The term “federal employee” applies to millions of Americans across multiple governmental agencies. In the coming years, this demographic offers an enormous opportunity for advisors. 

CSRS, FERS and TSP. Welcome to the acronyms of federal employees’ retirement benefit programs. The term “federal employee” includes multiple groups: executive branch, postal, military, legislative and judicial. No matter how you slice it, it’s a large group, with an estimated 4.3 million employees as of 2013.

It’s also an attractive market for retirement planning services, particularly for advisors located near centers of government and military employment. According to a recent White House report, “Nearly 22 percent of the over 687,000 respondents to the 2012 Federal Employee Viewpoint Survey (EVS) expressed an intent to retire during the next five years.” 

Pension Basics

The biggest distinction between federal and private sector retirement benefits is that federal employees receive a defined benefit pension, says John Cermak, CFP, financial advisor with First Command Financial Services Inc. in Arlington, Va. There are multiple federal pension plans: Civil Service Retirement System (CSRS), Federal Employee Retirement System (FERS) and military. The table below highlights the basics of each plan’s coverage:

 

CSRS

FERS

Military

Eligibility

Hired before 1984

Hired after 1983

Eligible after 20 years service; 15 years in special cases

Employee contribution

7% of pay

3.1% of pay (0.8% if hired before 2013)

None

Social Security

No contribution; employment does not count toward determining Social Security benefits.

Full contribution and eligibility for benefits

Full contribution and eligibility for benefits

The plans’ retirement benefits also differ:

 

CSRS

FERS

Military

Basic benefit formula

Years 1-5: 1.5% times number of Service years times high-three average salary*;

Years 5-10: 1.75%;

Years 10+: 2%

1% times number of service years Times average high-three salary

 

 

Hired before 9/80: 50% of active duty Pay on last day of service;

Hired after 9/80: 50 percent of average high-three pay

Extended service formula

 

Multiplier increases from 1.0 to 1.1 for those who retire at 62 or later with at least 20 years service

20+ years: benefit increases 2.5% for each year of additional service

Minimum retirement age

55 for 30+ service years;

60 for 20-30 years;

62 for 5 -20 years.

No early retirement reduction.

55 for those born before 1948; date varies for those born later. Benefit reduced by 5% per year before age 62.

20 years service; 15 years in special cases

Cost of living adjustments

Consumer Price Index (CPI)

CPI if index is 2% or less;

2% if index between 2-3% percent;

CPI minus 1% if index above 3%

CPI for most retirees

*High-three average pay is the highest average basic pay earned during any three consecutive years of service. 

Some employees—firefighters, Foreign Service and law enforcement, for instance—receive a 1.7 multiplier instead of 1 or 1.1 in their benefit formula. It’s a complex system, but the government provides projected benefits statements annually to employees who request them, so you don’t have to run the numbers for each client. You can find more details on the plans in the Federal Employees Almanac, which is updated annually and is available in print and online versions. The U.S. Office of Personnel Management (www.opm.gov) also provides pension details on its website.

pensionPlanning for the Pension

The formulas favor long-term CSRS participants over those in FERS, Cermak points out. “If you spend 30 years as a CSRS federal employee, your pension is going to be a much larger fraction of your high-three salary than if you’re a FERS federal employee,” he says.

Randy Gantt, CFP with Artifex Financial Group in Cincinnati, Ohio has found that some employees misinterpret their projected benefit. They naturally tend to focus on the illustration’s high amount, which illustrates a monthly annuity with no survivor benefit.

But that number isn’t applicable when survivors need to continue the pension income after the retiree’s death. It’s a real eye-opener when the employee sees the difference between the life-only payment and the joint and survivor options, he explains.

Gantt provides an example of an employee retiring at age 60 with an average $100,000 salary: “If they take it with no survivor benefits, the pension is $2,900 a month. If they take it with a maximum monthly survivor (benefit), it’s $1,400 a month. It’s a huge difference.”

CSRS and FERS participants must also factor health insurance coverage into the pension decision. Retirees can continue to participate in the Federal Employee Health Benefits Program after retirement, which is a valuable benefit. To do that, though, the employee must start the pension annuity immediately upon retirement. Employees who want to defer the start of their pension can’t remain in the health insurance plan.

