Those who work for the federal government have constant uncertainty regarding the status of their pensions. Will they receive what their benefit estimate really says? Will they charge more for pensions already promised? Will they take them away or reduce them? Will they remove or reduce the cost of living adjustments or require a later starting point to retire? Depending on how desperate for revenues Washington gets, anything is possible. However it is becoming clear the initial steps the federal government intends to take.
The Associated Press reported on December 16th that effective in January new hires to the federal workforce will begin paying 4.4% of their salary to their pensions. Workers hired in 2013 were asked to contribute 3.1% and workers prior to that were paying 0.8%.
Individuals from different circles have varying perspectives on these changes. Representatives from employee groups like NARFE and the American Federation for Government Employees are expressing concerns as to the pace and scale of the changes.
Alternatively, employee benefit market research continues to show private sector employees almost universally do not have a pension to contribute to and would welcome the opportunity despite the cost.
For existing federal employees the change should be perceived as good news. They are not asking for additional contributions or negative adjustments to what has already been promised. The longer it takes congress to agree to any budget concession that would require existing workers to contribute more, the better for their personal financial goals. For those considering federal employment going forward, is paying 4.4% of your salary for a pension still a good deal? Let’s see if we can find out.
For a moment let us estimate that the starting salary at age 30 in a government job is $50,000 and it grows by 2% every year until age 65 when retirement occurs. Currently raises like this are not happening, however, hopefully over one’s entire working career it is still safe to assume some raises will be earned that end up averaging out to 2% annualized growth. This would mean by the time you retire you would be earning $100,000 annually, specifically $99,994 in the year 2049. This would also mean your average high-3 over that time period is $98,046, which as it stands now, is still to be used but who knows how it will work in 2049. This is the average of $96,111, $98,033 and $99,994. For FERS pension recipients who retire after age 62 they would receive 1.1% of this amount for each year of service which in this example is 35 years or 38.5% of the average high-3 or $37,747.71 annually not including any survivor benefit option chosen. This is an oversimplified calculation, you should check with your HR department for exact formulas but it gives us an idea for comparison.
So how much money would we need to accumulate to comfortably pay out $37,747.71 annually plus provide cost of living increases annually for an indefinite period of time? If we say that no more than 4% of the accumulated balance should be taken out in the first year of retirement, a generally accepted measure, than we would need a balance of $943,692.75 by age 65. The next step then is to determine whether 4.4% of $50,000 annually over a 35 year period being set aside in an account would accumulate to the $943,692.75. The fact is it does not. 4.4% of $50,000 is $2,200 so that is how much you would contribute your first year. Every year that contribution would grow by 2%, the same amount as your raises. And let us estimate that the funds in the account are growing by 7% annually. 7% may be overly aggressive given today’s investment uncertainty but even at this rate the balance at the end of 35 years would only be $381,774. The investment would need to average an 11.3% rate of return to accumulate to a high enough sum to pay out an income stream equivalent to the estimated pension. This is not a reasonable rate of return to expect over time.
To summarize, employee benefits are expensive to administer and costs all around are going up. Personal and government budgets will continue to get squeezed. However, having a pension, despite the required contribution, can still be a valuable tool in planning your financial goals, and the adjustments Congress has made so far still offer a pretty good deal.
If you would like an assessment of the pace you are on toward your goals feel free to give me a call or email.
Securities offered through Triad Advisors, Member FINRA / SIPC. Advisory Services offered through Planning Solutions Group, LLC. Planning Solutions Group, LLC is not affiliated with Triad Advisors. PSG Clarity is a division of Planning Solutions Group, LLC.