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I went to a co-worker’s retirement earlier this month. In the federal government, it is a big deal when you reach retirement. She served in the government for 27 years, so they threw a huge celebration for her. More than 100 of her co-workers, friends, and family came to the event. She clearly made an impact on a lot of people. Speech after speech effused her praise and accentuated how she was essentially irreplaceable.
Working for the Government
Afterwards, I attended a post-ceremony gathering to socialize with all of the people that had come to celebrate. There were quite a few other government employees that were also near retirement. They highlighted how wonderful it was to work for the federal government, namely because of the amazing benefits. They specifically expressed how valuable the pension was, particularly in light of the fact that pensions are disappearing outside of the government.
Over the years, I have nodded my head in agreement as I have heard this said many times. Admittedly, I had never really taken the time to calculate to truly know how great these pension benefits really were.
Quick side note: In this post, I’m not going to talk about health care benefits. If you have a crystal ball of what the future holds, please clue me in. My boss strongly believes that the government’s health care benefits will become worthless when we’re ready for retirement since we’ll be in a single-payer model. His boss thinks he’s crazy. He, on the other hand, believes the federal government health care benefits are more important than the pension we receive. Clearly, nobody really knows the future value of these benefits.
Additionally, since most of the major contractors in the DC area all have equivalent or better 401(k) plans, I’m also going to ignore this in my analysis as well, since theoretically, that should essentially be a wash.
I am only going to focus in on the pension.
The Government Pension
Getting a monthly check the rest of your life sounds really great in theory. However, I’ve always wondered what the breakeven would be between choosing to work for the government and receiving its pension versus going private sector.
So before I get too far, I want to share the different payout systems in regards to a pension.
Civil Service Retirement System (CSRS)
If a federal government employee was hired before 1983, they were eligible for a type of pension under a program known as CSRS (Civil Service Retirement System). Federal workers were required to pay between 7-8% of their pay each year, and in return, they would receive a pension based on a certain formula.
|Years of Service||What You Receive|
|First 5 years of service||1.5 percent of your high-3 average salary for each year|
|Second 5 years of service||Plus
1.75 percent of your high-3 average salary for each year
|For all years of service over 10||Plus
2 percent of your high-3 average salary for each year.
This meant that if you put in a 30-year career with the federal government, that you would be eligible for a pension of 56.25% based on the average of your highest three (high-3) salaries. For most people, that was usually the last three years of their career. That means that if you started in 1982, the year before CSRS ended, and retired in 2012 at the ripe age of 55, with a high-3 average salary of $100,000, you would make $56,250 every year for the rest of your life.
Did I also mention that the pension increases each year for cost of living adjustments? It’s a pretty sweet deal if you were under CSRS.
Federal Employees Retirement System (FERS)
After 1982, they started a new program called FERS (Federal Employees Retirement System). FERS started with a multi-tier approach, in which employees would be eligible to retire based on their age. Retirement could start as early as age 55 and graduating to age 57, if you were born after 1970.
Instead of the lucrative 1.5-2%, like CSRS, the FERS formula pays 1% of your high-3 salaries, if you are under age 62 or less than 20 years of service. You can also receive 1.1% of your high-3 salaries, if you are older than age 62 or have more than 20 years of service.
FERS requires that its employees contribute 0.8% of their pay each year towards the pension. What they failed to emphasize is that there is an additional 6.2% that will also be taken out to account for Social Security payments.
Thus, there is no real difference in deduction for a CSRS or FERS member.
|Under Age 62 at Separation for Retirement, OR–
Age 62 or Older With Less Than 20 Years of Service
|1% of your high-3 average salary for each year of service|
|Age 62 or Older at Separation With 20 or More Years of Service||1.1% of your high-3 average salary for each year of service|
This means if you put in a 30-year career with the federal government, that you would be eligible for a pension of 33%, based on the average of your high-3 salaries. That means that if you started in 1983, the year after CSRS ended, and retired in 2013 at the ripe age of 55 with a high-3 average salary of $100,000, that you would make $33,000 every year for the rest of your life.
If you’re like me, you may be looking at that number thinking, $23,000 is a pretty substantial difference.
Even if you incorporate the average Social Security benefit of $16,000 per year under FERS, a CSRS employee still receives $7,000 more.
Additionally, FERS participants will have to wait 11 years, if they want to receive full Social Security, in order to receive their complete benefits. That’s over $250,000 that a FERS employee would lose compared to their CSRS brethren.
That’s certainly a ton of money.
Can you see why the federal government wanted to move employees off of CSRS and onto FERS?
I doubt anyone was thrilled when FERS replaced CSRS. However, most people still joined the government regardless for the benefits and pension. According to the latest stats, just 14% of companies currently offer a pension. That percentage is dropping by the day though. Government personnel are one of the last vestiges to hold onto this benefit.
How Great Is This Pension Really?
Let’s use me as an example.
I started working for the government when I was 25. When I reach the age of 57, I will be eligible to retire. Therefore, I would have worked for the government for 32 years. According to Social Security, I can expect to live until I’m 82 years old, although I am hoping to live longer than that if possible. That means that I should receive a check every month for the next 25 years of my life if/when I retire from the government, until I pass away.
Now the only two variables left to calculate my pension are (1) how much I’m going to receive and (2) what my risk-free rate should be. I’m going to use a round number and say that I will receive $40,000 a year. My risk-free rate will be the 30-year treasury note, which stands at 2.89%.
|2.89%||Rate of Return|
As you can see, these factors contribute to a future valuation of $1.43 million. Who wouldn’t want the benefit of knowing that they were set for retirement? Especially if you only had to wait 5 years, age 62, to start taking out reduced Social Security, or age 66 to take out full retirement benefits from Social Security.
Why Be Anything But A Government Employee Then?
If you said, “More money,” ding ding ding, you are correct.
Of course, if you are a contractor for the government, you would expect to be paid better than a government employee. Otherwise, you would just work for the government instead, right?
So let’s say I received two offers when I was a freshly-minted graduate from college. One offer from the government and one offer from the private sector supporting the government. Which one is the better option?
Well according to the math, the private sector would probably pay me a whole lot less money than I initially thought. I would have to make a net of $18,000 or if I was in the 25% tax bracket, the private sector would need to pay me at least $24,000 more than the government offered in order to be comparable to a government offer, including the pension.
|Net Salary Above Government||Gross Salary Above Government|
|Age||Salary based on 30 Treasury Bond|
|Future Value (at age 82)||$1,437,761.87|
As you can see, that figure of $1.43 million matched up very closely with Table 3.
So how did I come up with the math?
I first took the future value of the pension at age 82. Then, I applied it to 57 periods to get back down to the age of 25. (82-57=25).
|2.89%||Rate of Return|
If you are more aggressive than me and use the stock market with an 8% yield or 5.5% from a 60/40 (stock/bond) split, you might be able to get away with a lower salary. However, I used the 30-year Treasury Bond since it’s a guaranteed rate of return, as is my federal government pension in theory.