Federal retirement expert Chris Kowalik discusses the financial impact recent proposed changes to pay, benefits and retirement could have on both federal employees and retirees.
Chris provides insight on the likelihood of whether each of the proposed changes may (or may not) happen — plus some practical examples of how costly they could be if implemented.
Key takeaways include:
- 2019 federal pay freeze (02:45)
- Slow within grade pay increases (07:48)
- Combine annual leave and sick leave (convert to a “paid time off” leave model (09:22)
- Changes to the federal government’s FEHB contribution rates (14:17)
- Increase retirement contributions for FERS employees (15:37)
- Change federal retirement annuity calculation from high-3 years average salary to high-5 years (25:33)
- Eliminate or reduce cost-of-living adjustments (COLAs) for current and future federal retirees (38:45)
- Eliminate FERS Special Retirement Supplement (49:06)
- Reduce the G Fund interest rate in the Thrift Savings Plan (53:01)
At the end of this episode, Chris provides some additional observations to help federal employees make decisions from a position of confidence.
Scott: Hello, and welcome to this episode of FedImpact, Candid Insights on your Federal Retirement. I’m Scott Thompson with My Federal Retirement.com, and I’m here today, with Chris Kowalik of ProFeds, home of the Federal Retirement Impact Workshop. In today’s episode, we’re going to be talking about the retirement benefit changes, which have been recently proposed, and how those changes could affect both federal employees and retirees. Welcome back again, Chris.
Chris: Wonderful, always great to be here Scott. Thank you.
Scott: Well Chris, the news has been flooded with many of these proposed benefit changes, and I’m certain that you have quite a lot to share with us today on your take of what you think will or won’t ultimately happen. So, can you give our listeners today an idea of what’s in store?
Chris: Oh, of course. What I do want to make certain for anyone listening, that we agree on something right out of the gate, that this podcast is not political. Sure, there are politics involved in the legislative process, and all of that, but sometimes all of that can just feel like a bunch of noise. So, while I know politics might play an important role in all of this, I would like to stay really focused on the financial impact of the proposed changes. That’s really what we want to get to. Why should these things matter, or should they matter to an employee? Of course, when appropriate, I want to be able to share some ideas of what employees can do to prepare and really protect themselves from the negative impacts that might be coming. I also have a few observations and insights to share with our listeners based on who is making these proposed changes, and their justification for doing so. We’re looking at about $143 billion worth of proposed changes. Okay? First, we’ll get through the proposed changes themselves, and then I’ll share these thoughts at the end before we wrap up.
Scott: Okay. Well that sounds like a fair way to tackle this. With all of these changes, where should we start?
Chris: In the proposed changes we’re going to talk about today, these have kind of come from a couple of different places. We’ve got the White House, we have OPM, we’ve got quite a number of different influencers in all of this. In all of that, there are some distinct changes that would affect employees. Right? Those people who are still working and have not retired yet. And then, of course, we’re gonna have others that affect retirees. I think, since the vast majority of our listeners are still working for the federal government, it seems smart to start there. Okay? We’ll start with a simple one first.
Chris: Federal employees are no strangers to pay freezes. You and I have worked in this space for a long time, and we know that this happens more frequently these days. The proposed changes call for a pay freeze in 2019. Now, historically, federal employees have been subject to pay freezes in the midst of these budget crisis situations and we’ve got congressional gridlock. Pay freezes happen quite often. While pay freezes are not enjoyable, because they happen so frequently, federal employees understand them very well. They’re kind of getting used to pay freezes, unfortunately.
Chris: Let’s kind of transition to the financial impact of what pay freezes tend to do to people. Now, when a pay freeze happens to the federal workforce, some people looking at this could say, “Oh, well this is just the government keeping the status quo for this year.” Like, they’re just going to freeze things and everything will be fine. If we really look at the numbers on an employee’s pay stub, it tells a different story. It’s not the status quo at all. The government isn’t freezing ALL of the numbers on a pay stub. They’re only freezing the dollar amount that we start with before we’ve paid for anything. So, the cost of many of these benefits are continuing to rise, even though the pay stayed the same.
Chris: A prime example of this is FEHB. If we have any spouses listening, that is the Federal Employees Health Benefits program. Over the last 10 years, FEHB premiums have increased by an average of 5% per year. That’s over all of those different options that OPM gives, Blue Cross, Aetna, Kaiser, we’ve got all these different carriers and all these different plans, but the average has been 5%. Meanwhile, the pay raises over that same 10 year period have averaged barely over 1% each year. Even in a scenario when an employee is receiving a pay raise (even a modest one), when their FEHB premium goes up that substantially, it ends up that they’re bringing home less money each pay period. Right?
Chris: This feeds into the old adage that it feels like we can never get ahead. I get it. I see the numbers with federal employees who are coming to our workshops and all of that. Even though we might be making more money, when things around us get more and more expensive to have, like benefits, the money simply doesn’t go as far. In fact, a pay freeze really feels like a pay cut to most of these employees. If we fast forward to the proposed changes that we’re talking about, while a pay freeze might seem simple, it really only exacerbates the problem that federal employees face each year, just trying to keep up with those numbers.
