of the principles and concepts of the compensation
system for members of the uniformed services.  The 5th QRMC in 1984
focused attention on the retirement system.  The 8th QRMC is
evaluating human resource management systems for future military
needs. 


   THE RETIREMENT SYSTEM AFFECTS
   FORCE COMPOSITION
---------------------------------------------------------- Chapter 3:2

The retirement system, as one aspect of military compensation and
force management policy, influences the composition of the force
primarily through its impact on a service member's desire to continue
military service.  Other influences on retention include the general
level of pay and allowances; up-or-out nature of the officer
personnel management system;\2 reenlistment policies; special and
incentive pays; and satisfaction with conditions of military life,
ranging from ship rotation policy to family housing. 

The military's unusual personnel structure of a closed hierarchical
system--with essentially no lateral entry at upper ranks--provides
unique challenges.  Because of the lack of lateral entry, shortfalls
in numbers of midlength careerists cannot be easily rectified; thus,
the compensation system needs to ensure a continual flow of personnel
through the ranks.  Each year the military recruits and trains many
new entrants, most of whom will not make the military a career.  The
DOD Actuary reports that about 48 percent of new officers and 15
percent of new enlisted personnel attain 20 years of active duty
service.  Figure 3.1 illustrates average retention patterns across
all the services for all personnel categories. 

   Figure 3.1:  Retention Patterns
   for Active Duty Personnel

   (See figure in printed
   edition.)

Source:  DOD Actuary. 

The retirement system exerts an increasing "pull" effect on personnel
as they approach the 20-year point but a substantial "push" effect
thereafter.  That is, retention rates for enlisted personnel have
historically increased with each successive reenlistment.  Similarly,
after the initial term of obligated service, officer retention rates
tend to increase with each year of service.  The retention pull is
generally believed to be strong by the 8th to 12th year of service. 
After 20 years of service, however, the retention rate drops
significantly.  For example, approximately 36 percent of personnel
who attain 20 years of service retire within 1 year of reaching that
threshold.  In addition to its impact on overall retention, the
retirement system likely affects force characteristics by providing a
stronger incentive for some service members to stay than others.  For
example, because retirement pay is a form of compensation that is of
greater value at the higher ranks, some analysts maintain that it
particularly encourages the most able to stay in service because they
view their promotion chances most favorably. 

The "lock-in" effect of the 20-year vested retirement system lessens
the impact on retention rates that fluctuations in the private sector
employment market would otherwise have.  As personnel get closer to
the 20-year point, it takes a greater private sector lure to offset
the value of the military retirement benefits that would have to be
foregone.  For example, the percentage of personnel with 10 years of
service who reach retirement eligibility has been about 70 percent
for enlisted personnel and over 90 percent for officers.  Thus, the
retirement system has been valuable as a force stabilizer.  Highly
predictable retention rates beyond the 10th year of service make
personnel planning and management considerably easier than if
retention rates were influenced more by external labor market forces. 

Another way in which the retirement system fosters midlength
careerist retention comes from the "push" effect after 20 years.  The
availability of an immediate annuity means that military personnel
are effectively working for reduced compensation after 20 years of
service, which prompts many personnel to retire at that point to
begin a second career while they are still relatively young.  The
20-year retirement option therefore enables more rapid promotion
opportunities in the midcareer years, which prevents grade stagnation
and increases the attractiveness of remaining in the military. 


--------------------
\2 For officers, the basic elements of personnel management policy
are contained in the 1980 Defense Officer Personnel Management Act,
which consolidated regulations concerning officer careers and
specified the numbers of officers each service can have in the higher
grades. 


   THE RETIREMENT SYSTEM CAN
   HAMPER EFFECTIVE FORCE
   MANAGEMENT
---------------------------------------------------------- Chapter 3:3

Across DOD, the force has been growing more senior since the early
1970s.\3 Some growth in seniority was to be expected after the change
to an all-volunteer force because those who entered military service
after that time did so by choice.  Many defense analysts maintain,
however, that the current grade structure and seniority has come
about more by happenstance than design.  According to our 1991
report, the structure came about as retention improved and the
services allowed more personnel to reenlist than they needed to meet
force profile goals.\4 As RAND's recent study noted, the services'
desired force structures reflect the actual retention patterns that
emerge as a result of the current compensation system, particularly
the retirement system; without the current retirement system, the
desired force may differ significantly.\5 Moreover, since the
retirement system operates equally for all categories of personnel,
it cannot be used to increase or decrease retention of personnel in
particular occupations. 

A negative aspect of the military retirement system with respect to
force management is that the lack of earlier vesting makes it
difficult to separate some personnel.  Because of the great financial
loss to personnel nearing 20 years of service if they are separated
earlier, the services have been reluctant to separate without any
retirement benefits all but the worst performers after they have
reached the midcareer point.\6 This difficulty has consequences both
for dealing with performance problems and adjusting force size or
composition as requirements change.  Two of our roundtable
participants indicated that, even in the case of a serious breach of
conduct, the decision to separate personnel not eligible for
retirement is extremely difficult.  They also said that many
personnel with significant problems are kept until the 20-year point
partly because of the implications of preretirement separation for
their families. 

The recent drawdown required DOD to use a variety of tools, primarily
temporary voluntary separation programs, to separate personnel with
less than 20 years of service.  To reduce the active duty force of
2,174,100 military personnel in 1987 to 1,485,500 in 1996, DOD
employed voluntary separation tools, such as Voluntary Separation
Incentives (VSI),\7 Special Separation Benefits (SSB),\8 and the
Temporary Early Retirement Authority (TERA) to separate 148,700
personnel.  All of these temporary programs are scheduled to expire
in 1999.  VSI and SSB are targeted programs for overstrength or
oversubscribed fields, careers, and military occupational
specialties.  Individuals with 6 to 20 years of service are eligible
for VSI and SSB.  The TERA program allows voluntary retirement of
members with
15 years of service in personnel categories subject to the discretion
of the services. 

