How to Avoid Buyer’s Remorse
Federal retirees should understand the ins and outs of each retirement system, especially if they have been misclassified.
We’ve all experienced buyer’s remorse at one time or another. You buy something new only to discover there’s a better version of what you just purchased, or maybe you just have second thoughts about your choices. In some cases, you bought the wrong thing and find there’s no simple fix for a costly mistake. The same thing can happen in retirement planning.
Maybe, you’ve felt buyer’s remorse after moving your TSP into a different fund right before a big increase in the account where you were previously invested. A less frequent but more significant issue occurs when a federal employee is placed incorrectly in the wrong retirement system. Fortunately, when this happens, employees generally have a period of time when they have the option to move into the correct system or they can decide to stay with the system to which they were incorrectly assigned. This option is available under the Federal Erroneous Retirement Coverage Corrections Act. If you are facing a decision under FERCCA, be sure to understand all the variables.
Today’s column aims to show how the Civil Service Retirement System, the CSRS Offset, and the Federal Employees Retirement System were all designed to provide complete retirement and disability benefits for federal workers, but in very different ways.
First, it’s important to understand the differences between the three systems:
- The CSRS was established 15 years before Congress created the Social Security system. Federal employees under CSRS were excluded from participating in Social Security until 1987, when the FERS was created and the Thrift Savings Plan was established. CSRS was designed as a single benefit system that didn’t require employee involvement other than to work for the government for a full career.
- The CSRS Offset is similar to CSRS, however this system accommodates federal employees covered by the Social Security amendments of 1983. Most employees covered under CSRS Offset receive their retirement through a combination of a reduced (offset) CSRS benefit, plus Social Security.
- FERS is a three-part retirement system that provides benefits to the vast majority of federal employees today. It includes a government pension (smaller than the pension under CSRS), Social Security and money an employee has saved through the Thrift Savings Plan, government’s 401(k)-style retirement plan. FERS requires employees to decide how much and where to invest in the TSP, and employees are responsible for continuing to manage these funds after they retire.
In addition to the government pension, federal retirees may also qualify for Social Security retirement no matter which federal retirement system they were covered by during their federal career. All federal employees may participate in the TSP. Despite all three components being present in the retirement of most CSRS, FERS, or CSRS Offset retirees, the value of these three components can vary tremendously in retirement.
Before I offer a general example comparing CSRS to FERS to CSRS Offset, remember that every individual’s situation will be different. The factors that will affect your retirement income include, but are not limited to:
- Age at federal retirement
- Age at claiming Social Security
- Basic pay rates in effect throughout your career (this impacts all three of the benefits)
- Marital status and spousal benefits
- How much you’ve saved in the TSP
- Your investment choices in the TSP
- The choice of distribution options from the TSP
- There are also different formulas for those federal employees covered under special provisions of CSRS and FERS such as for law enforcement officers, firefighters and air traffic controllers.
In light of these variables and others, let’s consider an employee who had 30 years of federal service at retirement and a high-three average salary of $80,000. For the CSRS Offset scenario, the 30 years included 15 years under CSRS before leaving federal employment and later returning to work another 15 years under CSRS Offset. It is also important to remember that a CSRS employee had to be hired before 1984 in order to be covered under CSRS, so for simplicity, we are going to ignore the fact that a CSRS employee today would have at least 38 years of federal service if they never had a break in their career. We’ll also assume a typical career progression starting out at an entry level salary and progressing to higher pay later in the career. Despite these assumptions, this comparison shows that CSRS, FERS and CSRS Offset provide similar retirement income when all components are considered, but in different ways.
