The Three Components of FERS Retirement

/ Patrick Facey / 3 Comments

Employees of the Federal Employee Retirement System (FERS) accrue money for retirement in three ways: the FERS annuity, TSP and Social Security. Each of these are accrued independently of one another, but are used conjunctly in funding retirement. Each component of the retirement package has its own unique benefits, but they all come together to produce complimentary, fortified retirement income.

(1) FERS Annuity: If you’re able to work in the government long enough (at least 5 years), the FERS pension is a very valuable asset to have in your financial arsenal. For each year that you work in civil service, 1% of your basic annual pay (not including locality) is accrued towards your FERS Annuity. At the end of your career, you will be entitled to an annuity that is payable for the rest of your life. This risk-free, government backed guarantee of income for potentially 20+ years is one the best financial benefits of government employment. Virtually every investment that can be made in the open market carries some risk with it–Markets can decline, property can be destroyed and businesses can fail. Unless the entire government collapses, you’ll be collecting this income for life.  

The formula used to compute the exact amount of a FERS annuity is: (Average of 3 highest annual salaries) X (Years worked) X (1% if taken at age 60; 1.1% if taken at age 62 with 20 years of service) = Annual payment. For example, an individual that worked 20 years, earning $100,000 in basic pay during their 3 highest paid years, decides to begin receiving the annuity at the soonest possible date will receive an annual payment of: ($100,000) X (20) X (1%) = $20,000. Under the normal retirement scenario (not early, deferred or disability retirement), the soonest you become eligible for collecting the annuity is based on different combinations of age and years worked: Age 60 with 20 years, age 62 with 5 years or minimum retirement age (MRA) with 30 years. The MRA is age 55-57 depending on your date of birth.  

You may decide to start annuity payments before reaching these eligibility dates. However, in that case 5% of the annuity will be deducted for each year that you are under the required age.

(2) Thrift Savings Plan: The Thrift Savings Plan (TSP) is the government’s version of a 401K. It’s like every other 401K in most respects– offering stock, bond and target date funds, creditor protection, loans and annual limits. However, the TSP distinguishes itself from most 401Ks with 2 specific attributes: The efficient offering of investments and extremely low fees. Fees can have a major impact on the balance of an investment account over time. This chart demonstrates how fees discreetly eat into your money. Mind you, the TSP fees of .03% are 1/8th of even the lowest fee of .25% on the chart.

Investment fees graph

Source: investor.gov

The TSP could add tens of thousands of dollars to your account balance, which would otherwise line the pockets of fund managers, by the time you are ready to withdraw the money for retirement. Additionally, it only offers 5 core funds aside from its target date funds, which are just various combinations of those 5 funds determined by your retirement time horizon. This is viewed as a negative by some, but it is really a great benefit to the vast majority of TSP participants. These 5 funds offer broad, diversified exposure to the most valuable markets in the World. If you could pick stocks like Warren Buffett, this could be a disadvantage. Although if that were the case, it’s probably safe to say that you wouldn’t be a TSP participant. Less is more when it comes to investment options in the TSP. The TSP also comes with a nice 5% match by the government, so contributing at least 5% of pay to the plan is a must.  

(3) Social Security:  Each paycheck that you receive has 6.2% taken out and contributed to the social security fund.  This deduction is mandatory, so whether we like it or not, that percentage of our earned income is being sliced off the top in a “promise” for future repayment. Social security receives quite a bad rap these days. Most young to middle aged people are of the opinion that social security payments simply won’t exist by the time they become eligible for payments. While it’s true that the full benefit likely won’t be available in the coming decades, according to most current projections we should still be able to receive about 70% of what we’re entitled to. The average social security benefit has been trending up towards $1,400/month in recent years, so the average retiree is collecting a decent chunk of income from social security. For that reason, we should still account and plan for receiving something here. If you can easily fund retirement without banking on social security, even better. As long as the social security fund doesn’t end up going completely bankrupt at some point, social security payments are still a valuable source of stable, guaranteed income that can be relied upon in our later years.   