Some senior DOD officials indicated they would like to have these
temporary authorities made permanent because they provide benefits
for separating personnel and control over potential losses of
critical personnel.  Some officials indicated that they did not want
TERA after the drawdown because they believed it would result in a
constant stream of requests and undermine the concept of the 20-year
commitment.  The Selective Early Retirement Boards permit the
services to exercise authority to select retirement-eligible officers
to retire earlier than normal.  This program was used to separate
10,420 officers from 1992 to 1995. 


--------------------
\3 The percentage of enlisted personnel in the top six grades
increased from about 59 to about 72 percent between 1973 and 1994
(and occurred over periods of growth as well as drawdown).  Also,
officers, as a percentage of the total force, grew from about 11
percent in 1966 to about 16 percent in 1995. 

\4 Enlisted Force Management:  Past Practices and Future Challenges
(GAO/NSIAD-91-48, Jan.  22, 1991). 

\5 A Policy Analysis of Alternative Military Retirement Systems,
RAND, National Defense Research Institute, 1994. 

\6 Title 10 U.S.C.  638a(b)(2)(c) contains a provision that permits
officers who have not been promoted and have 18 years of service to
remain in the service until they can retire after 20 years. 

\7 The VSI program, authorized in 1991, allows the services to pay
annuities to eligible service members volunteering to leave the
military.  The VSI annuity is calculated as 2.5 percent of the
member's final month of basic pay multiplied first by 12 and then by
the number of years of service.  The VSI annuity is paid annually for
twice the number of years of service.  For example, a staff sergeant,
technical sergeant, or petty officer first class with 12 years of
service would get an annuity of $6,249 for 24 years, or a total of
$150,696. 

\8 The SSB program, also authorized in 1991, allows the services to
make a one-time payment to eligible service members volunteering to
leave the military.  The SSB payment is calculated as 15 percent of
the member's final month of basic pay multiplied first by 12 and then
by the number of years of service.  For example, a staff sergeant,
technical sergeant, or petty officer first class with 12 years of
service would get a lump-sum payment of $37,675. 


   RETIREMENT SYSTEM ASSESSMENT
   DEPENDS ON CHARACTERISTICS OF
   THE DESIRED FORCE
---------------------------------------------------------- Chapter 3:4

Assessments of the value of the military retirement system in force
management depend on the characteristics of the desired force.  One
key aspect of desired force characteristics is the optimal length of
military careers.  The military retirement system implicitly assumes
that the optimal career length is the same for all military
occupations and that career length should be relatively short due to
the high physical demands of military duties.  However, some analysts
contend that, although some military occupations undoubtedly call for
young and vigorous personnel because they entail physically demanding
work under harsh conditions, many other occupations do not require
exceptionally vigorous duties.  Furthermore, in today's more
technologically and politically complex military environment,
capabilities that peak later in life than physical capabilities, such
as experience, knowledge, and judgment, may be more important in many
military occupations than vigor.  Therefore, the optimal career
length is likely to vary by military occupation category, with some
that are longer than 20 or 30 years (e.g., acquisition) and some that
are shorter (e.g., infantry). 

One of the strongest arguments for longer careers for senior military
leaders is the increased education and joint operational experience
requirements of the modern career.\9 One of our roundtable
participants strongly advocated lengthening military careers for
senior officers and shortening careers for other officers.  Under
such a proposal, each service would establish a general career length
for officers that would be shorter than the current length, possibly
ranging from about 12 years for the Army to about 17 years for the
Navy.  Beyond that point, only a small percentage of officers would
be promoted to the next rank, and the career length expectation for
those personnel could be greater than 35 years. 

Considerable uncertainty exists in the defense community about the
size of the future force and its composition.  The particular
characteristics of the desired force need to be determined to design
a retirement system that supports that force, according to several of
the roundtable participants.  In its 1993 Bottom-Up Review, DOD
concluded that by fiscal year 1999 an active force of about 1.4
million personnel, down from about 2.2 million in 1987, would meet
national security needs.  Current personnel levels for all of the
services are based on that assessment.  However, future changes in
personnel levels are possible.  For example, DOD, in response to the
1997 DOD Authorization Act, is planning a review of defense strategy
and force structure through 2005. 

Several recent studies have examined the mix of skills the future
military will need.  Joint Vision 2010, for example, prepared by the
Chairman of the Joint Chiefs of Staff, describes a future force that
relies on smaller, mobile units with more precise weapons and
high-technology intelligence gathering, information warfare, and
advance training simulators.  Also, a recent Army Science Board
report concluded that the Army's development of technologically
sophisticated officers was lagging behind its needs for the future. 

The types of management systems that will support the military's
personnel requirements in the post-Cold War environment have been the
focus of (1) several studies being carried out by RAND for the Under
Secretary of Defense for Personnel and Readiness and (2) the 8th
QRMC.  RAND's study of alternative career management systems for
officers examined several alternative officer career flows and their
potential for meeting DOD's objectives.\10 The study generally
concluded that the benefits of uniformity need to be balanced by a
capacity for flexibility in the management of officer careers.  The
types of officers the services need may be increasingly varied.  One
example of a proposal the study described is an officer management
system that would substantially increase the number of officers
forced to leave at the 5- and 10-year service points but would
encourage longer careers for those who remained.  A preliminary
conclusion of the 8th QRMC review of the principles of military
management and compensation is that uniformity of human resource
management systems among all DOD organizations is not desirable
because the various DOD communities have different strategies and
therefore should also have their own human resource management
systems. 


--------------------
\9 The Goldwater-Nichols DOD Reorganization Act of 1986 made service
in a joint (multiservice) position a prerequisite for promotion to
general or flag officer rank. 

\10 Future Career Management Systems for U.S.  Military Officers,
RAND, National Defense Research Institute, 1994. 


