The FERS pension is one of The Three Components of FERS Retirement. For Federal employees, the FERS annuity and social security benefits serve as the fixed sources of retirement income, with the TSP being the variable source. It is one of the rare pensions that is still in existence, which is why it’s coveted by many. There’s no doubt that the FERS annuity is a big factor for those who have chosen, or are considering, a career with the government. Knowing how much the annuity is worth can help provide clarity on retirement and also help with making an informed decision about the value of working for the government.

The real value of the FERS pension lies in that it is a no risk, fixed stream of income, that is secured for life.

Guaranteed Income

Guarantees are hard to come by in life, especially with money. The fact that an annuity provides a guaranteed stream of income for a set period of time is what makes it so attractive as an investment asset. Planning for retirement becomes much easier and less stressful when you know that regardless of what the stock market or economy does, you’ll still have a reliable source of income. This can also be thought of as an essentially risk-free return—the only risk being that the company (or the government in this case) goes bankrupt and can no longer pay you. The only sources of similar risk-free returns available to the public are in private annuities, treasury bills, money market accounts and savings accounts. Since risk equals reward in investing, the rate of return on those low risk assets is extremely low, typically hovering around 1%. Let’s say you worked a 20 year career with the government and the average of your highest three salaries was $70,000. At age 60, you would be looking at collecting an annuity of $14,000 for life. If you wanted to achieve that same level of risk-free payment from T-Bills or a money market account, you would need to have $1,400,000 to invest. You would be able to adjust that number downwards if you planned on burning through all of the principal before death, but for illustrative purposes, receiving a risk-free income of $14,000 per year requires astronomical initial investment.

The 401(k) Equivalent of the Annuity

Aside from the government, few other employers offer any form of a pension to their employees for retirement. The bulk of private sector employees have to rely heavily on a 401(k) to fund their retirement above and beyond what social security provides. It’s known that a lot of the value in a government job is embedded in the benefits, and the FERS annuity is no small part of that equation. Let’s look at how the annuity can be quantified into a dollar value equivalent for a government employee.

*Note: The formula for calculating your annuity at the time of retirement is: (Number of years worked X Average of highest three salaries X 1%) = Annual payment

*Employee: 40 years old; Plans to retire at age 60; salary $70,000*

Each year that the employee works they will accrue 1% of their salary as a lifelong income stream, to begin at a minimum age of 60. In this case, each year of work will earn this employee an annual retirement payment of $700 (1 X $70,000 X 1%), provided by the annuity. Assuming the unlikely scenario that this employee’s salary never increases, , they will have accrued 20 years of service and an annual retirement income of $14,000 (20 X $70,000 X 1%) by the time they reach age 60.

To translate $14,000 per year of retirement income to an equivalent dollar amount in a 401(k), we can apply the standard investment withdrawal rates. At the age of 60, an individual can expect on average to live about another 20 years. Using a 5% withdrawal rate (approximate safe withdrawal rate for 20 year time horizon), a 401(k) would need to have a value of about $280,000 in order to provide the retiree with $14,000 per year until death. To build up $280,000 in a traditional 401(k) over 20 years, the employee would need to invest ~$6,120 each year and earn 8% annually on those investments. So in effect, this employee is actually earning a salary equivalent of $76,120 ($70,000 + $6,120) because of the annuity value. Keep in mind that this doesn’t account for qualitative factors like the unpredictable returns of the stock market (401(k)), or the guarantee of the annuity. It’s up to the individual to determine how much that safety is worth. Another distinction to make is that with a 401(k), you have to be able to actively exercise the discipline to make the contributions. The annuity simply accrues in the background while you work your career and live your life. Removing that behavior requirement from the equation is invaluable while saving and investing for retirement.

The FERS annuity offers a unique value proposition to federal employees in that it lowers the nominal value of their government salaries in comparison to the private sector, but in turn provides a secure, no risk stream of income for retirement. It is a key asset to have for federal employees in building wealth for retirement, as it provides fixed income for life and eliminates chances of detrimentally emotional behavior. Knowing how to value the annuity ultimately helps you understand your total compensation as a federal employee, but it also helps to determine if a federal career is the right decision for your future.