The FERS annuity, TSP and Social Security are the primary sources of funding for the golden years of federal employees. Their unique characteristics combine to form a complementary force of stable and reliable income: guaranteed income with the annuity, investment growth with the TSP, and forced savings with social security. With proper planning, we are usually even able to add personal investments to the equation, such as equity in a home or other savings and investment accounts. Doing so would surely sweeten the pot, but if utilized effectively, the FERS retirement package should be able to put toes in the sand or gas in the RV for many of its retirees.

What Happens to Your Government Benefits After Leaving Federal Service?

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For whatever reason, you may eventually decide to leave your job in civil service before becoming eligible for retirement. If you are thinking about doing so, or have already done so, it is important to know and consider what will happen to your government benefits as the door closes behind you.

Health Insurance: Health coverage receives an automatic extension of 31 days upon separation. After the 31 days is up, you do have the option of purchasing up to 18 months of Temporary Continuing Coverage if you’d like to continue on your government plan. You could also either purchase an individual policy on the open market, or assume coverage under a new employer’s policy at any time. If you opt for the Temporary Continuing Coverage, you will need to pay the premium you were paying while employed + the premium the government was paying + a 2% administrative fee.

Accrued Leave: On the first or second federal payday after you separate, you will receive a lump sum payment of all accrued annual leave, comp time and credit hours. Your sick leave balance will remain on the books with the government and will be re-instated if you return to federal employment.

Life Insurance: Life insurance coverage will be granted a 31 day extension after separation, as well as the option to convert to an individual policy.

FEDVIP/Disability/FSA: Dental and/or Vision coverage, disability coverage, and your flexible spending account all terminate upon separation.

TSP: There are a few different ways to handle your TSP:

1) Leave the balance: This requires no action as you simply leave your TSP balance alone upon separation. You will still have access to the account and can move investments around, but no new funds can be contributed. This is likely the best option for those who still have awhile until they plan to eligibly withdraw the funds, since it is unlikely that your next 401k or IRA will best the combination of fees and diversification that the TSP has to offer.

2) Rollover the balance: You can request that your TSP balance be transferred into a new 401k plan or IRA. If you wish to do so, make sure that the transfer is made within 60 days and as a direct transfer. A direct transfer simply means that your previous employer (the government) directly sends the balance to the new plan without sending it through you first. Since the money never touches your hands, this method avoids any tax or penalty implications.

3) Withdraw the balance: This should be considered a non-option for most, but is a choice nonetheless. If you decide to cash out your TSP balance when you leave, you will effectively be withdrawing the funds from a retirement account. Doing so under the age of 59 1/2 subjects the entire withdrawn balance to income taxes, as well as a 10% penalty. A side point here is that if you wait to separate until age 55 or later, TSP funds can be immediately accessed penalty free. This option should always be carefully thought over due to its financial repercussions.

Accrued Retirement Benefit: Each year that you work in civil service, essentially 1% of your salary (the average of the highest 3 years in the end) is accrued towards a lifelong pension. The monthly payments of this pension begin penalty free (depending on your years of creditable service) as early as age 55 for some, and age 60-62 for most. Although you aren’t fully eligible to begin receiving that annuity until a later date, the benefit is still accruing in the background during your working years. When you leave employment, there are two ways to handle the benefit that has been accrued.

1) Leave the benefit: By simply doing nothing and leaving the benefit in the system, you can come back later and apply for the pension when you become eligible. You will need to have at least 5 years of creditable civil service to be eligible for an annuity, but by leaving the accrued benefit on deposit you can also restart your accrual clock where you left off if you decide to return to federal employment later on. Pensions are a valuable form of guaranteed income that have gone extinct, so this option can provide a lot of long term benefit if you’re willing to put in at least 5 years and wait patiently until becoming eligible at the appropriate age.