OPTIONS FOR MODIFYING THE MILITARY
RETIREMENT SYSTEM
============================================================ Chapter 4

Many changes to the military retirement system have been previously
suggested and analyzed, including several proposed at the roundtable
discussion we hosted.  Some of these changes would modify or add to
the current system, whereas others would completely replace the
current defined benefit system.  A common feature of suggestions for
modifying the current system, which was generally supported by our
roundtable participants, is earlier vesting.\1 Analysis suggests that
some types of earlier vesting could be offered with little or no
increase to DOD's retirement costs, although the ultimate cost
impacts to DOD depend on retention and force composition effects. 
Some analysts, including several roundtable participants, have called
for more far-reaching structural changes to the retirement system,
possibly with other changes in compensation and personnel policy, to
accommodate different career lengths for different personnel.  These
changes could increase effectiveness or reduce costs through yielding
a force of a different composition and size than today's force. 


--------------------
\1 In this report, the term vesting refers to a service member's
right to receive some retirement benefit, whether the benefit is paid
immediately or deferred. 


   SEVERAL FEATURES TARGETED FOR
   CHANGE
---------------------------------------------------------- Chapter 4:1

Several features of any retirement system that could be considered
for change include the following: 

  -- the specific type of system--defined benefit, defined
     contribution, or both;

  -- the benefit accrual formula;

  -- the formula for inflation adjustments;

  -- the amount employees can contribute, the level (if any) of
     matching contributions, and investment options for a defined
     contribution system;

  -- the point at which benefits are paid; and

  -- the amount of time until employees are vested in benefits. 

One or more of these features can be modified to adjust the current
system or create a complete alternative.  The features to be changed,
of course, depend on the objectives to be fulfilled.  For example,
the 1980 and 1986 changes to the military retirement system were
designed primarily to reduce the system's cost and thus affected the
benefit accrual formula, calculation base, and adjustments for
inflation.  The 1986 changes had the additional objective of
increasing the incentives to continue in service for 30 years. 
Neither legislative change affected the system's other features, such
as the time benefits are paid, the amount of time until service
members are vested, or the nature of the system as a defined benefit
system exclusively. 

Recent suggestions for changing the military retirement system,
including those put forth during our roundtable discussion, have
generally focused on improving force management and making the system
more attractive or fairer to service members.  Analysis of these
changes focuses on two types of management impacts.  The first is the
potential for DOD to reduce cost or enhance effectiveness by
increasing its ability to manage a given force through separating
poor performers and adjusting force size or composition as needs
change.  The second concerns whether DOD could design policies and
incentives, including those for retirement, that better yield the
force needed, including one with career types and lengths that differ
across military occupations.  Most roundtable participants believed
that the 1980 and 1986 reforms made reducing retirement accrual costs
a less compelling motivation than it had been, although several
stated that pressures on the defense budget would cause continued
examination of all personnel costs. 


   ANALYSIS OF SELECTED
   MODIFICATIONS TO THE CURRENT
   SYSTEM
---------------------------------------------------------- Chapter 4:2

Most of our roundtable participants supported changing the military
retirement system to provide some benefits to personnel who serve
less than 20 years.  A common feature of several proposals is that
members would be vested earlier in a portion of their retirement
benefits so that the sharp rise in the value of military retirement
benefits at 20 years of service would be somewhat leveled.  One
proposal for vesting benefits earlier was adding a deferred annuity
for those retiring with less than 20 years of service.  This change
would reduce costs by deferring receipt of the benefit until, for
example, age 62 and maintain most of the current incentive for
personnel to remain for 20 years. 

Several roundtable participants proposed adding a tax-deferred
savings plan, similar to the 401(K) plans commonly available to
workers in the private sector, to the current defined benefit system. 
This change could also include some government matching of service
member contributions.  Although a tax-deferred savings plan without
government matching might not be considered to constitute earlier
vesting, it does provide a way for personnel to acquire some
additional long-term savings.  Some participants noted that this
option could offset the limited opportunity service members have to
build equity in a home, although others commented that most enlisted
personnel would have little extra income for a tax-deferred savings
plan. 

The DOD Actuary, at our request, estimated the impact on retirement
accrual costs as measured by the normal cost percentage of several
options, all of which retain the basic feature of allowing retirement
with an immediate annuity after 20 years.  The options selected for
analysis reflect previous proposals and suggestions from roundtable
participants.  The options, which are fully detailed in appendix II,
are

  -- adding a deferred annuity (or equivalent lump-sum separation
     payment) to the current system for service members separating
     with between 10 and
     20 years of service, either not adjusted for inflation (option
     1A) or adjusted for inflation (option 1B); \2

  -- adding a tax-deferred savings feature, with no government
     matching, to the current system (option 2);

  -- adding a tax-deferred savings feature, with government matching,
     to the current system (option 3); and

  -- vesting members at 10 years of service in a retirement annuity
     that is based on years of service and gradually shifts from
     being deferred to being received as an immediate annuity with 20
     years of service (option 4). 

The Actuary's estimates of the impact of options 1, 2, and 3 on DOD's
budgetary cost for military retirement are shown in table 4.1.  These
estimates assume the modifications do not change retention patterns
and do not reflect any potential changes in other DOD costs. 



                               Table 4.1
                
                  Accrual Cost Measured as Normal Cost
                    Percentages of Current Military
                         Retirement System and
                          Options 1 Through 3

                                                           Normal cost
                                                                    as
                                                          a percentage
Retirement system                                         of basic pay
--------------------------------------------------------  ------------
Post-1986                                                         28.0
Option 1A--deferred annuity without inflation adjustment          28.3
Option 1B--deferred annuity with inflation adjustment             28.7
Option 2--deferred savings plan without government                28.0
 matching
Option 3--deferred savings plan with government matching          31.5
----------------------------------------------------------------------
Source:  DOD Actuary. 