Scott: Right. Chris, what do you think the likelihood is that the pay freeze will happen?
Chris: I do believe that this proposal of the pay freeze has a really high likelihood of passing. Of all of the proposed changes that we’re going to discuss today, this is the one that’s easiest to do, with relatively minor blow-back. Let me be clear for all of our listeners, when I say a minor blow-back, I don’t mean that this doesn’t actually have an affect on federal workers. What I mean is that federal workers have not been promised a set pay raise, so for them not to receive one doesn’t appear that the government is taking away a promised benefit. Okay? It does have an impact, and it can be substantial when there’s pay freezes over a long period of time, but it’s the easiest one for the government to do. Anytime our pay stays the same, but the things around us get more expensive, we feel it.
Chris: There’s also a psychological component that I think is important to address, and it’s not just with pay freezes, but really with all of these proposed changes. That is with respect to federal employees and them feeling that the work that they’re doing is appreciated, pay levels and pay raises play a big role in the way that they feel that their work is valued. I see that being something that really hits home with these employees, of not feeling that the work that they’re doing every day is valued by their employer.
Scott: Well those are good points Chris, and I appreciate the perspective that you bring, because I think for some people, they might only look at the proposed change or changes in a bubble without realizing how they affect the bigger picture.
Scott: What is the next proposed change that affects federal employees who are still working?
Chris: Yeah, so the next proposed change would cause federal workers to wait for a longer period of time between step increases, or the technical name is the within grade increase, or a WIGI, as some employees refer to it as, a within grade increase. Depending on where an employee falls on the pay scale, after a certain number of years being in that particular pay grade, they get a longevity increase, which we call a step increase, or a WIGI. The proposed change would add one year between step increases. It’s simply delaying that natural progression in the pay scale with those steps.
Chris: If we look back to my previous comment about pay raises, we can kind of extrapolate quite a number of those financial impacts to this topic as well. Now with step increases, many folks already have this money spent before they ever receive it, like they’re anticipating having this money paid to them. If they’ve already obligated their anticipated step increase to their budget, and now more time is going to be place between the steps, federal employees are going to need to adjust and really manage their expectations accordingly.
Scott: Well, I have a feeling that managing expectations will be a theme throughout the rest of the topics that we’re gonna talk about today, right?
Chris: Exactly. Exactly.
Scott: Okay, so what’s the next proposed change that current employees should have on their radar?
Chris: The next one is really interesting to me. Essentially, the proposal is to combine annual leave with sick leave. Now, in the private sector, this is generally known as ‘paid time off’ or PTO. There’s no distinguishing between vacation time versus sick time out in the private sector, for the most part. It just gives a wider flexibility on how people can use this time. From an administration standpoint, this seems like a much simpler way to handle time when an employee is not coming in to work, regardless of the reason why. I’d give this proposal an A+ for simplicity, but like most things government, there are a couple of catches that are important to acknowledge.
Chris: The first is, the proposal to combine annual and sick leave would yield fewer days off, but they’ve not been really clear as to how many days off an employee would actually lose under this proposal. It’s not just combining the time and calling it a day, they’re not terribly clear on what that’s actually going to look like, but they have made it clear that it will be fewer days that an employee has off. So that something that we need some clarity on so that we really understand the impact of combining these two types of leave.
Chris: The second thing that I think is important to acknowledge is that right now, unused annual leave and unused sick leave are paid out very differently at the time of retirement. Here we’re talking about someone’s gotten through their whole career, now we have this leftover leave in both categories, annual and sick leave, but it’s paid out differently.
Chris: So, just a quick recap for all of our listeners. Annual leave is paid out in lump sum to an employee when they retire. If you haven’t used your annual leave, it’s all going to be paid out to you in cash. That unused annual leave, in the final years of working, many employees painstakingly save up their annual leave so that when they retire, they get this big check, this influx of cash. It’s paid pretty quickly. This check typically serves as a pretty good cushion for this transition period between the time they leave federal service and them going into retirement, but OPM hasn’t quite got their pay straight yet, so it serves as a good cash cushion for them.
Chris: Sick leave is paid out very differently. Here, we’re talking about leftover sick leave, so unused at the very end of someone’s career. It’s converted into years, months, and days, and that length of time is added to the employees creditable service under CSRS or FERS. So if someone had, say 30 years of federal service, and they also had 2,087 hours of sick leave, then that equals one year. So pension-wise, it’s as if they had 31 years, and that’s what’s going to be put into the pension calculation, which is pretty great. Sick leave doesn’t quite have the same impact as annual leave when it’s paid out, because it only affects the pension to a certain degree, and then that pension, of course, is paid for a retiree’s lifetime. Presumably it’s a smaller amount, because it’s going to be paid over a longer period of time.
Chris: It’s not terribly clear how the new PTO model will treat leftover hours or days when someone retires. Because these two things are going to be combined, and let’s say they call it paid time off, whatever the phrase is that they’ll use to talk about this leave, they’ve not been terribly clear on how the leftover PTO is going to be treated at the end of someone’s career. Is it going be paid out in a lump sum like annual leave? Is it going to be added to the creditable service like sick leave is today? Those are things that until we have clarity on that, it will be harder to know what the real financial impact is for these employees.
