Rates and Returns

Answers to your questions on retirement benefits.

In April, I wrote about a webinar I had conducted on the subject of long- and short-term planning for retirement. Following the webinar, participants posted hundreds of questions about topics I had covered. I decided that over the next two weeks, I’ll try to address some of them. So let’s get right to it.

Is it true that the recent change in the retirement contribution rates (2.3 percent) affects new hires with less than five years of federal service?

Under a law President Obama signed in February, federal employees hired after Dec. 31, 2012, with less than five years of federal service must contribute an additional 2.3 percent of salary to their defined benefit plan, bringing their contribution to a total of 3.1 percent. Under the law, current employees -- most of whom contribute 0.8 percent now to their defined benefits under the Federal Employees Retirement System -- would not see their contribution rate rise. But last week, the House passed a bill requiring current federal workers to pay 5 percent more toward their retirement, with the increase introduced incrementally over the next five years. The Senate is not expected to go along with this move, though, and President Obama has threatened to veto such legislation if it reaches his desk.

What I'm most worried about is possible change to "high five." Do you think we'll have a window before they do something like that?

There are proposals in Congress that would change the high-three average salary to a high-five for the computation of both FERS and Civil Service Retirement System benefits. I think it’s unlikely, but not impossible, that this could happen before the elections in November. I honestly hope Congress can find a different solution to the budget problems than to cause a panic among employees who have neared the completion of their federal careers and are counting on the benefits promised throughout their federal service.

To me, it would make more sense to make changes to benefits for employees hired in the future. This way, they would have time to plan for the retirement that they will have based on their benefit package.

In the event that the high-five proposal becomes law, it’s important to think about how much it really would affect your retirement. How different was your salary five years ago than it is today? This change might not be catastrophic for you.

I understand that the lump-sum annual leave payment is taxed higher than regular income. Is that true and is there any way to avoid or defer it?

You will pay federal, state, FICA (Social Security) and Medicare tax on your lump-sum leave payment, assuming you normally pay these taxes on your salary. (CSRS employees are exempt from the FICA tax and some states do not have a state income tax.) On the other hand, you will not pay retirement contributions, insurance premiums or contribute to the TSP from your lump-sum leave payment. (There is a proposal in Congress that would allow you to contribute to the TSP from your lump-sum leave check, but it hasn’t been enacted yet.)

Your payroll office may use a flat withholding for federal taxes from this payment since it is generally going to be much larger than a normal biweekly paycheck. When you file your tax return for the year in which you receive your lump-sum payment, you will treat this payment like any other ordinary income.

Can you clarify whether any residual sick leave, at time of retirement, is paid out to the employee?

Employees are not compensated for their unused sick leave. The balance of sick leave is converted to months and days of service and added to an employee’s length of service used to compute retirement benefits. (Under FERS, only half the sick leave balance will be credited for employees who retire before Jan. 1, 2014.) Here’s more information on this topic.

Please explain more about the FERS benefit at retirement. I was expecting only Social Security and Thrift Savings Plan investments. When does FERS benefit kick in?

You are not alone. I have met many federal employees who are pleasantly surprised to find out that they have a government retirement benefit payable under FERS in addition to the TSP and Social Security. Here are more details.

Is 7 percent a realistic rate of return to expect from the TSP?

No one can guarantee any rate of return. The best that you can do is make reasonable assumptions. A 7 percent rate of return might be realistic over the long haul. But if you’re going to invest for only five to 10 years, it will be difficult to pull off, especially in today’s economic climate. If you’re not sure how to invest to achieve your goals, you might want to seek the advice of a financial adviser, who can help you minimize the risk and maximize the returns.

Here’s an example of short- and long-term investing: Andy and Wendy are within five years of retirement and are saving money to pay off the balance of their mortgage. The money earmarked for this purpose is in the bank -- safe and secure, with a very low rate of return. That’s because they’ll be spending the money in less than five years and they don’t want to expose it to any market risk. On the other hand, their retirement money is in a well-diversified mix of investments.

To achieve a rate of return that will exceed inflation and allow for the tax consequences at the time of withdrawal, you either have to know what you’re doing or pay someone to help you. Don’t be too short-sighted when it comes to your investments.

I'm thinking of retiring in about a year, but am worried about the huge Office of Personnel Management backlog that might delay my retirement processing for six to eight months. Can I use my TSP to fund the gap in pay?

Many recent retirees have requested partial withdrawals from the TSP to tide them over while they are waiting for the final processing of their retirement. The downside of doing this is that once the money is out of the TSP for 60 days, you can’t roll it over to an individual retirement account and you’ll have to pay taxes on it in the year it is received. If you are younger than 55 when you retire, you also may be required to pay a 10 percent early withdrawal tax penalty on anything you take out before age 59 ½.

In addition, you can make only one partial withdrawal from the TSP after you retire. If you choose to make a one-time partial distribution, then the next time you make a TSP withdrawal you would have to choose a full withdrawal that would include the choice of taking a series of monthly payments, a life annuity, another single payment or a combination of these options.

Another option for tiding you over while your retirement is processed is to save your annual leave while you’re waiting to retire and use the lump-sum payment for leave to carry you through.

If I choose to continue working past 70 1/2 years of age, can I still participate in the TSP? Will I be required to withdraw the funds due to the IRS-required minimum distribution rules?

You won’t have to begin your TSP withdrawals until April 1 of the year after you retire and you are older than 70 ½. You can continue to participate in the TSP and make contributions until you retire. Here’s a reference. If you are older than 70 1/2 and you retire on Dec. 31, then you will have to take a distribution by April 1 of the first year you are retired. If you retire after Jan. 1 and are older than 70 ½, then you can postpone your first required distribution until the year following your first year of retirement.

I am a new employee, age 21. How much should I contribute to the TSP? Which route of retirement planning should I go?

Congratulations on your appointment to federal service, and also for thinking about retirement at an early age. You’ll be glad you did. You should try to save at least the amount that is matched by your agency (5 percent). If you can’t accommodate that in your budget now, then work your way up to it. One strategy is to commit to increasing your TSP allotment every time you receive a step increase or earn a promotion.

For allocating your investment, you can use one of the TSP life-cycle funds pegged to your likely date of retirement. These funds spread your TSP investments across all a range of options and rebalance your account on a regular basis to minimize your risk and maximize your long-term growth. You also need to decide if the new TSP Roth option is for you. With this option, you pay taxes on the money you invest today and get tax-free withdrawals after you retire.