Adding a deferred annuity (options 1A and 1B) for those who separate
early increases retirement accrual costs by less than 1 percent of
basic pay.  Cost increases are small because relatively few service
members separate between 10 and 20 years of service and the value of
the benefit for an individual service member is low.  Adding a
tax-deferred savings feature (option 2) to the current retirement
system does not increase DOD's retirement accrual costs if there is
no government matching of contributions.  Option 3 increases accrual
costs because of the government's matching contributions to the
tax-deferred savings plan.  The Actuary also calculated that, for DOD
to match service members' contributions under option 3 without an
increase in the normal cost percentage, the value of the defined
benefit portion of the plan would need to be reduced by about 11
percent. 

Service members' contributions to a tax-deferred savings account that
do not increase DOD's retirement accrual costs would, however, have a
near-term cost to the government in terms of a reduction in tax
revenues.  However, contributing members will eventually owe taxes on
their contributions and earnings.  These deferred taxes offset much
of the near-term cost to the government. 

Our analysis suggests that DOD could offer some earlier vesting of a
portion of retirement benefits without significantly raising
retirement costs.  However, the previous options are unlikely to
substantially increase force management flexibility.  Figure 4.1
illustrates the pattern of the value of future retirement benefits,
under the post-1986 system and options 1 and 3, for an officer
leaving the military after different years of service.  The present
value of option 3 as illustrated reflects the government's matching
contributions to a tax-deferred savings plan and not the service
member's contributions or tax benefits.  Since option 2 has no
additional government contribution, it is not illustrated. 

   Figure 4.1:  Value of Officer
   Future Retirement Benefits
   According to Years of Service
   Under the Current System and
   Options 1 and 3

   (See figure in printed
   edition.)

Note:  The values reflect the average pay history of a representative
officer at different years of service.  The values represented are
present values, that is, the value of the future income stream
discounted to reflect the time value of money.  A real personal
discount rate of 5 percent is used in the calculations.  The real
personal discount rate is the rate at which individuals trade current
for future dollars after inflation adjustments.  Using a higher
discount rate in the analysis, based on evidence that service
personnel strongly discount the value of future compensation, would
lower the present values illustrated but would not substantially
affect the patterns observed. 

These modifications to the post-1986 system do not substantially
alter the sharp increase in the value of retirement benefits at 20
years of service, although members who serve less than 20 years can
receive some retirement (or tax-deferred savings) benefits under the
options.  Some analysts have thus questioned the desirability of
earlier vesting options such as options 1A and 1B because they
involve some additional cost to DOD and may not significantly
increase DOD's management flexibility.  Other analysts, including
some roundtable participants, have maintained that limited earlier
vesting options are in fact desirable because they offer some benefit
to members separating with less than 20 years at very low cost. 

The DOD Actuary estimated cost impacts of an additional earlier
vesting option that, unlike options 1 through 3, would lessen the
sharp increase in the value of benefits at 20 years of service and
thus decrease the difficulties associated with separations for
individuals with less than
20 years of service.  Figure 4.2 illustrates the impact of this
modification on the present value of retirement benefits at different
years of service compared with the post-1986 system. 

   Figure 4.2:  Value of Officer
   Future Retirement Benefits
   According to Years of Service
   Under the Current System and
   Option 4

   (See figure in printed
   edition.)

Note:  See note in figure 4.1 for information on the values
illustrated.  The graduated vesting option specified here does not
completely smooth the pattern of the value of benefits at the 20-year
service point. 

Instituting the change as specified in option 4 would increase
retirement accrual costs from 28 to approximately 29.9 percent if
retention behavior were unchanged, according to the DOD Actuary's
analysis.  The increased cost represents payment of partial
retirement benefits to some personnel who are presently leaving
before 20 years of service without benefits.  However, because the
incentive for service members to stay to 20 years is substantially
reduced under this option, it is unlikely that current retention
patterns would continue.  Thus, we asked the DOD Actuary to estimate
retirement accrual costs with changes in retention patterns.  The
Actuary found that a 25-percent reduction in the probability that a
service member would stay 20 years (with increased exits spread
evenly between 10 and
20 years of service) would reduce the normal cost percentage to 24.7
percent and a 10-percent reduction would reduce normal cost to 26.7
percent. 

This estimated decline in normal costs under graduated vesting
results from the lower value of retirement benefits received by those
service members who would normally be expected to stay in service at
least 20 years but are assumed to leave with between 10 and 20 years
of service.  Thus, our analysis shows that the reduced value of
retirement benefits to service members who leave earlier because of
graduated vesting more than offsets the increase in benefits paid to
service members who would normally have left with between 10 and 20
years of service under the post-1986 system. 

Our analysis of a graduated vesting option illustrates that the
impact on retirement costs largely depends on the impact on retention
patterns.  Since retention patterns affect force seniority,
significant changes in retention patterns would result in a more
junior force.\3 There could also be changes in personnel quality or
work effort, according to some analysts.  If DOD wanted to maintain a
certain level of seniority or personnel quality with a substantially
smoother vesting pattern of retirement benefits, changes in other
aspects of compensation or personnel policy might be required, and
these changes would have their own cost implications.  Pay raises or
other incentives could, for example, offset to some extent reductions
in retirement costs.  Even if a more junior force were desired, some
adjustments in pay or incentives might be required to retain certain
individuals. 


--------------------
\2 Rather than deferring benefits for service members leaving the
military with less than 20 years, the government might choose instead
to offer a lump-sum separation payment of equivalent value.  In fact,
the strong preference service members indicated for a lump-sum
separation payment when choosing SSB over VSI during the drawdown
period indicates that DOD would likely find the present value of
lump-sum separation payments to be less costly than annuities.  Our
analysis assumes the lump-sum and deferred annuity are of equal value
and is not affected by the differences between these two types of
benefits. 

\3 Changing the seniority profile of the force would have
implications for other aspects of personnel costs.  For example,
training costs would likely be higher due to more accessions. 


