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Congress Makes Changes to FERS for New Employees Only
The first change takes effect Jan. 1, 2013 at which time newly hired employees will have to contribute each pay date a higher portion of their after-tax salary to FERS. The second change is that new members of Congress and Congressional employees will also have to contribute more to FERS and will accrue retirement benefits at the same rate as regular employees.
This column discusses the first change -- higher payroll contributions to FERS for newly hired Executive and Judicial Branch employees. Also presented in this column is what current FERS-covered employees should do in order to take advantage of the fact that they will not have to contribute more to the FERS Retirement and Disability Fund.
In general, those employees who enter federal service as a full time or part time permanent employee on or after Jan. 1, 2013 will be covered under FERS as Revised Annuity Employees (RAE), or FERS-RAE. There are exceptions to the new retirement coverage rule, and the date Dec. 31, 2012 is a key date for each of those exceptions. An individual will be excluded from FERS-RAE coverage if any of the following exceptions apply: (1) An employee on Dec. 31, 2012 was covered under FERS; (2) An employee on Dec. 31, 2012 was performing civilian service which is creditable or potentially creditable (see below) under FERS. An example of the second exception is an employee who is covered under any of the other retirement systems from which service credit may be transferred to FERS such as CSRS or CSRS Offset; or (3) An employee on Dec. 31, 2012 was not covered under FERS and was not performing civilian service which is creditable or potentially creditable service under FERS, but as of Dec. 31, 2012 had performed at least five years of creditable civilian service or potentially creditable service under FERS, CSRS or CSRS Offset in prior years.
Potentially Creditable Service
Certain categories of service become fully creditable only if the employee takes certain actions including applying to pay for prior service or waiving rights to benefits under another retirement system for federal employees. For example, service covered by the Foreign Service Pension System is potentially (but not fully) creditable when an employee waives his or her rights to benefits under that system and makes the required FERS deposit to OPM.
Break in Service of Three Days or Less That Includes Dec. 31, 2012
If an individual leaves a FERS covered position immediately before Dec. 31, 2012 and returns to a FERS-covered position after a break of three days or less, the employee will continue to be covered under FERS even if the employee returns to service after Dec. 31, 2012. A break in FERS coverage of three days or less is not considered to be a separation from service and the individual is considered to be covered under FERS as of Dec. 31, 2012.
Performing Active Military Service on Dec. 31, 2012 Following a Separation from Civilian Service
If a FERS-covered employee separates from federal service before Dec. 31, 2012 to enter active duty military service and returns to federal service after Dec. 31, 2012 upon exercising his or her reemployment rights, the employee is not considered to be separated from federal service for purposes of determining FERS-RAE coverage.
FERS Employees in a Leave Without Pay Status on Dec. 31, 2012
FERS covered employees who are not separated from federal service but who on Dec. 31, 2012 are in a leave without pay status are excluded from FERS-RAE coverage, even if: (1) The employee has been on leave without pay for more than six months in 2012 and does not receive service credit for Dec. 31, 2012; or (2) The employee has been on leave without pay while performing active duty military service and does not return to the federal civilian service by exercising his or her reemployment rights.
Unless an individual does not fall into any of the above exceptions, the individual will pay an additional 2.3 percent of their after-tax wages to the FERS Retirement and Disability Fund. Currently, FERS-covered regular employees contribute 0.8 percent of their after-tax wages to the retirement fund while their agencies contribute on the behalf of the employee 11.9 percent of the employee's gross salary. Law enforcement officials, firefighters and air traffic controllers covered by FERS contribute 1.3 percent of their after-tax wages to FERS while their agencies contribute 26.3 of their gross salary to FERS.
Under FERS-RAE, employees will contribute 2.3 percent more of their after-tax salary and their agencies will contribute 2.3 percent less to the retirement fund. A regular employee will therefore contribute 3.1 percent of their after-tax wages to FERS. Law enforcement officials, firefighters and air traffic controllers will contribute 3.6 percent of their after-tax wages to the retirement fund. Table 1 (FERS) and Table 2 (FERS-RAE) summarize the contribution rates for different categories of employees and their agencies.
Table 1. FERS Contribution Rates
Table 2. FERS-RAE Contribution Rates
Those individuals who have applied for and have been accepted for a federal job are encouraged to start service before Jan. 1, 2013 in order to pay less to their retirement.
What about current FERS employees? What should they be doing in order to take advantage of the fact that they have "dodged a bullet" and will not have to contribute more to the FERS retirement system?
