Federal employees who are eligible to retire should be fully financially prepared to retire. With a sufficient amount of preparation, an employee can do more than just dream about a comfortable and financially secure retirement.
While no one knows what the national economy and the investment landscape will be during the 10, 20, 30 or more years, all employees should know what to expect financially once they retire — and what necessary tasks to perform in order to fully prepare for their retirement years.
The following are 10 recommendations and suggestions for employees who intend to retire during the next few years to help them prepare.
1. Understand the full economic consequences of retiring from federal service earlier than later – particularly before age 62.
Federal employees covered by the Federal Employees Retirement System (FERS) can retire under the immediate FERS retirement rules with a minimum of 30 years of FERS service upon reaching their minimum retirement age (MRA) (age 55 to age 57 depending which year an employee was born). They are also eligible to retire at age 60 with a minimum of 20 years of FERS service.
While retiring in their late 50’s or early 60’s may sound appealing, there are a few items that these employees should consider before deciding to retire, namely:
(1) Once retired, contributions to the Thrift Savings Plan (TSP) are not allowed. Is the retiring employee certain that there is a sufficient balance in his or her TSP account to last throughout the retiring employee’s (and their spouse’s retirement, if married) retirement, as many as 30 to 40 years?
(2) No matter how many years a retiring FERS employee has (at least 20), by retiring before age 62 the employee’s FERS annuity is calculated using a 1 percent per year of service accrual factor. If an employee with 20 or more years of FERS service decides to retire at age 62 or older, a 1.1 percent per year of service accrual factor is used in the calculation of the FERS annuity. In other words, by retiring before age 62 the retiring employee will be forgoing a 10 percent permanent increase in their annuity;
(3) No cost-of-living adjustments (COLAs) are paid to FERS annuitants until they have reached their 62nd birthday. That means FERS employees who retire before age 62 will receive the same amount of a FERS annuity with no COLA (lasting anywhere from 1 to 6 years depending at what age an employee retires). Given the steep inflation that has occurred over the last three years and is expected to continue during the next five years, those FERS employees who retire before age 62 will receive FERS annuities that are losing purchasing power until these retired FERS employees become age 62 and their annuities become eligible for annual COLAs.
READ: High-3 Average Salary: What Is It and How Is It Calculated?
2. Be realistic about income and cash needs during retirement.
Many retiring federal employees utilize a “bottoms-up” approach with respect to making estimates of their income needs during retirement. Some employees use their current expenses to help determine their future retirement income needs.
Other employees use a flat percentage – say 70-80 percent – of their current gross annual salary as an estimate of cash flow needs during their retirement. But a more realistic and practical approach is to consider both typical and atypical expenses that may be incurred during retirement.
For example, will there be a sufficient amount of income set aside to pay travel expenses (typically a high priority for many retirees), especially during the early years of retirement? Will there be sufficient income to help struggling relatives (for example, adult children who are raising young families) during stressful and challenging economic times? Will there be a sufficient amount of liquid savings to pay for emergencies, increased federal and/or state incomes taxes and health care expenses (including Medicare Part B monthly premiums)?
3. Realize that the days of low annual inflation are behind us.
After several years of low inflation between 2014 and 2020, inflation in the US during 2022 was at its highest level in 41 years. The inflation rate during 2022 averaged 6.5 percent.
While economists do not expect inflation to continue at this level in future years (the inflation rate during 2023 averaged 3.2 percent, half of what it was during 2022), the low inflation rates averaging 2.5 percent between 2014 and 2020 are not likely to return.
Some federal employees make the mistake at looking at their current annual salary (which includes annual pay increases together with step increases and bonuses) and assume that they will be able to pay their expenses during their retirement years using their retirement income with no difficulty. They do not realize how above-average inflation can severely affect certain the cost of certain items. In particular, how high inflation can affect energy, food and medical costs.
For federal retirees, whose COLA is based on the CPI-W, higher and increasing out-of-pocket medical expenses can have an enormous impact on their budget. This is because annual increases in average medical expenses usually exceed the average inflation rate. Higher energy prices are also affecting the cost of travel. The result is that for those retirees who plan to travel much in retirement, more retirement income will be needed to pay for airline tickets, cruises or driving to see national parks, family or friends who live out-of-town.
4. Understand the relationship between investment risk and investment return, and how it applies to investing in the TSP.
Unfortunately for some TSP participants, “risk” connotes something “bad.” But because the TSP is a long-term tax-advantaged retirement savings plan, the “risk/return” relationship cannot be overemphasized.
There is no doubt that there is risk associated with stock market investing. With the TSP, there is investment risk associated with investing in the three stock funds – the C, S and I funds. But by willing to take the risk of allocating at least half of a TSP portfolio in the C, S and I, funds, a TSP participant should be rewarded over the long term with a higher investment return. TSP participants should also be aware that inflation can have a devastating effect on a long-term investment portfolio. Stock investments have demonstrated over the years that over the long term, they overcome the effect of inflation.
5. Social Security – decisions to make.
Most federal employees are or will be eligible for monthly Social Security retirement benefits. The three most-often asked questions among employees with respect to Social Security retirement benefits are:
(1) What age can I apply for my monthly retirement benefit and are there advantages to delaying the start of my benefits?;
(2) Am I eligible for any of my spouse’s, former spouse’s, or deceased spouse’s Social Security benefits, and under what conditions; and
(3) If I stop working in my late 50’s or early 60’s and wait until my late 60’s to start receiving my Social Security benefits, will my Social Security monthly benefit decreases as a result of retiring perhaps as many as 10 years before I start receiving my Social Security monthly benefit?