   PROPOSALS FOR FUNDAMENTAL
   RETIREMENT SYSTEM CHANGES
---------------------------------------------------------- Chapter 4:3

Some analysts have called for major structural changes to the
military retirement system, possibly along with other changes in
compensation and personnel policy, in part to better accommodate
different career lengths for different categories of personnel.  Such
changes include placing military personnel under a system similar to
FERS and having retirement systems that vary, for example, by
service, officer and enlisted status, or occupation and optimal
career length.  One suggestion offered at the roundtable was to
maintain the current system for occupations requiring youth and
vigor, except for a modification to provide earlier vesting of
benefits, and place other military personnel under a system similar
to FERS.  Among the roundtable participants who advocated major
retirement system changes, two views prevailed.  One view was that
designing the right retirement system required determining the kind
of force DOD was trying to build toward.  The other view was that
such foresight was unlikely and that a retirement system was needed
that could accommodate changes in circumstances and needs. 

Predicting the cost and other impacts of more substantial changes to
the military retirement system is difficult.  The DOD Actuary did not
estimate the cost of any military retirement alternatives that
completely eliminated the payment of an immediate annuity after 20
years of service because of the complexities of predicting the
behavioral impacts of such a substantial change.  One concern voiced
by several of the roundtable participants was that even the most
sophisticated analysis may be a poor predictor of the effects of such
changes. 

These complexities are illustrated in recent analyses of alternatives
to the current military retirement system.  The RAND Corporation
designed a computer simulation model of retention behavior with data
on Army personnel to predict the impacts of substantial retirement
system changes.  In addition to modeling retention effects, RAND also
predicted impacts on how hard individuals work and the likelihood
that the most capable personnel would stay and seek advancement. 
RAND used this computer simulation model in its 1994 evaluation of a
military retirement system with the following features:  (1) service
members with at least 10 years of service would be vested in a
deferred annuity based on years of service and high three basic pay
that would be available at age 60 and (2) members separating after 10
years of service could receive a separation payment based on years of
service and final basic pay.  Also, under this system the services
could vary eligibility for the separation payments to control career
lengths in different skills.  RAND found that maintaining a force of
the current size and quality under that system would require an
active duty pay raise and overall compensation costs, including
retirement, would be higher by about $800 million per year compared
with the post-1986 system. 

Placing military personnel under a retirement system similar to FERS
could save DOD $2.4 billion per year and maintain a given size and
quality force, according to a 1996 RAND study that used a similar
modeling approach.\4 If improved efficiencies allowed some reduction
in force size for a given level of effectiveness, savings could be
greater.  The system RAND analyzed includes a defined benefit plan, a
defined contribution plan, and social security benefits.  The defined
benefit annuity formula and the provisions for government matching of
TSP contributions would be the same as that for FERS general
employees.  Because retirement benefits would be considerably less
generous than under the current system for those who separate with 20
or more years of service, the RAND analysis provided for an active
duty pay raise that was sharply skewed toward the upper grades.  The
system also included separation payments.  The increase in basic pay
costs and the costs of separation payments were more than offset by
retirement cost savings, according to the study. 


--------------------
\4 Reforming the Military Retirement System, RAND, January 1996 draft
report. 


   CONCLUSIONS
---------------------------------------------------------- Chapter 4:4

Modifications to the military retirement system could make the system
more attractive to many service members and increase management
efficiencies at little additional cost to DOD.  Certain changes, such
as offering some type of retirement benefit to members serving less
than
20 years, may be worth careful analysis for implementation in the
short term. 

Evaluation of the costs and benefits of more substantial
restructuring of the military retirement system must be done in the
context of overall force needs.  As U.S.  forces adapt to new
challenges and budgetary pressures continue to require increased
efficiencies in all federal spending, the role of the military
retirement system as one tool in managing and shaping the force is
likely to come under increased scrutiny.  Although retirement
budgetary costs have declined, the rigidities of the system may be
inconsistent with fostering the most effective force possible.  As
DOD evaluates the size and type of military it wants to build, the
retirement system is an important personnel policy to be considered. 


   AGENCY COMMENTS
---------------------------------------------------------- Chapter 4:5

DOD provided written comments on a draft of this report, which appear
in appendix III.  DOD stated that it did not object to the overall
thrust of the report but did, however, express concern that the
report's discussion of potential changes to the retirement system
could be taken to suggest a consensus on specific shortcomings of the
system. 

DOD emphasized the overall effectiveness of the retirement system in
providing the military with needed personnel and stated that the
impact of 1980 and 1986 changes to the system should be fully
assessed before further changes are made.  DOD also believes that any
changes eventually made to the retirement system must apply only to
new entrants to avoid breaking faith with service members.  In
addition, DOD believes that an immediate annuity for members
completing at least 20 years of active military service is an
essential feature of the system that must be maintained. 

DOD identified several issues it believes merit great weight in
considering whether and how the military retirement system should be
changed.  These issues included DOD's beliefs that (1) the current
system has been effective in retaining experienced personnel while
simultaneously avoiding stagnation among senior personnel; (2) the
existing retirement system, augmented by temporary authorities
established for the ongoing force drawdown, has provided adequate
flexibility in managing force levels; (3) the 1986 changes to the
retirement system increase the incentive for service beyond 20 years;
(4) changes to the retirement system, such as those discussed in our
report, could result in increased cost of other programs; and (5)
changes in the retirement system are not needed to allow DOD to
adequately vary career lengths according to specialty, given other
available compensation and management tools.  We agree that these are
important factors and perspectives in evaluating the military
retirement system and possible changes and believe they are
appropriately discussed in the report. 

DOD also expressed concern about the report's discussion of proposals
to (1) gradually vest service members in retirement benefits and (2)
place military personnel under a retirement system similar to FERS. 
We presented those options to include the full range of views and
suggestions reflected in our roundtable discussion.  We also pointed
out that substantial changes to the retirement system would involve
significant uncertainties and require thorough evaluation. 


SUMMARY OF GAO'S MILITARY
RETIREMENT ROUNDTABLE DISCUSSION
=========================================================== Appendix I

Our June 12, 1996, roundtable discussion was structured around three
questions that reflected those aspects of the military retirement
system included in our review: 

  -- How does the military retirement system shape the force and does
     it provide enough flexibility for managing the force? 