Current FERS-covered employees will not be required to contribute more to the FERS Retirement and Disability Fund. These employees should ask themselves whether they want to take advantage of the 2.3 percent of after-tax wages "savings". For example, if they are not maximizing their Thrift Savings Plan (TSP) contributions, they are encouraged to take some, if not all, of their 2.3 percent "savings" and contribute more to the TSP. If they are maximizing their contributions to the TSP, they are encouraged to contribute to some other form of retirement account, such as a traditional or a Roth IRA.
Many federal employees have asked the question: Is there any "rule of thumb" as a measure for determining if they are saving enough for retirement? In September, Fidelity Investments, the nation's largest provider of 401(k) plans, attempted to provide such a number. Fidelity suggested "eight" as the "magic number." In particular, the typical wage earner should set as a retirement goal to save by the year they retire at least eight times their last year's (the year preceding their retirement date) annual gross salary in order to be sure they can afford to pay their basic living expenses throughout retirement.
Fidelity Investments also presented some benchmarks to measure an employee's progress for retirement savings throughout the employee's working career. In particular, by age 35, a federal employee's goal is to have a TSP account that is equal to at least the employee's annual gross pay at age 35. By age 45, the value of an employee's TSP account should be equal to at least three times their annual gross pay, rising to at least five times their annual pay by age 55. Are these achievable benchmarks? Consider the following example:
An individual enters federal service at age 25 with a starting annual salary of $60,000. The employee contributes five percent of their salary, $3,000, to the TSP. The employee receives an automatic one percent of gross pay contribution and four percent matching contributions from their agency. The employee receives on average three percent pay increase/step increase and/or promotions over a 10 year period. The employee's TSP account grows on average 5 percent per year for 10 years. At age 35, the employee's gross salary is $80,000 at which time the employee's total contribution to the TSP increases to $12,000 per year (includes employee contributions and agency automatic and matching contribution), growing on average 5 percent. By age 45, the employee's gross salary is $100,000 at which time the employee's total contributions to the TSP increases to $17,000, including the automatic and matching agency contributions.
The following table summarizes the results of the employee's TSP contributions and investment performance.
*Starting salary; employee receives on average three percent pay increases
**Employee receives three percent pay increases each year
***The "annualized investment return" is the annualized investment return of the combined C, S, I, F and G funds. Past performance is no guarantee of future investment return.
Note the following:
1. The assumptions are somewhat "conservative" in that many employees will
contribute more to the TSP than the amounts shown; also, long term averages
(more than 25 years) will show that the C, S and I funds
annualized return is greater than 5 percent.
2. By the time the employee becomes age 35, they would have saved their annual salary.
3. By the time the employee becomes age 45, they would have saved nearly three times their salary.
4. By the time the employee becomes age 65, they would have saved nearly six times their annual salary.
Ideally, how much should federal employees save for their retirement? The following is a guide to finding a "magic" savings number:
• The more an employee makes, the more the employee needs to save.
• Those employees who plan to retire early need to save more.
• Other savings will help. Those employees who contribute to other savings plans such as IRAs will not necessarily have to contribute as much as to the TSP. But FERS employees need to contribute a minimum of five percent of their gross pay each pay date in order to receive the maximum agency match of four percent.
• A retiree's lifestyle also matters. Those retirees who expect to spend less during retirement - for example, if they no longer have a mortgage or have children in college, they may be able to live on less during retirement thereby requiring less retirement income. This could reduce an employee's savings burden.
• As a retirement savings backup, FERS employees also have the FERS annuity and Social Security for their retirement. As federal government-sponsored defined benefit plans, both provide "guaranteed" retirement income and can provide survivor benefits for family members. Also, the FERS annuity and Social Security retirement checks come as a result of "forced" (mandatory) payroll deductions. Receiving guaranteed retirement income puts less pleasure on saving more in the TSP. Nevertheless, employees should strive to maximize their TSP savings.
About the Author
Edward A. Zurndorfer is a Certified Financial Planner, Chartered Financial Consultant, Chartered Life Underwriter, Registered Health Underwriter, Registered Employee Benefits Consultant and Enrolled Agent in Silver Spring, MD -- and the owner of EZ Accounting and Financial Services, an accounting, tax preparation and financial planning firm also located in Silver Spring, MD. Zurndorfer is also is an instructor at federal employee retirement seminars throughout the country and writes numerous columns and books on federal employee benefits.
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