Scott: Okay. Well, the clarification on those two points you mentioned will be helpful in determining how costly of a change this will be for employees who are transitioning into retirement.
Scott: Okay, well what’s next on our list?
Chris: The next proposed change has to do with the FEHB program. Currently, and for a long time, the government has paid roughly 72% of the overall FEHB premium, based on the plan that that employee chooses. So again, lots of carriers, lots of different plan options, and while it’s not 72% exactly, it’s roughly 72% with some minor adjustments. There are some additional minor adjustments that are being proposed that would shift more of the premium to the employee. It’s unfortunately that the FEHB program is already really complicated, and then to not exactly know how they’re looking to shift more of that pay, or the premium, to the employee, makes it, again, a little bit more difficult to determine the financial impact of this proposed change.
Scott: Right. Well, FEHB has long been viewed as one of the greatest benefits that federal employees have. It sounds like that great benefit might get more expensive for most of these employees then?
Chris: Yeah, I suspect it will.
Scott: Okay. What is the next change in benefits we’re going discuss?
Chris: This is the last proposed change that is targeted to federal workers, as opposed to retirees. In this case, I saved the worst for last. When I first read this proposed change, I bet I read this paragraph 10 times. I could not believe how drastic of a change this is, and it has to do with how much a current federal employee is contributing to the FERS retirement system. Currently, the vast majority of FERS employees contribute 0.8% of their pay every pay period into FERS. Essentially, this becomes the pool of money that helps to fund the pension when someone retires. In addition to the employees’ contribution, the agency is contributing contributions as well into this pool. It’s what allows those pensions to happen.
Chris: For any of our listeners that have been hired since 2013, we want to make a special clarification, that for those hired in 2013, their contribution into the FERS system is set at 3.1%, and those are called FERS-RAE employees. Then we have those hired in 2014, their contribution into FERS is set at 4.4% and they’re known as FERS-FRAE. Okay? So, some special groups of people. Typically, we’re not seeing those types of people in our retirement workshops, because they’re not close to retiring yet, unless maybe they were a little bit older when they joined, but we’re going to see those more and more as time goes on, as those folks approach retirement. For the most part, FERS employees contribute 0.8% into the retirement system.
Chris: With the new proposed legislation, the contributions that all FERS employees make, either that 0.8%, 3.1%, or 4.4% would be increased to 7.25% of their pay each pay period. This is the part that I reread 10 times. This cannot possibly be right. I must be reading this wrong, and in fact, unfortunately, I wasn’t. When we look at the math, this proposed change, it would increase the employee’s contribution, if we’re looking at the 0.8% that the vast majority of FERS are contributing today, it would increase their contribution to the pension plan by over 900%. This really is unbelievable.
Chris: They plan to phase this in by increasing the employee’s contribution by 1% each year until they reach the correct amount, that 7.25%. So it’s not going to be all at one time. It’ll be a slow, painful process as people have to contribute more and more each pay period, really unfortunate. What that all means is that by October of 2024, all regular FERS employees would be paying 7.25% into FERS, and might I also add, they contribute 6.2% into Social Security. This is really tipping the scale not in the favor of FERS employees compares to their CSRS counterparts.
Chris: I should also note that we have some special categories of federal employees, like Law Enforcement Officers, Firefighters, and Air Traffic Controllers, who have historically contributed an extra 0.5% each pay period, so they’re going to continue to do that extra 0.5%. They’ll still experience that 1% increase each year until they get to the correct amount, but it will still be a 0.5% higher than what every other employee is contributing.
Chris: Why are employees mad? Because when they were hired by the federal government, they were told that the pension that they were going to receive was going to be a certain amount, and that every pay period, they had to contribute a certain amount as well, and it happened to be a percentage of their pay. And now the government wants to change that by over 900%. Crazy. Crazy. The biggest financial impact that I believe will result from this change, if it were to pass, and this is really important for our listeners, is that because an employee’s take home pay is going to be considerably lower, they’re going to decrease the amount of money that they are contributing to the Thrift Savings Plan to offset this pay cut.
Chris: For all of our listeners, I strongly encourage you not to go this route. The reason being, is that with these proposed changes, the winds are not in the favor of pension plans. The government, if they were to really have their way, they would do away with the pension plan altogether, and move just to TSP. The takeaway that I want all of our listeners to have is that the more that you can control the money that you have in retirement, for instance in an IRA, or in this case the Thrift Savings Plan, the better off you are.
Chris: Things are not getting better for pension plans in the federal government. They’re getting worse, so I would hate to see people abandon their contributions to the Thrift Savings Plan, or reduce them (that is the pool of money that they can actually control) simply because they had to pay more into FERS. It’s a scary position for these employees to be in that they’re being forced almost to choose between the two systems, and it’s easy, really, for these employees to say, “Well, because I have to put more into FERS, I’m going to put less into TSP,” and I encourage all of our listeners to resist the urge to do that.