  -- Could changes in the retirement system result in cost savings
     for the Department of Defense (DOD)? 

  -- What types of changes to the military retirement system most
     merit further analysis? 

A summary of the discussion and a list of the roundtable participants
follow.  The comments presented are the opinions of the individuals
but not necessarily the agencies or organizations they represent. 


   FORCE COMPOSITION AND
   MANAGEMENT FLEXIBILITY
--------------------------------------------------------- Appendix I:1

The participants generally agreed that the military retirement system
plays a strong role in shaping today's force, although some noted
that the system cannot shape the force very precisely.  One
participant stated that the important question was whether retirement
shapes the force in a way that is desirable.  DOD's rules and
regulations for compensation, including the retirement system, are
not producing the kind of personnel structure that is wanted for the
21st century, according to several participants.  An example of a
need, cited by several participants, that is not met by the current
system is longer careers. 

The participants acknowledged that the military retirement system is
not the sole compensation factor or driver that shapes the force. 
Military retirement has a tremendous influence on people beyond a
certain point--perhaps the first enlistment or 5 to 10 years of
service--by pulling them toward 20 years of service, which enables
the military to retain sufficient people.  The participants
reiterated throughout the discussion that the military retirement
system cannot be evaluated without considering total military
compensation or the prevailing conditions in the rest of society. 
One participant said that private sector employment is a relevant
consideration because the military must compete with that sector to
retain people. 

Some participants disagreed about whether the military retirement
system was sufficiently flexible.  Several said that the retirement
system was not suited to the services' needs for different career
lengths among occupations.  One noted that optimal career lengths may
differ considerably for officers and enlisted personnel.  One
participant proposed lengthening military careers for senior officers
and shortening careers for other officers.  One participant noted
that personnel under the current system could be required to serve 30
years before receiving retirement benefits, although DOD has not used
that option.  Other participants pointed to the use of temporary
separation authorities to facilitate the recent drawdown as evidence
of flexibility within the current system. 

Many participants considered the system's 20-year vesting unfair and
an impediment to the effective management of personnel.  For example,
the current system creates difficult management decisions in specific
individual situations because of its rigidity.  The participants
disagreed about whether the treatment of individual cases, such as
the discharge of an officer with about 19 years of service convicted
of a serious offense in a civilian court, provided a strong argument
for changes in the military retirement system.  One participant
suggested as stronger evidence of a problem with the system the
financial implications of discharging a service member who had 18
years of service but had not been promoted. 


   COST
--------------------------------------------------------- Appendix I:2

A range of views were expressed by the participants regarding the
cost of the military retirement system.  Participants remarked that
the cost of the system (measured by its normal cost percentage) has
decreased substantially over the past 10 years.  Participants pointed
out that retirement accrual costs have fallen not only because of
reduced retirement benefits but also because the DOD Actuary updated
actuarial and economic assumptions.  Some participants were surprised
that the move to accrual accounting, under which the services'
budgets reflect the retirement costs of current personnel, had not
resulted in the services focusing more on the cost of military
retirement. 

Several participants said the services might not have increased their
focus on retirement costs partly because an aggregate retirement
accrual cost is calculated for personnel across all services.  They
said that, because the underlying determinants of retirement accrual
costs vary, the aggregate accrual charge does not reflect in the
services' budgets the true retirement costs of their own personnel. 
Several participants expressed support for having accrual costs
calculated separately for each service and for officers and enlisted
personnel.  One participant expressed the view that this change would
require legislation. 

Several participants cautioned against comparing military and
civilian retirement costs because military service differs
significantly from civilian occupations and personnel management. 
Some panelists noted that the true indicator of the adequacy of
retirement benefits, along with other aspects of compensation, is
whether the services can attract and retain the personnel they need. 

Several participants said that federal budget pressures will continue
to focus attention on DOD's struggle to control all types of
spending, including personnel compensation costs.  Participants
referred to tensions within DOD between military personnel costs and
other resource needs.  One participant said that lifting the
legislation that restricts the services' control over separate
categories of funding would enable the services to better balance
their compensation needs with their operational, training, and
procurement priorities and needs. 

Some participants commented that earlier vesting would raise costs. 
Others stated that the impact on costs depended on the specific
details of the retirement vesting scheme.  According to some
participants, earlier vesting might aid the services in separating
nonproductive personnel before 20 years of service.  That could save
costs, according to one participant.  A participant noted that
earlier vesting options had been proposed for years and not come
about because the services did not believe the options proposed would
give them additional flexibility in managing the force. 

The participants addressed the issue of grandfathering retirement
system changes, that is, applying changes only to new entrants. 
Several panelists asked whether DOD could end grandfathering as a way
to achieve greater cost reductions.  Others stated that
grandfathering was essential to avoid breaking faith with service
members. 


   MODIFICATIONS FOR CONSIDERATION
--------------------------------------------------------- Appendix I:3

Participants offered specific suggestions for changes to the
retirement system.  Most believed that some modification to the
current system, such as earlier vesting, was a good idea.  However,
three participants voiced specific concerns about force management
impacts, particularly the impact of earlier vesting on retention. 
Participants also expressed reservations about making modifications
before DOD knows the impact of the 1980 and 1986 changes. 

Several participants proposed or expressed support for adding a
defined contribution component--a 401(K)-type plan--to the current
defined benefit system, and one observed that the option of a
tax-deferred savings plan is available to most federal civilian
employees.  However, some participants noted that most enlisted
personnel have little extra income for savings.  Other specific
suggestions were

  -- adding provisions for earlier vesting in an annuity that would
     begin at age 62 or 65;

  -- making temporary early separation authorities permanent;

  -- vesting personnel in a small benefit, such as a deferred
     annuity, starting between 5 and 10 years of service and
     increasing the size of the benefit until it matches the value of
     the immediate annuity after 20 years of service; and

  -- providing a choice between receiving full credit for each year
     of service toward the current retirement benefit or receiving
     government contributions to a 401(K)-type plan. 