FERS Scenario: Under FERS, the government pension is computed as 1% x high-three average salary x length of service. If the employee retires at age 62 with 20 or more years of service, then the computation factor is 1.1% instead of 1%. In this example, that would provide a government pension of:
1% (or 1.1%) X $80,000 X 30 = $24,000 (or $26,400)
CSRS Scenario: The CSRS pension benefit can be computed by using this shortcut to the general formula: length of service minus two and then that answer times two and add .25 and a percent sign:
(30 - 2) x 2 + .25 = 56.25% x $80,000 = $45,000
CSRS Offset Scenario: The CSRS Offset formula is identical to CSRS, but when the retiree is eligible for Social Security the CSRS benefit is subject to an offset (reduction). The $45,000 retirement benefit would be reduced by approximately 15/40 of the Social Security benefit. The number 15 represents the years covered under CSRS Offset and 40 is a constant that represents a career from age 22 to age 62. If the employee is not entitled to Social Security at age 62 because, perhaps they retire younger than age 62, there is no offset until or unless he or she later becomes entitled to Social Security. Depending on how many years of substantial Social Security covered work this employee had during their lifetime, their Social Security benefit may be reduced by the Windfall Elimination Provision of Social Security. The end result might look something like this:
(30 - 2) x 2 + .25 = 56.25% x $80,000 = $45,000
Then, offset by 15/40 x $11,400 (Social Security benefit)
$45,000 - $4,275 = $40,725
FERS Scenario: The Social Security retirement for this employee will be based on those 30 years of federal employment wages plus any other employment that was subject to FICA tax withholding over their lifetime. For this example, at the time of retirement, let’s assume that the annual Social Security benefit is $18,000.
CSRS Scenario: The 30 years of federal service was exempt from FICA tax withholding. This may result in the CSRS retiree not qualifying for Social Security since you must earn 40 credits in order to qualify for a Social Security retirement benefit. Credits are based on your total annual wages; it takes 10 years of work (or more if fewer than 4 credits were earned in a year) to earn 40 credits. The average of your earnings over your working years, not the total number of credits you earn, determines how much your monthly payment will be when you receive benefits. CSRS retirees also have to consider that their earned Social Security benefit may be reduced due to the modified formula used under the Windfall Elimination Provision and the impact that the Government Pension Offset will have on the spousal or widow’s benefit entitlement.
For this example, let’s assume that the individual had earned 40 credits of coverage from work they did outside of their government career, however due to the Windfall Elimination Provision and the short amount of time paying into Social Security, the annual benefit they are entitled to is $3,600.
CSRS Offset Scenario: Like FERS, the CSRS Offset retiree will have a more substantial Social Security benefit entitlement. Many CSRS Offset retirees become fully or partially exempt from both the Windfall Elimination Provision and the Government Pension Offset from their continued coverage of the FICA tax on their federal wages. The Social Security benefit for this retiree is based on the earnings during the 15 years of CSRS Offset service and additional years of other Social Security covered employment for an annual benefit of $11,400.
Thrift Savings Plan
FERS Scenario: FERS employees typically are more focused on managing the TSP as an integral part of future retirement. FERS employees receive 1% of basic pay each pay period automatically from the agency whether they contribute to the TSP or not. In addition, agencies match contributions dollar for dollar up to 3% and then 50 cents on the dollar up to 4% of basic pay. For this example, we’ll assume the employee had 30 years of contributing a minimum of 5% of basic pay to the TSP, as well as diversifying the investment more aggressively in the early years and more balanced in the later years, for a balance of $550,000.
CSRS Scenario: CSRS employees have been permitted to contribute to the TSP since its inception. CSRS employees receive no agency automatic or matching contributions. For this example, let’s assume that the employee was hired in 1983 (4 years before the TSP started) and retired in 2013. Let’s also assume that they saved in the TSP when available at a rate of 5% of basic pay and their TSP balance is $300,000 at retirement.
CSRS Offset Scenario: Let’s assume that the employee had a TSP balance around the same $300,000 as the “pure” CSRS employee at retirement.
How the Systems Compare
So, how would this employee with 30 years of federal service and a high-three salary of $80,000 come out under each scenario? Here are the results:
- $45,000 CSRS retirement;
- $3,600 / year Social Security
- Total annual lifetime stream of income: $48,600 plus:
- $300,000 in TSP at retirement
- $40,725 CSRS Offset retirement
- $11,400 Social Security retirement
- Total annual lifetime stream of income: $52,125 plus:
- $300,000 TSP account balance
- $24,000 (or $26,400 if age 62 or older) FERS retirement
- $18,000 Social Security benefit
- Total annual lifetime stream of income: $42,000 plus:
- $550,000 TSP balance
The FERS employee’s higher balance in the TSP should make up most of the difference compared with lifetime pension and Social Security benefits of the CSRS and CSRS Offset scenarios. As you can see, the three systems are comparable, but it’s important to understand the many variables that will affect an individual’s total federal retirement benefit.
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