Scott: Right, and I can definitely see how that might have a domino effect where employees are just trying to figure out how to make their budgets work.
Chris: Right, right.
Scott: Now Chris, if I’m understanding you correctly, while reducing the amount of TSP contributions might fix a short-term budget problem that an employee faces because of this proposed change, is it your view that this might put them in a really vulnerable position, especially if there are additional unfavorable changes to the the pension programs in the future?
Chris: Absolutely. You really hit the nail on the head, Scott. In the work that we do with federal employees in our training workshops, one of the underlying themes is that we want employees to be able to make decisions from a place of power and confidence. We share with them that in retirement, they can either stand by and let things happen to them, or they can be proactively controlling the various aspects of the retirement and their money. When people don’t know the choices that are available to them, and the financial impact of each of those choices, they’re simply not making a decision from a place of power. Again, it’s going to be very easy for an employee to kind of acquiesce to a change like this, if it were to pass, where we have this 900% increase to the contribution to FERS by reducing the amount that they’re contributing to TSP.
Chris: Instead, what I would really encourage employees to think about is to look more closely at their household budget to see what might be able to be trimmed there, to still allow the same contribution into TSP, if not more. Whether it’s TSP or another retirement vehicle like an IRA, there’s lots of different options out there, but if we can, find out how to at least secure what we’re currently contributing into TSP, and not let that go down, but even looking to see, what would have to happen in our budget to make our contribution go up.
Chris: I would just hate to see an employee jeopardize that flexibility and control that they’re going to have over that big bucket of money because of this particular legislative change. I’m not suggesting that this won’t be difficult for many employees to do, but I would hate to see an employee step into retirement with a tremendous amount of regret because they hadn’t saved enough in an account that they can actually control.
Scott: Well, I can tell you’re very passionate about topics like this, Chris.
Scott: And I know you want to help federal employees get a glimpse in the future so that they can make better decisions today.
Scott: Based on the feedback that we get from this podcast and the feedback you get from your retirement workshops, we know employees appreciate the perspective that you have and the training you give to them, so on that note, I think we’ve wrapped up the proposed changes for the employees that are still working, and now I know that there are also proposed changes for retirees, and those don’t really look a lot better.
Chris: Yeah, they really don’t, and some of this bleeds over. Sometimes it’s an employee problem that becomes a retiree problem, so it’s hard sometimes to distinguish these, but this next group of proposed changes have to do with the actual pension itself and things that are going to happen at that time in someone’s life, once they’ve already retired. Across the board, things are not looking really great for employees and retirees, if we’re looking at these proposed changes.
Chris: The first one that I want to start with for retirees is the calculation of the pension. Currently, the federal pension is calculated based off of an employee’s highest 3 years of consecutive earnings, known as the high-3. Now, for most employees, this is earned a the very end of their career. There are exceptions to that, but for the most part, that’s a normal career progression where they’re making the most money at the very end. The proposed change that’s on the table now is that this will change, instead of being the highest 3 years of consecutive earnings, to being the highest 5 years of consecutive earnings.
Chris: For those who have been paying attention to all of the proposed changes over the last decade or so, the high-3 changing to the high-5 is not new. This is not a harebrained thing that someone pulled out of their hat. This has been a rumor for a long time. This has been batted around in Congress through many administrations, but has simply failed to pass in the past.
Scott: is there a particular reason it’s failed in the past, and also, what do you think the likelihood that it would pass this time? Also, could you touch on, if it did pass, what affect this would have on someone’s pension?
Chris: Sure. The reasons that it’s been tough to get this high-5 legislation passed is that it actually changes the benefit that someone is expecting to receive in retirement. When these powerful federal unions hear this type of proposed change, they have a really valid argument, that this was the benefit that was promised to employees. Now, we have employees who have worked for decades serving the public interest, we can’t just decide to change this in the eleventh hour of their career and say, “Sorry, the calculation that you thought you were going to get is not actually what we’re going to give you.” Right? Of all of the proposed changes, I do expect the high-5 to pass. It will be challenged, and it will be opposed. There will be many fights over this legislation, but I do believe that this will make it all the way through the process and become law.
Chris: Before I get into the financial impact of a change like this, let’s discuss the idea of grandfathering. In our retirement workshops, anytime we’re talking about things like the high-3 turning to the high-5, we get an awful lot of questions that look something like, “will I be grandfathered?” That always seems to come up. The proposal as it is today would affect future retirees. But it would not retroactively go back and recalculate the pensions of those who have already retired. That would be really cruel, of course, and we’ll get there (there’s a proposed change that’s going to affect current retirees here in just a moment).
Chris: Knowing that the high-5 would affect future retirees, Congress would have two choices when they’re trying to decide when to make this effective. Their first choice would be to make the high-5 effective immediately. So, they give no real grace period or anything for folks to go ahead and retire under the old rules (under the high-3). They just say, “As of this date that the legislation is passed, this is how it is.”
Chris: The second decision that they could make would be to delay it for a certain period of time. If they were to make it effective immediately, there’s gonna be a whole lot of people who are blindsided, and many of them have had their retirement paperwork into their agency for some time, and now they’re just waiting for everything to be ready. Maybe they’ve decided to retire at the end of the year, and now things don’t look the same. The calculation of the pension isn’t the same. If Congress were to delay the implementation of that high-5… again, let’s say they were to pass it today, but it not go into effect until the end of the year, imagine the tsunami of federal employees who were on the fence about retiring, that are now going to choose to go ahead and retire under the more favorable calculation. It could be pretty crazy.
Scott: Yeah, and if we think that the OPM backlog of processing retirement applications is bad now, we can imagine what it would look like then.
Chris: Exactly, exactly.
Scott: Do you have some advice for employees who might be in this boat to make a quick decision?
Chris: Yeah, you know, generally speaking, I do not like knee jerk reactions to things like this. For the most part, when we are emotionally charged about something new like this, we make really poor choices that we regret in the short, and in the long term. It would be really unfortunate for an employee who hears of this legislation passing, and their immediate reaction is, they feel undervalued, underappreciated, they’re angry and frustrated, for someone like this to make a swift decision to retire without fully considering the financial impact of the big picture, this would be really scary. My advice would be to slow down and really think through, not only what they might be getting by going ahead and retiring, like if they had this grace period and they might be able to get the high-3. I also consider them to think about what they might be giving up in retiring in this manner.
Scott: Okay. Can you give us an example so employees can put some numbers on this?
Chris: Oh, sure. To give context to this, let’s do some math, a quick math lesson. When it comes to averages, anytime we bring in lower number into an average, for instance, pay levels from 4 or 5 years ago, then of course we know that the number is going to be lower. That’s what everybody’s worried about. If we have the averages of the last 3 years of pay versus the last 5 years of pay, we know that that yields a lower number in the high-5 versus the high-3. That alone is enough to make employees angry that they’re not getting what they were promised, and I totally get that. That makes absolute sense that they’re irritated and frustrated with this. But before everyone decides that they’re gonna cut bait and retire in a knee jerk reaction because of something like this passing, I would want them to understand how that high-5 calculation translates into the actual pension. In other words, what different does a high-5 make in the pension versus a high-3?.
Chris: I’m going to try to make this really simple since we’re obviously in audio form here, and we don’t have something for everyone to look at. Let’s make some easy assumptions so everyone can follow along. Let’s assume that we have an employee who is currently making $50,000 a year in 2018. Again, just some easy numbers for everybody. If we look back historically over the last 3 years, we could deduce from actual pay raise historical data, that the high-3 average would be $49,173. In this example, I haven’t assumed any grade or step increases, just the approved annual pay raise. This $49,173 would be the high-3 if they were to retire at the end of 2018. Again, trying to make this easy for everyone to follow along. If this were a 60 year old with 30 years of service, their pension would be calculated to produce $14,741 per year. We’re going to come back to this number and compare it, just in a few minutes.
Chris: I bet our listeners are curious how that changes if in fact that high-5 were in place today. Again, let’s say we have this same person that’s planning to retire at the end of 2018. Remember, they’re currently making $50,000 a year. If the high-5 were to pass, and we look historically over the pay raises over the last 5 years, that would yield a high-5 average of $48,533. Of course, lower than the one that we previous calculated. This figure would be put into the pension calculation and it would yield a pension of $14,560 per year. So when we compare that pension using the high-3 calculation to the pension using the high-5 calculation, it yields a different of $181 per year. Okay? I’m not saying that $181 a year isn’t important, but it’s not as significant of a different as most people would think.
Chris: You see, when we’re in a relatively low pay raise environment, and we introduce two lower paying years into the average, it doesn’t really make that substantial of a different in the calculation. If we were in a position where federal employees are receiving hefty pay raises, consistently 3, 4, 5% each year, that would produce a big different in the calculation. But that’s not at all the kind of pay raise environment that we’re in for federal employees.
Chris: Let’s play a little “what if”. Let’s assume that there’s a pay freeze for 2019, and the high-5 has passed. Let’s also assume that the employee did not really want to retire in 2018, like we used in our previous example (they were just considering that, kind of that knee jerk reaction), right? Emotions kind of get the best of them and they say, “I’m out of here.” Let’s say they do in fact go ahead and wait until 2019 to retire. Their pension under the high-5 calculation would now be $15,207 per year, which is a $466 a year increase from the high-3 calculation had he retired in 2018. What if he waited until 62? At this point he’s 61, so if he were to wait just one more year, again, let’s be fair. Let’s assume there’s no pay raise that year either, and we’re under the high-5. The pension would be calculated at $17,417 per year, a different of $2,676 per year, from the high-3 calculation in 2018.
Chris: I do want to make it clear why there’s this big different. Because at the age of 62, the pension formula changes to make all of those years in the calculation more valuable. Okay? My point to sharing this with everyone is that there’s more important things than just whether it’s the high-3 or the high-5 that affect the pension calculation and those numbers. Some examples of really great byproducts of perhaps working a little bit longer, would be that there, of course, are more years included in the pension calculation. Perhaps you’re able to get the higher formula, like we mentioned before, if you can reach age 62 with 20 years of service. And other things, like continuing to draw a full salary for another year or two, and continuing to contribute to the Thrift Savings Plan for another year or two, continuing to contribute to the Social Security program for another year or two.
Chris: Here’s one that most people don’t think of: By working two more years, you have two fewer years to have to support yourself in retirement, so your money goes further. There are simply so many more important things to focus on in being prepared to retire than whether the pension is calculated under the high-3 or the high-5. I do hope that just sharing this perspective will help reduce the knee jerk reaction that people have if something like this were to pass, and really help folks to think about the true financial impact of the changes that they’re making before they do it.
Scott: Yeah, well that’s a lot of great information Chris. I appreciate that. I think many employees have been somewhat nervous about the high-5, that they haven’t stopped to do some of the basic calculations to see how big or small that change actually might be.
Scott: Well, that was the first of the proposed changes for retirees, what is the next one?
Chris: Next up on the list are cost of living adjustments. Quick recap, COLAs are the retiree version of pay raises. We had a whole podcast a while back on the differences between COLAs and pay raises, so if there’s any confusion for our listeners today, we want them to go listen to that podcast, because we really break out the difference so that everyone is really clear on what we’re talking about. COLAs and pay raises are based on completely different things, and they operate independently of one another. Even when an employee gets a pay raise in a given year, that’s not a guarantee that the retiree gets a cost of living adjustment to their pension in that year. Okay?
Chris: Now that we got that out of the way, let’s talk about the proposed changes for COLAs. We’ll start with the older system, CSRS. Right now, CSRS retirees receive a cost of living adjustment based on what’s called the CPI-W. It’s the consumer price index for wage earners. It’s actually got a really long name, but we call it CPI-W. This is a number determined by the Bureau of Labor Statistics, and it measures inflation with respect to day-to-day living. For instance, the cost of consumer goods like milk and bread and gas. When the CPI-W number is released each year, CSRS retirees pensions go up by that same percentage. They get the CPI-W increase as the percentage of the COLA.
Chris: Over the last 10 years, CSRS retirees have averaged a COLA of 1.66% each year. The proposed legislation would reduce the COLA by a 0.5% for CSRS retirees. Instead of getting the CPI-W number, they get CPI-W minus 0.5%. It will change, of course, what the pension is going to look like. The longer that they live in retirement, the further and further they get behind of their pension actually keeping up with the cost of living. Now, that’s not too bad.
Chris: Let’s take a look at FERS. Currently FERS retirees also receive a cost of living adjustment based on the CPI-W, but we like to say, instead of getting COLA, they get diet COLA, because FERS retirees receive a COLA equal to CPI-W minus 1%. They’re always a point behind actual inflation, which is unfortunate, but that’s just the way the program was structured back in the mid ’80s. With respect to COLAs, FERS retirees have always fallen behind their CSRS counterparts. The proposed legislation would completely eliminate cost of living adjustments for FERS retirees. If they weren’t already furious that they were behind their CSRS counterparts, to know that the pension will never change in retirement is very, very scary for FERS employees looking to retire.
Chris: To be really clear, what we’re talking about here is that people who are already retired would lose their COLA. It’s not just new people stepping into retirement. The proposed change is that people who are already retired are going to lose their cost of living adjustment. Really scary. I’d like to briefly address a statement made by Mr. Jeff Pon. He’s the Director of the Office of Personnel Management. He says … This whole comment struck me as really odd, and I’ll share it with our listeners why here in just a moment, but here’s the statement from Mr. Pon. “I don’t know of any other retirement system that actually pays COLAs for annuitants, and we’re talking about annuitants, not federal workers,” Pon said. He goes on and says, “When federal workers become annuitants, it’s not up to the federal government to determine where they move in retirement, and pay for where they live.”
Chris: Now, I read this statement a number of times thinking, something’s not right here in this statement. Mr. Pon must not have listened to our podcast, Scott, because he would know that cost of living adjustments in retirement have nothing to do with where an employee or retiree lives. Now, locality pay, that’s a different deal. That’s paid to an employee based on where they live, again, while they’re still working. But COLAs for retirees have nothing to do with where they live.
Chris: This has sparked quite a response from the federal community, so what strikes me as odd is, Mr. Pon’s statement has left a lot of federal employees wondering if he really understands the very recommendations that he’s made to Congress. Does he think he is taking away a benefit to not influence people to be in higher cost of living areas? I’m not exactly sure. But, does he really understand that taking away retirees COLAs has zero bearing on where the retiree resides? Many of us that work in the space of federal retirement benefits are kind of left shaking our heads at this statement that he reiterated many times when he was asked to clarify. That really struck me as odd.
Scott: Right, and why do you think this proposal is on the table, and do you think this is likely to pass?
Chris: Each year, there are a lot of different studies on the comparison of federal employees compensation as it compared to private sector compensation. One of the things, and we’ll talk about this a little bit later, but one of the things that is Pon’s objective is to try to make the federal pay and compensation structure more similar to the private sector. He’s trying to mimic what’s happening out in the private sector. In the private sector, typically, private pensions do not receive cost of living adjustments. Now, we’re not talking about locality pay, or where someone lives, it’s just the change each year to the pensions, so that’s that. When we’re looking at these different studies of whether federal employees lag behind their private sector counterparts, or whether they make way more, it’s always a really heated debate, and depending on the study that someone reads, you could be persuaded that federal employees are overpaid or underpaid compared to their private sector counterparts. Quite a number of politics involved in each of those studies.