Some participants questioned whether the basic objective of providing
incentives for 20- to 30-year careers for all personnel remained
valid and suggested that fundamental and broader changes to the
system might be needed.  Most participants agreed that these changes
must be viewed in the long term.  Suggestions included placing
military personnel under a system similar to the Federal Employees
Retirement System (FERS) or having different retirement systems with
varying career lengths for different categories of personnel. 
Participants pointed out that uniformity only exists now in terms of
the benefit formula.  Individuals can depart from service with vastly
different pensions.  One participant suggested (1) maintaining the
current system for occupations requiring youth and vigor but
modifying it to provide some earlier vesting of benefits and (2)
placing all other military personnel under a FERS-type system. 

Two views were expressed regarding the information necessary to
justify fundamental and broader changes to the retirement system. 
One view was that designing the right retirement system required
first determining what kind of force DOD is trying to build.  The
other view was that such foresight was unlikely and that a retirement
system was needed that could accommodate changes in circumstances and
needs.  Several participants noted that past changes in the
retirement system have been forced on DOD, even if they have
eventually been viewed favorably.  One participant stated that any
change has to be forced on an institution from outside.  A
participant said that DOD could take some risks now in making
substantial changes to the military retirement system (without
knowing the impact of the 1980 and 1986 changes) because of the
potential for future downsizing. 


   PARTICIPANTS
--------------------------------------------------------- Appendix I:4


      PAUL ARCARI
------------------------------------------------------- Appendix I:4.1

Colonel, U.S.  Air Force (Retired) and Director, Government
Relations, The Retired Officers Association.  Formerly a member of
the Air Force's Directorate of Personnel Plans (1973-85) and
Assistant Director for Compensation Studies in the Office of the
Secretary of Defense (1968-73). 


      DAVID CHU
------------------------------------------------------- Appendix I:4.2

Director of the RAND Corporation's Washington Office and Associate
Chairman of RAND's Research Staff.  Formerly Assistant Secretary of
Defense for Program Analysis and Evaluation (1988-93) and Director of
Program Analysis and Evaluation in the Office of the Secretary of
Defense (1981-88). 


      ROBERT GOLDICH
------------------------------------------------------- Appendix I:4.3

Specialist in National Defense, Foreign Affairs and National Defense
Division, Congressional Research Service.  Formerly Head of the
Manpower and Budgets Section, Congressional Research Service. 


      TONI HUSTEAD
------------------------------------------------------- Appendix I:4.4

Chief, Veterans Affairs Branch, Office of Management and Budget. 
Formerly Chief Actuary in the Office of the Secretary of Defense
(1979-89). 


      CHRISTOPHER JEHN, MODERATOR
------------------------------------------------------- Appendix I:4.5

Senior Vice President, ICF Kaiser International, Inc.  Formerly
Assistant Secretary of Defense for Force Management and Personnel
(1989-93), Vice President of the Center for Naval Analyses (1981-89),
Director of the Marine Corps Operations Analysis Group (1979-81), and
Director of the Institute of Naval Studies (1977-79). 


      LAWRENCE KORB
------------------------------------------------------- Appendix I:4.6

Director of the Center for Public Policy Education and Senior Fellow
in the Foreign Policy Studies Program at the Brookings Institution. 
Formerly Assistant Secretary of Defense for Manpower, Reserve
Affairs, Installations, and Logistics (1981-85). 


      FREDERICK PANG
------------------------------------------------------- Appendix I:4.7

Assistant Secretary of Defense for Force Management Policy. 


      MARTHA PATTERSON
------------------------------------------------------- Appendix I:4.8

Director of Employee Benefits Policy and Analysis for KPMG Peat
Marwick. 


      BERNARD ROSTKER
------------------------------------------------------- Appendix I:4.9

Assistant Secretary of the Navy for Manpower and Reserve Affairs. 
Formerly Director of the Defense Manpower Research Center, RAND
National Defense Research Center (1990-94); Director of the Force
Development and Employment Program, RAND Arroyo Center (1984-90); and
Director of the RAND Manpower Personnel and Training Program
(1972-77). 


      FRANCIS RUSH, JR. 
------------------------------------------------------ Appendix I:4.10

Principal Deputy Assistant Secretary of Defense for Force Management
Policy. 


      THEODORE STROUP, JR. 
------------------------------------------------------ Appendix I:4.11

Lieutenant General and Deputy Chief of Staff for Personnel, U.S. 
Army.  Formerly Director of Program Analysis and Evaluation (1992-94)
and Director for Military Personnel Management, Office of the Chief
of Staff (1989-92). 


SELECTED RETIREMENT SYSTEM OPTIONS
========================================================== Appendix II

The DOD Actuary, at our request, estimated the impact on retirement
accrual costs, as measured by the normal cost percentage, of several
options.  All of the options retain the basic feature of allowing
retirement with an immediate annuity after 20 years.  They also
reflect previous proposals and suggestions from roundtable
participants.  The options are adding a

  -- deferred annuity for persons leaving with less than 20 years of
     service (options 1A and 1B),

  -- tax-deferred saving plan without government matching (option 2),

  -- tax-deferred savings plan with government matching (option 3),
     and

  -- graduated vesting schedule for persons leaving with less than 20
     years of service (option 4). 



   OPTIONS 1A AND 1B
-------------------------------------------------------- Appendix II:1


      DEFERRED ANNUITY FOR PERSONS
      LEAVING WITH LESS THAN 20
      YEARS OF SERVICE
------------------------------------------------------ Appendix II:1.1

This option includes two possible types of benefits in the form of a
deferred annuity for members who leave the military with at least 10
years of service.  One proposal (1A) does not adjust for inflation
before age 62; the other proposal (1B) adjusts for inflation. 
Benefits for members serving 20 years or more would be the same as
under the current system--paid as an immediate annuity. 