2) Withdraw the benefit: The second option is to apply for a refund of your benefit. This can be accomplished by submitting a standard form (SF) 3106 to your personnel office if still employed, and to OPM if you’ve already separated. The form lays out various combinations of how each portion of the payment will be taxed and how it can be paid out, so you will have to determine which treatment is best.

It’s important not to forget that some value can still be extracted from the benefits of your government job even after you separate. By leaving your TSP contributions in place and perhaps your annuity accrual as well, you can still capitalize on the unique financial vehicles that the government offers. If nothing else, taking the time to consider how your government benefits can be used after leaving employment ensures an informed and seamless transition to whatever your next stage may be.

The Only Relevance of a Budget

/ Patrick Facey / 1 Comment

We hear it time and time again–if you want to get ahead on your finances, you need a budget, and you need to stick to it. While modern technology has made it much easier to plan and track spending, worrying about our budget every month can start to feel like the dollars run our lives. Knowing where our money is going is important. It’s simply impossible to know if we’re making progress towards our goals without that knowledge. However, it’s not so much the amount being spent that matters, but whether or not the spending is bringing value to our lives.

Track Spending
There are a number of apps these days that can seamlessly accomplish this task. You simply link your bank and/or credit card accounts, and the software collects the information for you. Or, simply busting out the old Excel spreadsheet and manually entering what we’re spending money on each month works as well. Regardless of the method, this is a task that anyone seeking control of their finances should engage in. Knowing where your money is going is the first step towards taking the reins of your financial future. Not only does it give you a bird’s eye view of how cash is flowing in and out of your life, it provides insight on how much of your paycheck is reasonably available after expenses to fund any goals.

Then, Evaluate Spending
The most useful part of tracking spending, is having the ability to then analyze it. This is where having a “budget” really makes a difference. When we look at spending under the microscope, we get to determine if we like what we see. More often than not, we’ll find at least one area of spending in the beginning that gives us a little shock. Eating out and entertainment are common culprits. But maybe it’s something more rudimentary, like the cost of car ownership. It’s easy to forget that commuting to work comes not only with the cost of gas, but also car payments, insurance, maintenance and depreciation–not to mention the time it involves. However, maybe you enjoy the alone time on the commute, enjoy driving, or like using the time to listen to audiobooks. I personally enjoy nice beers more than some might consider economically justified. But I also feel that consuming them brings me a level of enjoyment that exceeds what saving the money instead would provide. Whatever the case may be, it’s important to ask yourself if each purchase brings an equal value to your life. This is the surefire way to use a budget to begin weeding out the expenses in your life that don’t bring enjoyment, and instead diverting those funds toward building the life you desire.   

The true value of having a budget is not in controlling how much you spend, but in how you spend.

Having a budget to simply constrain yourself, in turn feeling guilty about spending, undermines its purpose: becoming empowered by having control over your money. If spending extra–reasonably and within your income of course–on the lifestyle you genuinely want  boosts your quality of life, it may simply be worth it. The maximum enjoyment of life isn’t promised to those squirreling away every last dollar. At the end of the day, money exists to be spent. It’s up to each of us to figure out how it is best spent.

The Value of Cash

/ Patrick Facey / 1 Comment

When building wealth, it’s only natural to put a lot of focus on how to best invest our money in order to make it grow. When savings begin to accumulate, so do the anxieties about what to do with it. We all know that the interest rates paid on savings accounts are abysmal, so the knee jerk reaction is to get the money out of savings and into some sort of investment. While it’s true that the monetary return of holding onto cash is less than stellar, having cash on hand can produce benefits in seemingly unnoticeable ways.

