A Federal employee with prior military service has the option of making a deposit into the retirement fund, in order to receive credit for this service in his annuity. This is known as a “buyback.” The process is deceptively straightforward: just multiply the employee’s military earnings by 0.03*, and then add interest beginning with two years after his entry-on-duty date as a civilian. However, there is a complication.
The interest is compounded annually in accordance with the varying interest rate announced by the Treasury Department each year. What really makes it complicated is that, by law, the interest charged to the employee every twelve months is a composite of the two adjacent years. For example: if the employee’s anniversary date is, say, May 22, then for each 12-month interest period you would add (218/360) * previous year interest rate to (142/360) * the current year rate (public law requires use of a 360-day year). Do this for all the years until the year he makes the deposit. It is helpful if you have a computer program for this part!
What are the cost/ benefit factors? Is it worthwhile for the employee to make the deposit?
Let’s take a look at two examples.
First, the employee served a 3-year enlistment during which his earnings were $168,000.
His entry-on-duty date is August 18, 2002. In this case his cost will be (0.03 * 168000) + interest for six years, or $6,463.20. Payment of this deposit will add 3% of his final high-three to his annuity. If his final high three is, say, $81,000 then the $6,463.20 payment will increase his annuity by $2,430 per year, or $202.50 per month.
In less than three years, then, he will recover his $6,463.20 “investment.”
Here is a second example.
Seven years service, earnings $400,000, $55,846 high three, and entry-on-duty Oct 13, 1999. In this case, the employee owes $17,778 and if he pays, he will see his annuity increase $3,909.22 annually, or $325.76 per month. The one-time payment will be recouped in 4.5 years.
Retired Military Personnel
How about retired military? Can they make the deposit?
Yes, they can, and it is calculated the same way, but the numbers are larger. And the decision has an additional element: the military pension must be waived in order to have the larger civilian annuity. Let’s do another example.
Twenty years retirement. Total salary = $1.2 million. High three $108,442. Start date: March 20, 2003. In this case, the deposit would be $44,528. This payment would generate an annuity increase of $21,688.40 per year, or $1,807.36 monthly. In just over two years, he would get his money back. But he would also have to waive his military pension. It seems that when there is a pension to lose, it is less likely to be worth the “investment.” But this is just a generalization – you need to run the numbers.
The above examples are illustrative, intended to show how the process works.
(The author developed the software at www.fedbens.us)
* For earnings in 1999 there is an additional 0.25%, rising to 0.4% in 2000, then back to 3%. Also, above deposit amounts are for on/before the anniversary date; after this date, one more year’s interest is charged.