Saturday February 8, 2014

Federal Retirees Face Unique Challenges

If you are going to retire from a career with the Federal Government or one of its agencies, there are a great many benefits to be had, as well as some unique challenges.

First off there is the Federal Employee Retirement System (FERS) Pension / Annuity.  Throughout this post I will use Pension and Annuity interchangeably when discussing this FERS lifetime benefit. There is also another category of Federal retiree – those retiring under the the Civil Service Retirement System (CSRS) – that I won’t get into in this entry. With fewer than 15% of employers in the private sector still offering traditional pensions plans, a career with the government shines in this respect.

Health Insurance – the Federal Employee Health Benefits (FEHB) are superior and retirees can continue these throughout retirement if retiring with a minimum number of years’ service.  Once a Federal retiree attains age 65 and Medicare eligible, FEHB becomes their supplemental coverage.

FERS Annuity Supplement – a Federal retiree that leaves prior to the minimum Social Security age of 62 will receive a supplement to their FERS Pension. This is paid until the retiree reaches age 62. The calculation for how the amount paid is derived is more than I will undertake in this short article, but it is an amount approximating the retiree’s age 62 Social Security Benefit amount. If this makes it seem like a federal retiree is being lulled into taking Social Security early at age 62, it’s true. More on this later in the post.

Federal Thrift Savings Plan (TSP) – the government’s version of a 401(k) plan.  The TSP investment choices are all ultra-low cost to own (think index fund or ETF type expenses, but lower). There are just enough funds to provide adequate diversification without overwhelming one with choices. There are also Target Date Funds (their L Funds Series) to make asset allocation even easier. The TSP also offers a Roth TSP option to save on an after-tax basis.  And then there’s the magic G Fund, which is a special government bond fund that does not fluctuate in value, only in the amount of interest it pays. It is the equivalent of a Stable Value Fund, but with a much more attractive interest rate.

Here are some of the unique challenges facing a Federal retiree:

  1. The FERS Pension / Annuity amount payable to a government retiree currently takes the Office of Personnel Management (OPM) between 5-8 months to calculate and begin paying in full.  During the first months of retirement the retiree will be paid somewhere around 50% of the full amount due. This creates an income shortfall in the meantime.
  2.  The FERS Annuity Supplement, for those retiring prior to age 62, takes even longer to calculate and begin receiving, creating more income shortfall.
  3. Dental, Vision, and Long Term Care insurance coverages – These coverages are optional add-ons to a Federal retiree’s FEHB package.  While the retiree waits for their monthly FERS Annuity payment amount to be finalized, they must pay the cost of these coverages out-of-pocket. After the full FERS pension has begun, these costs will be withheld from the monthly annuity payment, just like their FEHB premiums. And you are expected to pay this while getting only about half your projected monthly FERS Annuity payment.
  4. Social Security – for a Federal employee that retires before age 62 and has gotten into the habit of receiving this monthly income via the FERS Annuity Supplement, it’s almost impossible to resist filing for Social Security benefits at 62.  But doing so reduces a recipient’s benefits by 25% for life, versus claiming benefits at Full Retirement Age (FRA) between ages 65 and 67.  This will mean a permanent reduction in Social Security benefits. The difference in total benefits paid over a normal lifespan could be well in excess of $100,000. Who benefits most if Social Security is claimed early? Not the retiree because they’ve just locked into a 25% lifetime pay cut. Choosing the optimal Social Security claiming strategy is a topic in itself, just don’t be lulled into claiming early if it can be avoided. This has even more impact for a married couple as it locks in what the surviving spouse will receive for the remainder of her/his life.
  5. Thrift Savings Plan – A retiring Federal employee may leave the TSP in place, transfer to an IRA, or have    the TSP turned into a lifetime or lifetime with survivor annuity (like the FERS pension). The most compelling reasons to leave at least some of the TSP balance in the Plan are the benefits of non-penalized withdrawals prior to age 59 ½, and the magic G Fund.

The TSP (and private sector 401(k) plans) give participants the ability to withdraw funds before Normal Distribution Age (59 ½) if the participant is at least age 55 at retirement. You can’t do this from an IRA. If retiring before 59 ½ and knowing how long it could be before receiving full FERS Annuity payments and the FERS Supplement, it’s important to have reserve funds to make up the income shortfall and the TSP can provide this.

Even if one chooses to Transfer/Rollover the TSP balance to an IRA Plan (regardless of the investment plan chosen) the G Fund is a compelling place to leave the overall Bond / Fixed Income Allocation for your retirement portfolio. A U.S. Government Bond Fund that can never lose money is a great thing and can’t be found any place else.

So what’s a Fed to do? You’re 50, have 25 years of service, and want to retire in five years at age 55.  Where is the money coming from to make up your monthly income deficit until you start getting paid properly?  A Federal Employee needs to start thinking about this at least 5 years before the Big Day.

A viable option would be to increase your TSP and / or Roth TSP contributions a few years before retirement. Check with the OPM to see what your projected monthly FERS Penion and FERS Supplemental payments should be. Then plan for having to live on about half of the FERS Pension for up to 8 months.  Whatever the amount is of your monthly living expenses that cannot be covered by one half of the FERS Annuity payment is your monthly shortfall.

Do these rough calculations:

  1. (Projected Monthly Living Expenses) – (one-half Projected Monthly FERS Annuity payment) = Monthly Income Shortfall
  2. (Monthly income shortfall) x (8 months) = Additional amount to save between now and retirement.

Whether you are saving this through the TSP or Roth TSP, do it in the G Fund.  This is the money you will have to live on until your FERS Pension and Supplement get straightened out and you don’t want another Great Correction wiping out half of it right before you need it.

Are YOU Ready to Retire? Find out with this interactive quiz:

Will YOU Get the Most From Social Security? Get your Social Security Report here:

My Company Website: