Congratulations on a valuable career in federal service and your upcoming retirement! Before you send in your retirement papers, though, there are a few things you will want to take a closer look at to make sure you are getting the most out of the benefits you have earned. The following list covers some of the more common mistakes that federal employees can make at retirement. Keep in mind that everyone’s situation is different, and these recommendations are intended only to be general in nature. This article should not be construed as legal or tax advice, and you should consult a specialist regarding your particular situation.
1: Declining a survivor annuity
There are a few potential situations where declining the survivor annuity benefit may make sense, but they are very rare. It is often talked about by advisors unfamiliar with the federal benefit system, though, through what is called a “pension maximization” plan. That strategy essentially entails taking the larger single life annuity payment and using the difference to buy life insurance to provide for your spouse. While the numbers can look promising for someone who is insurable at a reasonable rate, there are some major drawbacks.
The first and largest of these drawbacks is the Federal Employee Health Benefit plan is only available to a surviving spouse that is receiving a survivor annuity. If you pass away having declined the survivor annuity, your spouse would no longer be eligible for FEHB. That can leave them with a significant uncovered period before the start of Medicare, or significantly more expensive Medicare costs if that coverage is declined when turning 65. A reduced survivor annuity would still qualify for the health benefits, but for the most part it should not be turned down completely.
Another downside is that a life insurance death benefit may be adequate at the time of retirement, but does not increase with inflation the way an annuity does with COLA increases. When considering this as an option, you should be sure to factor inflation into the calculations.
2: Retiring before the FERS annuity step-up
Before retiring, you should have a firm understanding of how your annuity is calculated. For both FERS and CSRS, the percentage of the payout increases for each year of service. A CSRS annuity increases by 2% of the “High-3” for each year after the first ten, and a FERS annuity increases by 1% of the “High-3” each year. The FERS calculation increases to 1.1% however, once you are at least 62 and have 20 years of service. For prospective retirees who may be eligible for retirement but have not met the 62/20 threshold, it often makes sense to hold out until they can get the additional benefit.
For an example, imagine a federal employee who is 61 with 25 years of service. Their annuity would be calculated as 25% of their high-3 salary (25 years at 1%). Waiting one more year would increase the payout to 28.6% (26 years at 1.1%). That difference can be significant, especially as it gets increased over time with COLA additions.
3: Retiring on the wrong day of the month
Transitioning to retirement will bring a lot of financial changes, including a possible interruption in cash flow. Keep in mind that you will stop receiving your salary on your retirement date, but the annuity will not begin until the following month. The actual payment will commence at the beginning of the second month. A FERS retiree should plan for retiring on the last working day of the month. That way, the retiree would get their full salary for the month they worked, and the next month would have a complete annuity payment. But, if you wait until the first day of the month to retire, you would not get an annuity payment until the following month. For a CSRS employee, they can retire up to the 3rd of the month (or the last working day prior to that) and still get an annuity payment for that same month.
4: Using up available sick time
Another way to increase your length of service for the annuity calculation is the application of unused sick time. For CSRS employees, any unused days are added to the length of service portion of the annuity calculation (using appropriate tables from OPM). FERS employees will get 50% credit for unused days if retiring in 2012 or 2013, and full credit after that. One way to leverage this benefit even further is to retire just after earning another allotment of sick time, which can then be applied to the retirement calculation. One important point to remember is that sick time can be added to length of service for the annuity calculation, but it can NOT be used in meeting the service time requirement for retirement in the first place.
5: Retiring too soon after a significant pay increase
The primary factor in any retirement annuity calculation is the “High-3” salary base. This is recorded as the highest average salary for any 36 consecutive months. If you have recently received a promotion or pay increase, waiting until you have had the position for 3 years will increase your annuity payment accordingly.
6: Missing an opportunity to fund a Roth IRA account using the Voluntary Contribution Program (CSRS only)
The Voluntary Contribution Program (VCP) is a unique benefit only available to CSRS employees. Through the VCP, you are able to contribute extra funds (after-tax) to the Civil Service Retirement and Disability Fund. The contributions earn a market rate of interest equal to average of the investments in the fund. This interest rate has typically been higher than any rate available on a CD or other guaranteed investment. At retirement, the accumulated balance can either be used to purchase an additional annuity or withdrawn and rolled over to an IRA. Since the contributions were after-tax, they can be rolled into a Roth IRA, with the earnings to a standard IRA.