  1. Unexpected Emergencies: Of course the main reason that having some savings is beneficial is for funding the unexpected events that will undoubtedly occur. Creating an “emergency fund” is personal finance 101, and for good reason. Having to come up with cash on short notice for car or house repairs can be stressful. Without adequate savings available to easily pay the bill, it may be tempting to reach for the credit cards–a move that can snowball an otherwise minor financial setback into something worse if not handled with care.
  2. Unexpected Opportunities: Unexpected events also come in the positive variety. Occasionally, we come across great deals or unique investments. Every day there are people trashing things that you treasure, and others launching business ventures that few (but maybe you) understand. Or maybe even the stock or real estate markets experience a sharp decline. When the stars align and these opportunities present themselves, having cash readily available to make a move is invaluable. Sometimes there just isn’t time to apply for a loan or borrow the money elsewhere. It would be unfortunate to miss an amazing deal because all of your money is tied up in an index fund.
  3. Self Insurance: The reason we need insurance in the first place is to protect against the expense of losing an object or encountering an unfortunate occurence. Therefore, there is value in paying a company to cover that risk of loss for us. The catch is, insurance companies employ highly skilled actuaries to determine the rate that will be charged to a customer based upon the probabilities of a claim. These companies also operate for a profit, so we can be sure that we aren’t often getting the better side of that deal. By maintaining a larger amount of cash, we can begin to assume more risk in some areas of our lives. Rather than paying the risk premium to a company who has the odds stacked in their favor, we can assume higher deductible arrangements and begin to turn the statistics in our favor. Of course self insuring every aspect of our lives isn’t prudent, but self insuring some of our physical possessions could be a good start towards meaningful insurance savings.
  4. Peace of Mind: Arguably the best things that money can buy are freedom and security. Having money that isn’t subject to the whims of markets, or claimed by creditors for debts, simply brings a level of comfort to life. Assurance in the fact that we have some economic safety in the midst of life’s uncertainty is of special value.

Recognizing the value in holding onto cash can be tough. It’s easy to feel that we’re losing money when we’re not fully invested, but not having enough money available when it’s needed most may be the costliest error of them all. The “right” amount of savings is based on individual preference, but finding that sweet spot can produce some of the best returns that money can generate. 

The Best Strategy For Investing in Retirement Accounts

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Tax advantaged accounts, commonly known as retirement accounts, provide us with a number of benefits during the wealth building process. When optimized, attributes such as income tax deferral, tax free investment growth and creditor protection can act as beneficial forces to building and maintaining wealth. However, choosing what accounts to fund and which investments to fill them with is no easy task. Between allocation amounts, types of accounts, and investment choices, there are countless combinations to choose from. The best strategy for an individual looking to use tax advantaged accounts will of course vary, but for the average federal employee it might look something like this.

Overview: Traditional TSP contributions up to employer match -> Fully fund Roth IRA -> Remainder of annual contribution limit in traditional TSP

