As a fiduciary responsible for managing and delivering retirement plans for my clients, most of whom are or were federal employees, I am concerned about possible changes to Civil Service Retirement System and Federal Employees Retirement System formulas that are being considered as ways to reduce government spending.
I urge lawmakers to be careful in their deliberations on this issue and to avoid allowing special interests and other secondary considerations to affect their decisions. It is sometimes easy to focus on the big picture while losing sight of individuals. Assuming that an effect is small for the average employee or retiree might overlook the fact that it may be meaningless to some and devastating to others.
A 1 percent reduction in the average standard of living in retirement for the general population of federal annuitants, for example, seems fairly small by most standards. But what if that average is produced by a combination of retirees seeing no reductions and a significant population of individual retirees enduring severe cuts from which they can’t easily recover? Is the fact that the average effect is small any consolation to a retiree whose retirement is unexpectedly and irreversibly reduced to existing at a subsistence level?
One of the things that concerns me most in the cost-cutting proposals that have been floating around is that the easiest solutions, politically, may be the most painful for individual retirees, financially.
Reducing the cost-of-living adjustment (COLA) for retirement benefits for annuitants might be a relatively easy path to choose politically, but this change can produce significant reductions in the post-retirement standard of living. Ironically, the fact that it is difficult for most individuals to understand the long-term effects of a COLA change on their lifestyle makes this option more likely than some others. It seems that politicians have learned that the small but obvious sacrifice is tougher to sell than one that is large but hard to see.
It should come as no surprise that the most devastating changes to benefits are those that affect people who are already retired, and should be reserved as a last resort. The arguments in favor of protecting these benefits are numerous. They represent compensation for services already rendered. Their promise served as the basis for many irreversible decisions and commitments that must now be honored by the retiree. Retirees are the least able to compensate for a loss by making modest adjustments to their lifestyle and financial affairs.
The proposals to modify the federal retirement system, so far, fall into one of three categories:
- Increase the pension contributions required from employees;
- Change the calculation used to determine the initial annuity amount; and
- Reduce the COLA on annuity benefits.
As I’ve mentioned, the proposal to reduce COLA is scary because it is difficult or impossible to accurately predict its effect on spending over an entire retirement. Moving from the current consumer price index (CPI) to an alternate CPI might not be too damaging, but reducing it to zero would create serious problems for many retirement plans.
Shifting from a high-3 to a high-5 calculation will have different effects on different people. If your pay is rising rapidly during the calculation period, you will suffer a greater loss of benefits than if your pay was nearly flat over the five years used in the calculations. As long as it is not implemented in a way that affects those who have already retired, it is likely to produce smaller negative effects than a significant COLA reduction.
Requiring increased contributions to the system, while it has the greatest impact on those currently in the workforce, has no impact on current annuitants. It has the inherent advantage of affecting the youngest workers the most — those who have the most time to compensate.
In my practice, I work primarily with people age 40 and over who have given many years of their life to public service in exchange for the promise of certain benefits. If you fall into this category, paying for a larger share of your pension benefits will likely be the least painful way, in the long run, to a hit.