Chris: Now, when we look out to the private sector, and any pensions that still exist there, like I said, very rarely does a private sector pension receive a cost of living adjustment once someone is set to receive it. Again, not talking about locality pay. We’re talking about just the annual increase to the pension to keep up with inflation. Okay? I’m not advocating for the removal of cost of living adjustments for federal retirees. But I do acknowledge that the private sector simply does not include this type of adjustment. The private sector does things a lot differently than the government does, because the role of the private sector business and the role of government are very different. I fully acknowledge that. But, I do believe that this is why the change to the COLA structure has been proposed the way that it is. This change alone would cost federal retirees a staggering $50 billion dollars, with a B, billion, over the next 10 years. Here’s the good news, I do not believe that this will pass. When we look at other important government benefits out there that most Americans will receive, not just federal workers, but most of the everyday American, like Social Security, it receives a cost of living adjustment each year, and it’s based on the CPI-W. The Social Security program is very much a program that was promised to the American taxpayer, that it would be there in a certain form and that it would continue to rise with cost of living adjustments each year, by design. That’s how the program was structured, so taking away this kind of increase to a benefit for retirees of any kind is unpopular. For a legislator to vote for taking away cost of living adjustments for the vast majority of federal retirees, and then turn around and fight for COLAs remaining in the social security program, they have a real problem on their hands. They would be very inconsistent with their justification to do so.
Chris: Again, I do not believe that this proposal will pass, but the caution that I would give to federal employees who are listening is to pay really close attention to which way the wind is blowing with respect to your pension. The tendency has not been to make it better. It’s been to make it worse. So if we were to rewind in our episode today where I talked about taking proactive steps to control every piece of the retirement landscape, I strongly reiterate that in this section. If it is possible for the pension to change in the future in ways that we don’t have control over, it’s even more important to have other buckets of money, like the Thrift Savings Plan, IRAs, other forms to be able to pull from. Of course, for the sake of the federal retirees, we hope COLAs will continue in the future.
Scott: Right, and it seems like the changes to the FERS program is more targeted in these proposed changes. Are there any other benefits that are specific to FERS employees that are on the chopping block?
Chris: Unfortunately there is, and I agree with that, it does seem very targeted to FERS. Not a lot of change on the CSRS side, at least not as significant of a change, but definitely. The next benefit that is on the chopping block is the FERS Special Retirement Supplement. For those employees who are perhaps unfamiliar with this program, let me give you a quick recap. The SRS, the Special Retirement Supplement is a program that’s paid to FERS retirees who are under the age of 62 and meet some other basic requirements when they retire. Okay? Although this benefit is not paid by social security, it is based on the Social Security benefit that a FERS employee is expecting to receive at age 62.
Chris: To give some easy explanation of how this is calculated, to determine how much a FERS retiree would receive from this Special Retirement Supplement, we would first determine what percentage of that employee’s work was as a FERS employee. So over their normal working career, what percentage of that was a FERS worker versus out in the private sector? I’ll try to give an easy example here. If we had an employee that spent 30 years as a FERS employee, the calculation would tell us that they’ll get roughly 75% of their expected Social Security benefit to be paid to them in the form of the Special Retirement Supplement. That happens between the time they retire and the age of 62. Ironically, this benefit provides an incentive for employees to retire under the age of 62, which I always have found ironic because all of the other incentives that the government is giving to FERS employees is to get them to wait until at least 62 to go. Again, that’s why I say it’s a little bit of irony there that this program exists to begin with.
Chris: Now, the proposed change is that the FERS Special Retirement Supplement is completely eliminated for new retirees. Current retirees, those already drawing this benefit, may have their benefit reduced or eliminated based on their earnings from a new job between retiring from federal service and age 62 when the SRS stops. But to make it clear, this benefit is only payable for a certain number of years, so it’s easy for the government to say this is only going to affect new retirees, because within six years, the government won’t be paying out this benefit to current people who are receiving it, because it only happens for a little window of time, so the government will simply phase those people out instead of ripping it away from the people who already have it.
Scott: Right, and do you have a sense of whether this will pass?
Chris: You know, this one’s been on the chopping block for many years. There’s always been a threat to this program because it’s not really a program that employees are directly contributing to. I do think that some reform of the Special Retirement supplement will happen. I hope that it’s not quite as drastic as has been laid out in the proposal, like to completely eliminate it, but maybe a revised calculation that would make the benefit not quite as rich. That’s what I’m hoping for at least.
Scott: Right, and we have definitely heard rumors that this program has been ripe for change for probably at least a decade now, and so it will be interesting to see what the end product is when Congress gets done with it. Let’s move on to what I think is our final proposed change, and it has to do with the Thrift Savings Plan.
