Freefalling FERS?

By Tammy Flanagan

March 6, 2009

Last week's column struck several nerves, judging from the comments I received from readers. I wanted to take some time this week to address one issue: the value of a retirement package under the Federal Employees Retirement System in the current economic environment.

Here's what one commenter said:

FERS is a paltry retirement, less than half a Civil Service Retirement System retirement with little inflation protection. The Thrift Savings Plan has lost 50 percent in value for many, plus there are plans to cut Social Security benefits. It would be nice if the federal government could offer a retirement to FERS employees that offers an actual retirement.

Another chimed in with this:

Here's the biggest problem with FERS: Even leaving at full retirement [minimum retirement age and 30 years of service], if you're younger than 62, will leave you without a cost of living increase until you're 62. So for example, with an MRA of 56, your FERS component remains static for six years. Assume just 4 percent inflation and run the numbers. You won't like what you see. And if inflation heats up during those six years ... lights out.

Let's look at it this way: After 30 years, a CSRS employee would have a retirement equal to 56.25 percent of their high three average salary. A FERS employee with 30 years of service would have a basic benefit of 30 percent (or 33 percent if they are 62 or older) of their high-three. Clearly the FERS retiree has to make up a difference of roughly 23 to 26 percent of their high-three to equal the CSRS benefit. Where is this going to come from?

If the employee is in the lower salary range, most of it will come from Social Security (or the FERS supplement, if the retiree is under 62 with unreduced FERS benefits). If the employee is in a higher salary range, then more needs to come from TSP savings. By design, Social Security replaces a proportionately higher amount of pre-retirement income for low-wage earners. The theory is that if you're at the higher end of the scale, you should be able to save more for your retirement.

COLA Concerns

The delayed cost of living adjustment under FERS and the less generous COLA applied after 62 is a concern. Social Security benefits receive a full COLA annually, but the earliest you can receive such benefits is 62. FERS retirees will have to consider whether they can afford to retire if they are younger than 62, or whether they need to supplement their retirement with additional wages from a second career or a part-time job. A lot will depend on how well they have managed their investments.

If all goes well, a larger investment portfolio can compensate for the loss of COLA. On the other hand, if your investment income is not adequate, you may need to reconsider your decision to retire.

To put things in perspective, though, consider how many employees outside government even get pensions these days, and how many of those are adjusted for cost of living. Only 21 percent of all private sector employees are covered by a traditional defined benefit pension, and COLAs of any kind are rare, according to the May 2006 edition of Fedgazette, a publication of the Federal Reserve Bank of Minneapolis.

Investment Management

Addressing the reader's comment about the TSP requires raising the issue of the way employees manage their accounts. Those nearing retirement shouldn't have the majority of their TSP investments in stock funds, since they are by definition riskier than other investment choices. Look at two of the lifecycle funds, which are aimed at providing a mix of investments based on an employee's targeted retirement date -- L 2010, aimed at employees retiring over the next few years, and L Income, targeted at those leaving even sooner than that. More than 70 percent of the L 2010 Fund is invested in two relatively safe harbors -- the G Fund (short-term Treasury securities) and the F Fund (fixed-income bonds). For the L Income Fund, the percentage is 80 percent. Over the last 12 months, L 2010 lost 13 percent and L Income lost 7.5 percent. Those are certainly not great numbers, but they're a lot better than the stock funds performed.

Finally, with respect to Social Security benefits, when the laws regarding them are changed -- as they probably will be at some point -- it's almost certain that protections will be put in place for those who are already retired or nearing retirement age. Remember that when the Bush administration considered modifications to Social Security, the president promised that people born before 1950 would not be affected by the changes.

I'm hoping that when the time comes, people born in 1958 or earlier won't have to worry about any changes. That's the year I was born.

Tammy Flanagan is the senior benefits director for the National Institute of Transition Planning Inc., which conducts federal retirement planning workshops and seminars. She has spent 25 years helping federal employees take charge of their retirement by understanding their benefits.

For more retirement planning help, tune in to "For Your Benefit," presented by the National Institute of Transition Planning Inc. live on Monday mornings at 10 a.m. ET on or on WFED AM 1500 in the Washington metro area.

By Tammy Flanagan

March 6, 2009