  1. Traditional TSP up to Employer Match: For federal employees, this means that a minimum of 5% of your salary needs to be contributed into the TSP. Because of the 100% match by the government on that first 5%, taking this first step shouldn’t even be considered optional.If your basic pay is $50,000, a contribution of $2,500 to the TSP will immediately earn you another $2,500 because of the match and agency contribution. That is a guaranteed, instant doubling of your money. No other investment or debt payoff will provide you that kind of return. Even if you have high interest credit card debt, making this investment will still increase your wealth more so than using those funds to pay down the debt. By electing to make these contributions in the traditional format instead of Roth, you also enjoy a bit of tax savings during the year that the contributions are made.
  2. Fully Fund a Roth IRA: Another reason for choosing the traditional contributions in the TSP is that some of the tax treatment can be diversified here. By choosing to fully fund a Roth IRA, instead of simply continuing to put that money into the TSP, you gain a few added benefits.(NOTE: Those in the highest income tax bracket will likely want to use a Traditional IRA here instead of the Roth due to the more beneficial tax break, although funds accessibility then becomes much more limited.)
    1. Funds Accessibility: The ability to withdraw money without any penalty on the funds that you have contributed into a Roth IRA is a huge advantage of this account. For most of us, financial objectives change over time and/or life happens. Having the flexibility to withdraw the full amount of funds that have been contributed into the account, as if it were a savings account, is invaluable. Additionally, if investments within the account have done well, the earnings can simply be left in the account to continue growing, tax free.
    2. Investment Diversification: An IRA is a great place to hold tax disadvantaged investments, such as real estate investment trusts (REITS). Since dividends and capital gains within an IRA occur tax free, holding securities that don’t get preferential tax treatment in taxable accounts is a good way to add some diversification, as well as tax efficiency, to a portfolio. Since most portfolios primarily consist of stocks and bonds, this is usually beneficial.
  3. Max Out the Traditional TSP: Making all of the contributions in the first two steps is excellent progress in itself towards building a well funded retirement. By doing so, at least $10,000 has been added to your investment portfolio for the year, which is a nice accomplishment. At this point, there should still be $10-$15k in allowable contributions to the TSP for the year. Continuing to max those contributions out to the fullest extent should be the next order of business. The tax breaks and general attributes of the TSP, such as low investment costs and appropriate diversification, make this account the ideal home for the remainder of your available investment funds. Also, each year only permits us one chance to make those TSP contributions and reap the tax deductions, so we should strive to make the most of them.

If you’ve managed to fully fund the TSP and an IRA for the year, congrats! You’re a little closer to comfortable retirement, or maybe even early retirement. If funds are still available for investing after these accounts have been maxed out, the available investment opportunities become even more varying. In any case, it’s a nice accomplishment that will hopefully become recurring during the wealth building journey.

The Best Investment in the TSP

/ Patrick Facey / 2 Comments

The Thrift Savings Plan offers a limited, yet very ideal selection of investment options for federal employees. Essentially, there are 5 investments available: the G, C, S, I and F funds. The “L” funds, or target date funds, are simply various combinations of these 5 core funds that have been professionally balanced to maximize the risk to reward tradeoffs for individuals with different time horizons for investing.

One of the biggest questions when it comes to the TSP is: what funds should I be invested in? Of course, that depends. For a 30 year old, investing in a way that is more weighted towards the C,S and I funds would be a prudent decision. These funds all track stocks, which are more volatile, but have also historically performed better over longer periods of time. With potentially 30+ years ahead until needing to use the money, these options should provide the best bang for the buck for younger individuals. On the other end of the spectrum, an individual who is 5 years or less away from retiring and wanting to soon begin accessing their TSP should take the opposite approach. With such a short amount of time left until the TSP funds will need to be used, risk in the stock market needs to be minimized. This type of individual will want to reduce exposure to stocks (C,S,I) and instead begin shifting a larger majority of the account into the G and F funds, the more stable investments. The general rule of investing in anything is that with youth invest in risk, with age invest in security. Everything in between just needs to be adjusted accordingly.

Determining a specific asset allocation( I.e how much should be in the C, S or I funds) is a difficult task. Some people enjoy spending the time researching markets to determine which sector is a better buy right now, but that’s neither practical nor prudent for most people. Heck, even the professionals attempting that feat rarely succeed. Most of us should prefer to just set it and forget it; have the contributions to the TSP deducted from our pay every two weeks, and go about living life. For that reason, I strongly favor the use of L funds. The meager cost of .03% ($3 for each $10,000) and a professional allocation of investments with automatic rebalancing makes it an attractive investment. It’s as simple as selecting the fund with the date that closely matches the anticipated date of withdrawal, E.g L2040 for withdrawing funds in the year 2040. As time goes on, these funds will automatically adjust the appropriate mix of stocks and bonds on their own, relieving the individual of having to continuously figure out how much should be invested in what. The L funds can simply operate on autopilot, providing us the most sensible range of investments while freeing us up to go spend time doing things that we enjoy. For the average federal employee, this is the most sound course of action when it comes to investing in the TSP.