Benefit formula:  Same as the post-1986 military retirement benefit
formula. 

Calculation base:  Average of the highest 3 years of basic pay. 

Timing of benefit receipt:  Payable at age 62. 

Eligibility:  All persons separating with 10 or more years of
service. 

Other considerations:  1A--The benefit is not indexed for inflation
between the time of separation and age 62, but annual increases based
on the consumer price index minus 1 point (2.5 percent) are included
after
age 62. 

1B--The indexed benefit assumes the consumer price index minus 1
point (2.5 percent) cost-of-living adjustments during the deferral
period as well as after age 62. 

Actuary output:  The Actuary provided the changes in the normal cost
percentages for this alternative under the assumption that only new
entrants to the military would be eligible.  The normal cost
percentages for the post-1986 system, the non-indexed alternative,
and the indexed alternative were 28, 28.3, and 28.7 percent,
respectively. 


   OPTION 2
-------------------------------------------------------- Appendix II:2


      TAX-DEFERRED SAVING PLAN
      WITHOUT GOVERNMENT MATCHING
------------------------------------------------------ Appendix II:2.1

All personnel who serve a minimum of 20 years would receive benefits
as specified by the current military retirement system.  In addition,
individuals would be allowed to participate in a Thrift Savings
Plan-type benefit, contributing up to 5 percent of their pay, but the
government would not provide matching contributions.  The income tax
on the money set aside would be deferred. 

Contribution level:  Up to 5 percent of basic pay at the initiative
of the individual. 

Timing of benefit receipt:  Available at age 62. 

Eligibility:  Immediately, or with 1, 5, or 10 years of service. 

Other considerations:  Federal government experience shows a
4.1-percent deferral rate and a 50-percent participation rate. 

Actuary output:  The Actuary projected contributions to a Thrift
Savings Plan-type benefit for service members that meet a minimum
service requirement.  With service members eligible to contribute
immediately contributions are projected to reach about $3.1 billion. 
The projected contributions for a 10-year minimum service requirement
reach about $1.5 billion.  These amounts are not adjusted for
inflation. 


   OPTION 3
-------------------------------------------------------- Appendix II:3


      TAX-DEFERRED SAVINGS PLAN
      WITH GOVERNMENT MATCHING
------------------------------------------------------ Appendix II:3.1

This option is a combination of both a defined benefit and defined
contribution plan.  All personnel who serve a minimum of 20 years
would receive benefits as specified by the current system.  In
addition, individuals would be allowed to participate in a Thrift
Savings Plan-type benefit, with government matching.  Matching rules
are identical to those of the Thrift Savings Plan under FERS. 

Timing of benefit receipt:  Defined contribution with government
matching benefit payable at age 62. 

Eligibility:  Personnel are immediately eligible to contribute. 

Other considerations:  The contribution rate is 5 percent with under
1 year of service to 7 percent at 20 years of service.  The
participation rate is 50 percent with under 1 year of service to 90
percent at 20 years of service. 

Actuary output:  The Actuary estimated that this option would
increase normal cost to 31.5 percent, if the current defined benefit
formula were not changed.  The Actuary also estimated that, to
maintain normal costs of 28 percent, a reduction in the defined
benefit formula multiplier of about 11 percent would be required. 


   OPTION 4
-------------------------------------------------------- Appendix II:4


      GRADUATED VESTING SCHEDULE
      FOR PERSONS LEAVING WITH
      LESS THAN
      20 YEARS OF SERVICE
------------------------------------------------------ Appendix II:4.1

All personnel who serve a minimum of 20 years would receive benefits
as specified by the current system.  Personnel who serve between 10
and 20 years are vested in an annuity based on the current military
retirement formula.  The benefit is a deferred annuity at 10 years of
service and becomes a combination of an immediate annuity and
deferred annuity until the entire benefit is an immediate annuity at
20 years of service. 

Benefit formula:  2 percent of basic pay times years of service times
calculation base.  (As specified here, the annuity for those with 10
to
20 years of service does not include the restoral of value at age 62
that is a part of the post-1986 system.)

Calculation base:  Average of the highest 3 years of basic pay. 

Timing of benefit receipt:  Combination of deferred and immediate
annuity.  The deferred benefit is payable at age 62.  The mix of the
immediate and deferred benefit changes with years of service.  After
10 years of service, the benefit is entirely deferred.  The immediate
annuity percent increases gradually to 100 percent at 20 years of
service. 

Eligibility:  All persons with 10 to 20 years of service. 

Other considerations:  The benefit is not indexed for inflation
between the time of separation and age 62, but annual increases based
on the consumer price index minus 1 point (2.5 percent) are included
after age 62. 

Adjust decrement rates by reducing the number of members exiting at
20 years of service by 25 percent.  Distribute exit among 10 to 19
years of service. 

Actuary output:  The Actuary provided an estimate of the cost of
adding a mixed immediate and deferred annuity for members who
separate with between 10 and 20 years of service.  The normal cost
percentage for this option, with the adjusted decrement rate, is 24.7
percent.  If retention behavior were unchanged, normal cost would be
29.9 percent. 




(See figure in printed edition.)Appendix III
COMMENTS FROM THE DEPARTMENT OF
DEFENSE
========================================================== Appendix II



(See figure in printed edition.)


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix IV


   NATIONAL SECURITY AND
   INTERNATIONAL AFFAIRS DIVISION,
   WASHINGTON, D.C. 
-------------------------------------------------------- Appendix IV:1

Sharon Cekala
Celia Thomas
Penny Berrier
William Beusse
Karen Blum
Charles Perdue
Laura Talbott


   OFFICE OF THE CHIEF ECONOMIST
-------------------------------------------------------- Appendix IV:2

William McNaught


   OFFICE OF THE GENERAL COUNSEL
-------------------------------------------------------- Appendix IV:3

Ernie Jackson


*** End of document. ***