What will you do if Congress raises the amount you must contribute to your pension? That’s a question that many of you should be prepared to answer — just in case. In the current environment, every federal employee should be considering the most likely threats to his or her financial plan.
One threat that should be on your radar is a bill the House passed May 10 to raise employees’ pension contributions by 5 percent of their pay. I thought I’d take a stab at quantifying the impact of this bill on an individual employee.
I considered a hypothetical employee, and assumed she had come to me for advice. This means that the results presented here are based on my assumptions, analysis and methods. This doesn’t imply that I have some unique magical abilities, but that the results you should expect, and that you ultimately enjoy, depend entirely on the decisions you make along the way.
My analysis considered a recently hired Federal Employees Retirement System employee earning $50,000 per year, before taxes. She plans to contribute 10 percent of her gross pay, per year, to her Thrift Savings Plan account from now until her retirement, 35 years from now at age 67. Her income and other tax factors bring her combined marginal income tax rate to 30 percent. After accounting for her TSP contributions and income taxes, she is left with $31,500 per year to live on. This is her current standard of living (SOL).
When she retires, she’ll be eligible to receive $21,000 per year, in today’s dollars and before taxes, in Social Security income and $19,250 per year in FERS benefits. If she makes her planned savings contributions and manages her TSP account prudently, she can expect to enjoy a retirement SOL equivalent to about $56,000 per year, in today’s dollars, for as long as she lives. In this case, the increase in her SOL between now and her retirement does not come from increases in pay beyond the rate of inflation, but from the growth in her savings and investments in the TSP, which I expect to exceed the general rate of inflation.
In other words, the expected return on her TSP investments, which I based on the current matching formula and an investment allocation of 60 percent equities, 37 percent bonds and 3 percent cash, produced a 78 percent increase in her retirement SOL.
If the required contributions to FERS rise, she has two possible methods to compensate: She can reduce her pre-retirement standard of living by 5 percent so that she can maintain her expected retirement SOL, or she can reduce her expected retirement SOL to maintain her current standard of living. In a nutshell: She can pay now or pay later — or some combination of these two.
To fully absorb the increase by reducing her pre-retirement SOL, without affecting her savings rate, she’ll need to cut her current spending by 5 percent, from $31,500 to $29,000.
But, what if, instead, she decides to maintain her current SOL and offset the entire increase by reducing her TSP contributions — the “pay tomorrow” alternative? Because her TSP contributions are taken from her pay, before taxes, the impact is less obvious. In this case, the tax deferral that is usually considered an advantage of saving to the TSP becomes an additional burden. To recover the $2,500 in net income lost to the higher FERS contributions, she’ll have to reduce her TSP savings by $3,571 per year. Since she was saving 10 percent of her pay, or $5,000 per year, this will reduce her TSP savings rate by more than 71 percent. In addition, the reduction to her payroll deferrals will also reduce the matching contributions she receives.
Based on my rather conservative projections, this reduction in TSP contributions will reduce her expected retirement SOL from $56,000 per year, after taxes, to $49,000 per year, in today’s dollars. That’s a reduction of nearly 13 percent for the duration of her retirement.
While the exact impact of an increase in the FERS contribution rates will vary from case to case, I hope that this example helps you to understand the kind of analysis that should guide your financial decision-making.
12 Comments
Paying the increased pension out of SOL (no TSP reduction) lowers SLO by about 8% ($29K/$31.5K=92%). So it’s a pretty noticeable change in lifestyle. Glad you noted that reducing TSP contributions had a negative tax impact.
All you are doing is confusing and scaring people with this type of analysis. Instead of saying that with the increased contributions a person will have more in retirement and pay less taxes while working. So what if their take home is less I am sure they can get used to and in the long run they will be better off. When people reads your analysis they think that they are getting screwed when in reality they are coming ahead.
Our Congress will not be satisfied until they have made the Federal employee pay dearly for their mistakes. In a nutshell, they bought votes with our money.
Thanks for the analysis. Your example doesn’t come close to my situation, but it does highlight the belt-tightening I am going to be forced to do in order to have any sort of existence once I retire! The “pay now option” is the only one that makes sense… even if a future life as a Walmart Greeter appears to be more reality than joke these days.
Generally speaking, our pay and benefits should be similar to the private sector and not substantially more.
But regardless of the private sector, our pay and benefits should only be that which is necessary to hire and retain qualified workers.
As our retention statistics clearly show, we believe we are getting substantially better pay and benefit than we would get elsewhere for our services.
However, discussions of our pay and benefits should never be predicated on where the money can be best used, or what other programs and services can better be funded. When that happens, then it all starts going south, and they will pine for the good old when just they disparaged us as bureaucratic.
Retirement plans should be self supporting. If they are not, it is far more fair to increase contributions for current or new employees, then it is to cut benefits for retired employees. New employees and current employees have the option of accepting the salary and benefits they are offered by an employer, or looking elsewhere. Retired employees already lived up to their end of the agreement and cannot go back in time to change their mind and work elsewhere.
The author does not explain the assumptions for the hypothetical worker’s tax rate in retirement or the assumed return on reasonably aggressive investment of the TSP account. So we don’t know how the $31,500 after tax SOL compares with the retirement income.
Looking just at before tax salary income of 50 K, the before tax retirement income, without the TSP, is about 40K, or 80% of the pre-retirement income. This is amazingly good! Taking out the 5K going into the TSP, this percentage is close to 90% of her salary. So. even reducing saving in the TSP under an increase in pension contribution would leave her with income close to her current salary. This seems more than adequate. I think the example presented shows how generous the current pension system is for us Feds
This is a total scam…. the “Hill” will just spend the excess they take as they have SPENT the Social Security Surplus we Had. The Govt. is running a huge ponzi scheme on the American people and now they want more money. Unelect the Elected folks and get all parties out of office because America falls into Socialism and becomes the next Cuba. We need business people in office, not lawyers and politicians.
I’m with “ml” they want us to pay more for our pensions, yet anytime Congress and the President can eliminate Social Security by law and those of us who have been paying into the system for years get nothing. It could be that many Baby Boomers and other later generations will have to make do with TSP and keep on working.
Fuzzy Math. At 50k minus her 10% (5k) TSP contribution, her marginal tax rate and bracket are 15% (counting herself as a dependent), not 30% for a total of 3,282 in income taxes and 3,100 (6.2%) in Social Security, for a total of approximately 38,618 take home. Two pluses no Social Security or TSP contributions during retirement.
I was putting 10% into my TSP. Three years ago, because of loans and higher utility bills, especially when PEPCO raised the rates very high, I had to cut down to 4% so I could make ends meet. Now, if they require this x amount I am not going to be able to pay my bills or mortgage and will end bankrupt or foreclosed on!! What are they thinking .. ?
Years and decades of loyalty and performance…and they don’t care about you in the slightest manner. It’s that simple. They’ve got theirs and now they want to deprive you of any chance of a reasonable standard of living, whether now or in retirement. Fight back. Don’t you get it? The answer lies in stopping work and letting the tax payers pay even more (because there will be no productive output when they pay after you no longer work.) Enough said.