It’s purely a mechanical issue, says Cermak, because the monthly insurance premium must be deducted from a retiree’s pension. “It’s actually no more difficult than that,” he explains. “It’s not an issue of ‘we just don’t want to give it to you because you chose to defer your benefit.’ The health benefit program couldn’t care less other than the fact that they only have a system set up to do monthly payments out of your retired pay. If you’re not getting any retired pay, they can’t get paid.”

peaceful retirementThrift Savings Plan

The thrift savings plan (TSP) is roughly the equivalent of the private sector’s 401(k) plan. Civilian and military employees can elect pretax salary deferrals or a Roth option and can choose from a range of low-cost index funds and lifecycle funds.

There is an automatic 1 percent government contribution for FERS participants. In addition, FERS participants get a 100 percent match on the next 3 percent contribution and a 50 percent match on the next 2 percent, which adds up to a full match on the first 5 percent contributed. CSRS and military personnel do not receive a match. Earning the full match is a powerful incentive, says Gantt, but the limited number of TSP-investment options means advisors might have to work with assets outside the plan for optimal asset allocation.

Maximizing the TSP’s effectiveness requires additional planning. For example, when a military member serving in a combat zone contributes to the TSP, those funds go into a tax-exempt “bucket,” Cermak explains. When the service member leaves active duty, those funds can be rolled into a Roth IRA to preserve their tax-free status plus tax-free growth and withdrawals.

There are several other reasons why retirees can benefit from rolling over their TSP. First, the plan only allows one withdrawal—retirees can’t take multiple partial withdrawals. Also, retired participants must use the same fund allocation in both their Roth and pre-tax accounts. You can’t decide to make one account more or less aggressive than the other, says Cermak—you must maintain the same portfolio in each.

The plan also makes post-70½ required minimum distributions proportionately from both the pretax and the Roth accounts, so rolling the pre-tax money into a traditional IRA and the Roth TSP funds into a Roth IRA prevents having to take post-70½ distributions on the Roth money.

The TSP also imposes restrictions on beneficiary distributions. Cermak gives an example. The husband, a federal employee, dies and his wife inherits his TSP as beneficiary. She names their two children as her equal beneficiaries on the account. If she dies after age 70½ when she’s taking required minimum distributions, the children cannot stretch the distributions as they could with an IRA.

Instead, the plan will send each child a check for his or her share of the account and they lose the option to roll it into an inherited IRA. “It all gets paid at once and all the future tax deferral is lost,” Cermak says.

retire overseasSpecial Challenges (overseas)

William Carrington, CFP, RMA owns Carrington Financial Planning LLC in Arlington, Va. His wife has been a diplomat with the U.S. State Department for over 20 years, including 16 years overseas. Carrington works with numerous current and former Foreign Service employees and he’s found that the overseas assignments can create unique retirement planning problems.

For starters, he says, many couples are forced to live solely on the employee’s income because the other spouse can’t work in the foreign country. In addition, their time overseas changes employees’ financial timetables.

Many don’t buy a home in the U.S. until they are close to or in retirement to avoid becoming absentee landlords, so they enter retirement with substantial mortgages. College costs for their children are another problem.

If the parents aren’t aware of how quickly costs are increasing back home and fail to plan accordingly, they risk taking on large of amounts of student loan debt later in life.

Income loss from disability creates another exposure. Carrington points out that Foreign Service employees stationed overseas can’t buy supplemental disability income insurance. They must rely instead on employer-provided coverage, which is often insufficient to sustain a lifestyle. “You have someone who makes, say, $80,000 a year,” Carrington explains.

“If they were to become permanently disabled, they would only get 40 percent of salary, which would be $32,000 and it coordinates with Social Security. So, if they also get Social Security disability, that’s subtracted from their disability pension. And you cannot buy supplemental disability coverage for Foreign Service. Most domestic employees through their employer get 60 percent salary covered by disability insurance and they could buy supplement insurance to fill the gap, but it’s not available in Foreign Service.”