The recent pay freeze for federal employees proposed by President Obama (and adopted by Congress) may not be the last of changes to federal employee pay and benefits.
The deficit commission has proposed changing federal retirement to use the highest five years of earnings to calculate civil service pension benefits for new retirees (CSRS and FERS), rather than the highest three years prescribed under current law. The purpose is to bring the benefit calculation in line with the private sector standard. (See Commission Proposes “High-Three” to “High-Five” for Retirement, Pay Freeze and Changes to FEHB for Federal Employees)
Calculating the Impact of This Change
How would the implementation of such a proposal impact your future retirement?
Some employees would be promoted during their last five years of federal service. Others would benefit from one or more step increases, and there will be a significant number of employees who are “maxed out” and would not have any pay raises
other than the annual cost of living.
So, how much of a difference would it make if your annuity is based on the highest five years of earnings instead of the highest three? It depends on your personal situation.
But, to illustrate how this might impact your future retirement, here are some examples.
First, let’s use middle of the road figures, and see how they look.
| Year | Salary |
|---|---|
| 1 | 66,300 +2% |
| 2 | 68,289 +3% |
| 3 | 71,020 +4% |
| 4 | 71,020 +4% |
| 5 | 73,151 +3% |
Assuming each salary is in effect for exactly 12 months, in the above scenario, the high three calculation = $70,820. If you count all five years, the average becomes $68,752, which is $2,068, or 2.92%, less.
So, if one assumes this employee is retiring with 28 years of service (FERS), then his annuity will be 28% of $68,752 instead of 28% of $70,820. This results in a reduction in his annuity of $48 per month.
Here is another scenario where the employee gets a promotion after year one:
| Year | Salary |
|---|---|
| 1 | 93,000 |
| 2 | 101,370 +9% |
| 3 | 105,425 +4% |
| 4 | 110,169 +4.5% |
| 5 | 113,474 +3% |
Here, the federal employee’s high-5 is $104,687 and the high-3 is $109,689. The difference is $5,002, or 4.56%. One more, where the promotion is after year 3, instead of after year 1:
| Year | Salary |
|---|---|
| 1 | 93,000 |
| 2 | 96,720 +4% |
| 3 | 101,072 +4,5% |
| 4 | 110,168 +9% |
| 5 | 113,473 +3% |
Under this scenario, the high-5 is $102,886 and the high-3 = $108,238. Moving the promotion to year three caused the difference between high-5 and high-3 to increase to $5,352, or 4.94%.
Conclusion
If the high-5 change is adopted, it appears most retiring employees will see a reduction in their annuity, compared to the current high-3 calculation. The reduction is likely to be at least 2% and possibly as much as 5%.
There will be numerous variations, of course, but the above models should help all readers calculate their particular situation.