The contribution limit to the VCP program is 10% of your lifetime earnings in CSRS, which can be significant after an entire career. Also, there is also no minimum limit to the amount of time that money has to be in the program, so it is actually possible to make a very large contribution to VCP and then immediately roll that same money into a Roth IRA. Since you can only typically contribute $6,000 to a Roth IRA ($5,000 if you are under 50), the VCP rollover option allows for a much higher one-time contribution. If you are a CSRS employee nearing retirement and you have outside investments that are not in qualified pre-tax accounts, you should consult an advisor familiar with the program to see if it makes sense for your situation.
7: Keeping FEGLI coverage in retirement
The Federal Employee Group Life Insurance (FEGLI) plan can be beneficial as an inexpensive source of life insurance early in your career, but the cost adjustments made every five years increase significantly as you get closer to retirement. If you are carrying anything more than “basic” to serve a particular need, you should evaluate other private options as well, since they may be more cost competitive and will keep a constant premium. If you have basic coverage, you will also have options to keep or reduce the amount in retirement; one of the most beneficial is the 75% reduction option. In this instance, your coverage is gradually reduced to only 25% of the basic amount while employed, but the premium is greatly reduced and stops completely at age 65. The benefit remains for the rest of your life at no cost, and can be a very effective way to have a policy in place that will pay for your final expenses.
8: Not doing a full retirement income projection; i.e. Retiring when you cannot afford to
One of the most common questions people ask when considering retiring is, “Can I afford to retire, and if so, when?” While the federal retirement annuities (either CSRS or FERS with Social Security) will provide a good base of retirement income, most people will also be relying on other sources as well. It is imperative you have a firm grasp on where all of your income will come from, and how long the funds you have will last at the rate you plan to use them. An experienced financial planner can help you work through all of the scenarios, but some key considerations include:
- What are your expenses going to be in retirement, and how much income will you need to support them?
- Does your spouse have any pensions that should be taken into consideration?
- How much of your savings are in qualified pre-tax accounts, Roth accounts, or standard investment accounts? Are there any significant capital gains?
- If you or your spouse are eligible for social security, when do you plan to start taking benefits? If you are getting a FERS supplement (which stops at 62) and are not planning to take social security until later, how will you make up the difference in the meantime?
- Do you know what your tolerance for risk is, and how much you can afford to take? For your investment funds, do you know how much risk you will need to take on to meet your income needs? Are guarantees in income important to you?
- Do you plan on working in retirement? If so, for how long? Do you know how employment will affect your Social Security income?
- Do you know how delaying retirement (even for a short time) affects your overall projections?
- Do you have a plan if you pass away, and your spouse’s annuity payment changes to the reduced amount?
At the end of the day, the most important factor is that you have a sufficient comfort level with your plan going into retirement, and you are sure that all of your bases are covered. Your fixed income sources as well as your investment allocations should be included. There will always be some variation in investment results, COLA changes, etc., but a well thought-out plan will give you guidance on how to adjust to changing situations.
9: Taking a MetLife annuity through TSP without considering other options
The Thrift Savings Program (TSP) has contracted with Metropolitan Life Insurance Company (MetLife) to provide direct annuity purchases with TSP accounts. Depending upon your situation, an annuity purchase for all or a portion of your TSP balance might be appropriate. Before making the purchase through TSP however, it is important for you to consider all of your choices. Annuities can be complex products, and there are many different options available and different levels of benefits. Speaking with an expert you trust is important to make sure you are getting proper guidance on what is available to you. Different insurance providers will also have different interest and payout rates for the same benefit package, and MetLife may possibly not the best available option. If you are considering an annuity, it is worth the time to make sure you are getting the best deal you can.
10: Failing to re-evaluate your estate plan
Part of planning for retirement is also the plan for when you are gone. Survivor annuity selections, FEGLI options, TSP designations, and investment account selection all play a part in an overall estate plan. If you do not already have them, documents such as wills, durable power of attorney, health care power of attorney, and living wills should also be considered. Keep in mind any beneficiary designation made on an individual account or contract (like an IRA, annuity, or the TSP) will override a designation in your actual will. It is very important to keep these designations up to date, especially if you have had family changes, for example: grandchildren or a divorce.
The other factor to consider in estate planning is federal and state estate taxes, which can be significant expenses depending on the size of your estate. The limit for an estate to avoid taxes in 2012 is $5 million dollars, but that amount could drop to $1 million in 2013. If this does happen, it is not uncommon for the estate of a retired federal employee (including TSP or IRA balances, home equity, the value of a survivor pension, etc.) to be over that amount and thus subject to additional taxes. Proper planning beforehand can reduce the amount of taxes required, and would be a significant benefit to your heirs.