Federal employees in CSRS have a phenomenal benefit called the CSRS Voluntary Contributions Program (CSRS VCP). This benefit allows CSRS (and CSRS Offset) to contribute 10% of the base pay they’ve received over the years into a special after-tax account.
Your contributions do earn a small amount of interest – and the interest is tax-deferred.
The VCP was designed to allow CSRS to contribute extra money into a special account that would buy an annuity to supplement your CSRS pension.
But once your money is in the VCP – you actually have two choices
- Choice #1) Leave the money in the VCP account until retirement – when your money is traded in for a VCP annuity (which we’ll be discussing here)
- Choice #2) Transfer the money out of your VCP account (most commonly to a Roth IRA)
We’ve talked a lot about the benefits of transferring your money to a Roth IRA. The biggest benefit being that the VCP becomes a way to max-fund a Roth IRA even for people who make ‘too much money’ to contribute to a Roth.
But let’s take a look at the other option – buying the CSRS VCP annuity.
Increasing Your Pension?
Sometimes pamphlets present the VCP as a way to ‘increase your CSRS pension’. BUT – you need to know that even if you bought the VCP annuity – it is separate from your CSRS pension and has different rules than your CSRS pension.
How Much Income Will You Receive?
If you want to buy the CSRS VCP annuity – the amount of monthly income you’ll receive is based on how much money you had in your VCP account – and what age you retire and start the annuity.
The more money you have in your VCP account at retirement, and the older you are when you retire – the more money you’ll receive each month from the VCP annuity.
At age 55, every $100 you have in your VCP account at retirement will provide $7/year. So for a quick example – if you retire at age 55 with $100,000 in your VCP account – you’ll receive $7,000 a year ($583/month).
At face value, many people look at the ‘payouts’ of the VCP annuity and it doesn’t look that bad. But the real problems with taking the VCP annuity are in the details of how it works.
Here are the biggest problems I have with the CSRS VCP annuity.
Problem #1) No COLA Increases – Ever.
There is no cost of living increase at all on the CSRS VCP annuity.
So continuing our example of $7,000 a year – you’ll be receiving $7,000 a year for as long as you live – it will never increase. That is a huge disadvantage.
So when the VCP annuity is billed as a way to ‘increase your CSRS pension’ – it’s not entirely accurate. While your regular CSRS Pension will likely be increased by COLA over the years; you need to know that your VCP annuity will not be increased by COLA – ever.
Problem #2) Survivor Options on VCP are Very Different (in a Bad Way)
There is an option for a survivor benefit on the VCP annuity – but it is very different from the survivor benefits of your CSRS pension.
If you want a survivor benefit on your VCP annuity – you must name them on your paperwork at retirement. Then – there is a 30 day window where you can make changes to your survivor on the VCP annuity.
But after that 30 day window – no matter what – you can not make changes.
And I mean – no matter what.
What if your survivor passes away before you? You can *not* even name a new survivor. But you will continue to have the cost of the survivor benefit taken out of your annuity each month.
Here’s the ‘Note’ at the bottom of Section 31A3.1-1 ‘Purchase of Additional Annuity’ in OPM’s CSRS/FERS Handbook:
- “If the employee elects to provide additional survivor annuity, the reduction of the additional annuity rate is permanent. The reduction will not be eliminated if the designated survivor predeceases the retiree, nor can the additional survivor annuity be transferred to a different person”
This is incredibly restrictive.
Here’s a link to Chapter 31 on the VCP if you’d like to see for yourself…
Problem #3) Income Starts Right Way – No Deferral Growth
If you take the CSRS VCP annuity – your annuity begins at retirement. This means you don’t have the choice to defer taking income and let the money grow.
This ability to defer some retirement income is a very important factor in creating a retirement plan that will help you outpace inflation.
But with the CSRS VCP annuity, your income starts right away at retirement, and you don’t have that option.
The VCP Annuity Mixes After-Tax and Tax-Deferred Monies
When you take the VCP annuity, *all* of your VCP money is turned in to buy the VCP annuity. While your contributions to the VCP are after-tax, the interest you earn on your contributions is tax-deferred.
But when you transfer your VCP, you have the option to send your after-tax contributions and tax-deferred interest to different places.
This means you can keep the money separate.
So when you transfer your contributions to a Roth IRA – all of your money stays after-tax. And you can send your tax-deferred interest to another tax-deferred account like a Traditional IRA or even into the traditional portion of your TSP.
Keeping your money separate like this gives you better advantages for tax planning.
But when you do the VCP annuity, you have to turn in the entire balance of your VCP account – after-tax contributions *and* tax-deferred interest. That means that the money you receive as income from the VCP annuity is partially after-tax and partially tax-deferred.
For most people, the part that is taxable is much smaller than the after-tax portion. But this complication can make tax planning in retirement more difficult.
VCP Annuity Misses Out on the Real Power of the VCP
While it’s always worthwhile to understand your options – if you take the VCP annuity – you’re missing out on the real power of the VCP…
*The real power of the VCP is that it allows you an alternative way to max-fund a Roth IRA.*
Once your money is in a Roth IRA, you have a lot of choices in how you invest it. Depending on where your Roth IRA is held, you may have a wide range of investment options indeed.
The kicker for most people is that it is difficult to take advantage of a Roth IRA. The annual contribution limits are pretty small, and depending on your income, you may not be able to make annual contributions to a Roth IRA at all.
However something interesting happened in 2010, and the limits on who could *convert* money into a Roth IRA were removed. This means that you might make ‘too much money’ to *contribute* money directly to a Roth IRA, but that you could still be eligible to *convert* money from other qualified accounts into a Roth IRA.
So what’s the catch?
Well first, you have to pay taxes on the amount converted now.
But second, the money you convert into a Roth IRA can only come from other ‘qualified accounts’ (think Traditional IRA, TSP, 401(k), etc.). And most of those qualified accounts also have their own limits on how much money you can put in.
So even though you can convert money from those accounts into a Roth – you can only *convert* as much money as you already have in those accounts.
Now, enter the CSRS VCP. It is also considered a qualified account – but the contribution ‘limit’ is really very high (especially compared to other qualified accounts).
Everyone’s limit will be different – but it’s not uncommon for CSRS to have a VCP contribution ‘limit’ over $100,000.
And it has a unique benefit in that your ‘contribution limit’ is cumulative, and not annual. So for CSRS who have their financial ducks in a row approaching retirement, the VCP is a tremendous opportunity to get quite a bit of money into a Roth IRA. That’s the real power in the VCP.
Once your money is in a Roth IRA – you still have a wide range of investment choices. But when you make those investments in your Roth IRA, you can get the advantages of the Roth on those investments.
Important: VCP Annuity is the ‘Default’ Choice
But even though most people decide to transfer their VCP to a Roth IRA – it’s important to know that OPM still considers buying the VCP annuity as the ‘default’ choice.
So if you intend to transfer your money to a Roth IRA – but don’t file the proper forms by retirement, OPM will sign you up for the VCP annuity anyway because that is the default action.