“Fully insured” individuals with respect to Social Security can apply for their Social Security retirement benefits as early as age 62. But if they elect to start their benefit at age 62, their monthly benefit will be permanently reduced. By delaying the start of their monthly Social Security retirement benefit, the individual’s monthly benefit will increase their monthly benefit by 7 to 8 percent for every year they delay the start of their benefits starting at age 62 and until age 70.
Those employees who will be retiring within the next 8 years, and who will be close to their 62nd birthday, are encouraged to wait as long as possible (ideally to age 70) to start receiving their Social Security. A guaranteed increase in monthly benefits of 7 to 8 percent should keep up with the current cost-of-living increase. Married couples in which both spouses are eligible for their own Social Security benefits are advised to seek advice as to the coordination of their respective benefits. This includes which spouse should file for benefits first and options for the surviving spouse when the first spouse dies.
6. Out-of-pocket health care expenses will keep rising – even with entitlement to keep FEHB health insurance.
Federal employees are eligible to keep their FEHB health insurance benefit after they retire from federal service with the federal government continuing to pay on-average 72 to 75 percent of the FEHB program health insurance premiums. But that does not mean that a federal retiree should expect to pay minimum out-of-pocket for their health care during their retirement.
For example, like other health insurance premiums, FEHB health plan premiums will continue to increase. Retirees are encouraged to enroll in Medicare Part A (Hospital Insurance) (at no cost) and Part B (Medical Insurance) (paying a monthly premium depending on the retiree’s annual adjusted gross income). But by being enrolled both in an FEHB health plan and in Medicare Parts A and B, a federal retiree and spouse will minimize any out-of-pocket health care expenses.
READ: FEHB Cost Saving Suggestions For Federal Retirees and Annuitants
7. Paying for future long-term care (LTC) expenses – a challenge for the current and future generations.
In general, there are three ways to pay for long-term care (includes nursing home care, assisted living care; and home care):
(1) Paying out-of-pocket using individual savings;
(2) Purchase long-term care insurance, and (3) Apply for federal government assistance in the form of Medicaid.
Paying for nursing home care with Medicaid is highly discouraged because it means lack of choice with respect to choosing the type of facility that best meets the individual long-term care needs.
While some federal annuitants may be able to pay for long-term care using their savings (including the TSP and IRAs), several years of nursing home care could severely drain one’s retirement savings. Long-term care insurance is definitely an option for employees to consider. However, one must qualify for LTC insurance (including the Federal Long Term Care Insurance Program) and LTC insurance premiums can be pricey, depending on an employee’s or annuitant’s age when they apply for the insurance. LTC insurance premiums will continue to increase as the number of insurance companies offering long-term care insurance continues to drop.
8. Review current life insurance coverage and the need for future coverage.
Many employees have a decreasing need for life insurance as they get closer to retirement. For example, one reason they have life insurance is to pay off their mortgage. But their mortgage is paid off or close to being paid off. Their children are financially independent, and they have a sufficient amount of liquid savings to pay any potential estate settlement expenses, including death taxes and funeral expenses.
Those employees who are enrolled in the Federal Employees Group Life Insurance (FEGLI) program and will be retiring in the next few years may consider decreasing the amount of their FEGLI insurance coverage especially because FEGLI premiums significantly increase in retirement. For example, at the time an employee applies for retirement, the retiring employee may want to consider decreasing the amount of their FEGLI Basic insurance amount to 25 percent of what they had on the day they retired. Another suggestion is to decrease or eliminate some of the optional FEGLI coverages – especially Option B (Multiple of Salary) – which gets significantly more expensive when an employee becomes aged 60.
9. Review Official Personnel Folder (OPF) at least six months to a year before retiring to make sure all periods of civilian and military service are recorded.
It is important for a retiring employee to have all of his or her federal service officially recorded in order to ensure that the correct number of years will be used in the calculation of their CSRS or FERS annuity. Within a year of his or her anticipated retirement date, an employee should contact their retirement specialist in their Personnel or Human Resources Office to document the employee’s service history using:
(1) Form SF 2801-1 (Certified Summary of Federal Service – CSRS/CSRS Offset employees) or
(2) Form SF 3107-1 (Certified Summary of Federal Service – FERS employees).
With this information, the employee can confirm with their retirement specialist that he or she has the correct number of years of service time (used for retirement eligibility purposes and in the computation of the CSRS or FERS annuity). Also, the certified summary of an employee’s federal service is performed in order to confirm eligibility for FEHB program and FEGLI program participation during retirement.
10. Have a complete and current estate plan.
A federal employee’s soon-to-be retirement is a perfect time for the retiring employee to make sure his or her estate plan is complete and current. A complete estate plan includes a written plan that designates the disposition of assets at death and assigns beneficiaries for all assets that allow for beneficiary designations.
These assets include life insurance policies, retirement accounts – including the TSP and IRAs, bank and brokerage accounts. Beneficiary designations should be current with no former spouses or deceased relatives named as beneficiaries. Another suggestion for naming beneficiaries is that in addition to naming primary beneficiaries, individuals should name a contingent beneficiary for each primary beneficiary named.
It is also important that the following documents be prepared by an estate attorney as part of an individual’s estate plan:
(1) Financial Power of Attorney, as they relate to the management of the individual’s assets;
(2) Health Care Power of Attorney, as they relate to the individual’s health care issues; and
(3) Living will.
Finally, a will or a living trust should be established as part of an estate plan. Both a will and a living trust are a means of transferring assets to beneficiaries or heir in the least costly and expedient fashion.