The lack of clarity on whether there will be a pay raise in 2019 feels a bit like Groundhog Day.
The top pay increase in the last several years was in 2017 when it was 2.1%. During that timeframe, federal employees also saw no pay raises when there was a two year pay freeze that was also extended for one year by Congress, and this was followed by only a 1% pay increase for two years thereafter.
Given that the President has claimed the economy is roaring, the lack of an increase seems almost punitive. Congress has recognized that this is an unpopular decision, but a raise is still far from certain.
Given recent trends, if you’re planning for the long-term it is helpful to understand the interplay of salary increases, expenses and long-term impact to your retirement.
Effects of Low or No Pay Raises
The first effect of low or no raises is how it impacts your ability to cover your expenses. We’ve been fortunate over the last 15 years or so that inflation has been well below its historical average. Expenses have risen slowly, and in that environment, the occasional lack of a raise is less financially harmful.
Take, for example, Sarah, a CDC employee earning $120,000. If she gets a 1% raise and inflation is 2%, her real salary – that is her salary adjusted for inflation – will decrease to $118,823. It’s a bit of a loss, but it probably won’t cause too great a financial hardship. If, however, this same trend continues for 5 years, her real salary drops to $114,231, and that may be a much harder gap to fill.
One thing to bear in mind is that in calculating inflation, the calculation uses a particular baskets of goods and services. If the basket of goods and services you consume differs a great deal from that used in the calculation, your personal rate of inflation will likely differ by a good bit as well. As I wrote in this article, while inflation has been below average over the last few decades, services have generally gotten more expensive while some goods have gotten a good bit less expensive.
Impact on FERS Annuity
Beyond current spending, though, raises that don’t keep up with the cost of living can reduce your FERS annuity as well as Social Security.
For both Regular Employees and Special Category Employees, the FERS calculation is based on your high-3 salary. The likelihood is that your high-3 will be your last few years of employment, and if there were a significant number of years in which pay increases trailed inflation, the high-3 amount would ultimately be lower.
If we return to the example of Sarah we can assume the following:
- Base salary – $120k
- Years of Service – 17
- Inflation – 3%
Further, let’s project that for the next two years she gets no raises and then receives raises over the next 3 years of 1% per year before she begins to receive consistent salary increases that keep up with the inflation rate of 3%.
Under that scenario, if Sarah worked at the CDC for 30 years, her FERS payout would be $50,193 versus the $56,477 she could expect to earn had her salary kept up with inflation. We’re simplifying the analysis by assuming there are no step increases for Sarah, but the point remains that low or no raises have a negative long-term impact on your ability to fund retirement.
Impact on Social Security
Low or no salary increases over an extended period have a similar impact on Social Security for most Federal employees.
The amount you receive in Social Security is based on the wages that were taxed for Social Security. The lower those wages are, the less you’ll receive from Social Security in retirement.
There are some exceptions to this rule. One notable exception is that wages that are taxed for Social Security are capped at $128,400 for 2018. If you earn more than that, the earnings above the cap aren’t taxed for Social Security, but they won’t increase the amount you receive in Social Security either.
Another caveat is that if you are married, you may earn more from Social Security if you have them base your claim on your spouse’s earnings record as opposed to your own. Still, for most Federal employees, low or no salary increases mean lower wages, and that leads to a lower Social Security benefit in retirement.
One final issue to consider if expenses increase by more than your salary is how you hit your savings targets. The good news is that over the long-term, returns on stocks as well as bonds have easily outpaced inflation.
The Thrift Savings Plan offers a limited but generally solid array of investment options that will allow you to build a diversified, low-cost portfolio, but that benefit is reduced if you’re able to save less and less over time because your salary isn’t keeping up with inflation.
Not receiving a raise in a given year can be frustrating and demoralizing. However, when salary increases don’t happen year-after-year or when they are below the level of inflation, not only is it demoralizing, it also has negative impacts over the long term on your ability to fund retirement.
Micah Porter is President and CEO of Minerva Planning Group, a CFA charterholder, and a CERTIFIED FINANCIAL PLANNER™ practitioner. He began work at Minerva in 2003 with extensive experience in business planning and corporate finance.
