If you work with federal employees and retirees, you already know that the current Federal Employees Retirement System (FERS) can be confusing to navigate. While FERS is comprehensive it is also complicated, with its numerous choices and moving pieces.
Although federal agencies routinely offer pre-retirement courses, you are the primary source of information for many clients who are covered under FERS. As we head into another year of potentially high inflation, it is especially important that you are prepared for these conversations.
First, it’s critical to distinguish between the different benefits offered to federal retirees.
Two distinct retirement systems
In 1987, FERS became the only choice for new federal employees. Prior to then, federal employees were covered by the Civil Service Retirement System (CSRS). State and local governments may have plans that are similar to what I discuss below but they are not CSRS or FERS, strictly speaking.
The main difference between CSRS and FERS is where the burden of contribution rests. CSRS was set up as a defined benefit plan. CSRS retirees typically have a larger monthly pension benefit and COLA increase. In the mid-1990s, CSRS participants were given the opportunity to access the Thrift Savings Plan (TSP) and Social Security, neither of which were part of the original package.
In contrast, FERS is an example of a defined contribution plan. While FERS retirees receive an annuity payment, it is less than what a CSRS retiree receives if length of service, age, and salary are equal. In place of a higher defined pension payment, FERS employees have the opportunity to contribute up to $27,000 (including $6,500 catch-up) in 2022 to their TSP and are eligible for a 5% match from their agency, depending on their contribution. (For 2023, contribution maximums are $22,500 and $7,500 catchup.)
The supplemental annuity payment, discussed below, was added to help bridge retirement to social security. Social security benefits have always been a part of FERS.
Among current retirees, just under one-half are collecting benefits under CSRS. However, nearly 80% of federal workers who are currently retiring are retiring with FERS benefits. Because of longevity and beneficiary payments, it is estimated that CSRS benefit payments will continue on a declining basis for another two decades.
This article focuses on FERS benefits.
One size doesn’t fit all
Through various online programs, I have guided thousands of civilian employees to better understand their benefits under FERS. As inflation continues, although somewhat abated from earlier this year, the issue of cost-of-living adjustments (COLAs) take on a greater significance for this population.
Did you know that under the FERS guidelines, not all retirees are treated the same? In fact, the system includes multiple categories of retirement. Each carries a unique combination of eligibility requirements for health benefits, regular and supplemental annuity payments, and COLAs.
The majority of federal retirees fall in the category best described as ‘full and unreduced.’ These retirees can claim immediate benefits based on their years of service and their age at retirement. Others FERS retirees may qualify under early, deferred or disability categories, depending on when and how they retire.
To determine how much inflation protection a federal retiree will receive, it’s critical to understand the FERS timeline for COLAs. Although FERS members may begin collecting a full and unreduced retirement pension beginning at age 55, COLAs are only applied to its retirees aged 62 and older. This holds true, too, for FERS retirees who take early or deferred retirement. However, individuals collecting disability retirement through FERS can receive COLAs starting in their second year of retirement, regardless of the retiree’s age.
A look at the numbers
The Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) is compiled by the Bureau of Labor Statistics and is a variation of the Consumer Price Index (CPI). FERS COLAs are calculated based on CPI-W, although they do not offer increases commensurate with the rate of increase of the index. This is especially impactful as inflation stays high. For instance, next year’s Social Security and Civil Service Retirement Service (CSRS) recipients will see an increase of 8.7% over 2022 benefits. This reflects the full rate of the CPI-W increase. In contrast, FERS retirees, will receive an increase equal to only 7.7%.
The FERS computation is tiered:
- Inflation < 2%: COLA = CPI-W
- Inflation between 2% and 3%: COLA = 2%
- Inflation over 3%: COLA = CPI-W – 1%
When discussing inflation and asset protection with your clients, it is also important to bear in mind the remainder of the FERS timeline.
As mentioned earlier, FERS’ minimum “full and unreduced” retirement age (55) is well below the COLA start point (62). Supplemental annuity payments begin at retirement, but only for those retirees who are eligible for an immediate or early retirement. These payments are calculated to approximate 80% of a recipient’s predicted Social Security benefits at age 62. Supplemental annuity benefits stop at age 62, just as social Security eligibility begins.
Curious how the supplemental benefits are calculated? Here are three easy steps to ballpark the monthly benefits.
- Take the Social Security benefit estimate at age 62 (I always suggest to clients that they set up a personal account at https://www.ssa.gov/myaccount).
- Multiply that figure by total years of FERS service, rounded up to the next higher year.
- Divide by 40.
This gives an approximate annual calculation for the annuity supplement. If you want a more precise calculation, check out the CSRS/FERS Handbook with detailed instructions.
Mind the potential cash-flow gap
Perhaps because the FERS timeline makes age 62 a key pivot point, the majority of its retirees take Social Security early. However, claiming social security prior to full retirement age (FRA) means a lifetime of reduced benefits. When meeting with clients and running programs, I’ve used the concept of a potential cash flow gap (age 62 to age 66 or later) as a starting point for conversations about planning for retirement income and inflation protection.
I also use the FERS timeline to expand the conversation. For example, age 65 is when Medicare eligibility starts and it’s important to note that Medicare Part B premiums can increase faster than inflation, resulting in a loss of buying power.
It’s also important to remember that the threshold for taxation on Social Security benefits is not inflation adjusted. This means that high COLAs on those benefits could increase a retiree’s tax burden.
Life after retirement
Of course, one of the considerations that all retirees face now is the question of how long to work. Retirement, like life, is different for each of us. For some federal retirees, the door is open to consult with the same agency where they worked; others take parttime or temporary work in the government to supplement their retirement income. State and local government retirement plans vary in terms of inflation protection; private pensions rarely address this.
Our longer lifespans convey opportunities and risks. The opportunity to continue to work or to pursue other passions is an enviable position if we have planned well enough.
Finally, remind your clients that real inflation protection in retirement comes more from the choices they make than from COLAs that get applied. Retirement is a balancing act for everyone Identifying different risks and your client’s reaction to them will help you in these conversations. Investment choices become even more important when we may need our need income for 20 or even 30 years post-retirement. The double-edged sword is that investing in growth could be the best way forward, despite it feeling especially risky for older clients.
Safety is often an illusion, and the greatest risk just might be outliving our money.
llene Slatko, is the CEO and founder DSS Consulting. She spent over 25 years as a financial advisor and built her business through her seminar series, “Women and Their Money.” For the last 10 years, Ilene has focused exclusively on financial education and helping clients build strong financial decision-making skills. She works frequently with women during the long tail of a divorce or an estate and assists them with the administrative and financial choices they face. She is a subject-matter expert on the Federal Employees Retirement System (FERS) and speaks to audiences across the civil-service spectrum.