Chris: Right. So, the part of the Thrift Savings Plan that we’re going to focus on now is the G Fund. Now, many employees have kind of a love/hate relationship with the G Fund. On one hand, the G Fund gives a great sense of safety, because an employee is guaranteed not to lose their principle, and not to lose their earnings in the G Fund. That’s the love part. The hate part is that by investing in the G Fund, employees are never going to see the big gains that are available in the other more volatile funds like the CS and I. Now, I’m not here to tell our listeners that I think they should or should not be in the G Fund. There are most definitely advantages to being in the G Fund, and being in the other funds as well. Okay?
Chris: Let’s talk about the proposed change to the G Fund. It has to do with the rate of return that the G Fund is currently providing. It will be (under this proposed legislation) it will be reduced to more accurately reflect the rate of return that employees would expect from a similar product in the private sector, more like a T-bill. By all accounts, the current G Fund rate of return is wildly disproportionate to the level of risk that employees take by investing in this fund. This is government securities. We’re not at a place where we’re concerned of default or a loss of principle, a loss of earnings, anything like that. So simply stated, the G Fund rate of return today is way too high when there is zero risk to be in it.
Chris: Most often, we expect there to be many years of high returns in funds that we have some level of risk in, but we also take the down turn of those funds as well. The G Fund doesn’t work that way. Okay? To know that you have a guarantee of principle and earnings in the G Fund and the rate of return is so high, it’s imbalanced to what reality is in the private sector. Now, I am fully aware that this is not a popular statement when talking with federal employees about the Thrift Savings Plan.
Chris: Scott, you know, I always want to be able to bring a very candid perspective to our audience, and sometimes that perspective will be a little bit unpopular. The reality is, that for the same … if all these federal employees were invested in a similar guaranteed program in the private sector, they would get a far lower rate of return. We can expect there to be a change to the G Fund rate of return for TSP. I do believe that some reform will happen. What that level is, is yet to be determined, but I do think it will be closer to the yield on a T-Bill, which is just a treasury bill.
Chris: The financial impact that I expect this to have with federal workers, and ultimately retirees who are going to utilize this money to live on in retirement, is that the money that is in the G Fund will not produce enough rate of return to overcome the rate of withdrawal that the retiree is taking from this type of account. Just to make things real simple here, if we have an account in retirement, like the TSP, that is returning less than what is being taken out each year, eventually we’re going to run out of money. It just can’t sustain that rate of withdrawal. That’s a really scary thought for folks stepping into retirement, and this window, and even scarier for those who are already retired, who will feel the effect of a lower rate of return on funds like the G. Okay?
Chris: While we love the idea of guarantees like a safety net, it is unbearable for most federal workers to believe that they have a likelihood or running out of money in retirement. It’s a scary thing. Forget even the category of federal workers, really, anybody that’s out in retirement is worried about running out of money. That is the number one concern of folks in retirement. I do encourage our listeners to consider options out in the private sector that may allow them some similar guarantees, but maybe an opportunity for a different type of growth out there. Right? I mean, the G Fund has been so good to employees for all these years, but with this change, it’s going to be even tougher.
Chris: The reason I encourage employees to not be afraid to look out in the private sector, is the Tirst Savings Plan itself is managed by Black Rock. It’s a private investment firm, so employees should not be fearful of looking out to the private sector -the clear thing that they want to make sure to have in their head is figuring out what it is they’re trying to accomplish, and helping by looking out to the private sector, they’re able to determine whether the solutions that they need are available in the TSP, or if they need to go out to the private sector to make sure that what they’re doing is most closely aligned with what they’re actually trying to accomplish.
Scott: Right. That makes sense. Well Chris, that was a lot to take in, and thanks for helping our listeners think through the financial impact of each of these proposed changes. You mentioned earlier in the episode that you had a couple of special insights or observations that you wanted to share with everyone, and just curious what those are.
Chris: Yeah. By now, most federal workers have learned that the latest round of proposed changes have come from the Director of OPM, Mr. Jeff Pon, that we had mentioned before. The feedback that we received from federal employees is they feel like this was an inside attack. They feel like the OPM Director should have their back on benefits and everything, and they’re a little taken aback by this. They feel like one of their own is proposing these massive slashes that again, like I mentioned earlier, it’s $143 billion that are now being put on the back of federal employees and retirees. Now, the OPM Director made it very clear this his intention in these proposed changes is that the changes that he is proposing for federal retirement benefits that they be more in line with the private sector. That’s his objective.
Chris: I do believe that these proposed changes do that. They’re in line with his proposed objective. I’m not suggesting that these changes are good, but they are in line with the objective. The real challenge that I have with the objective itself is that government service and private sector work, they’re just different, and they’re different at pretty much every pass. If you’ve ever worked out in the private sector, if you compare that to the work that you do in the government space, it’s just different. To say that we’re going to treat government employees in the exact same way that we treat private sector employees, in some ways, but not in other ways, is misleading. We can’t use the excuse that the government needs to look like the private sector when it’s convenient to the government, but operate on the complete other end of the spectrum when it’s inconvenient to the government. Right?
Chris: Government service is simply different. The challenge with many of these changes that have been proposed is that, not only do we run the risk of destroying the morale and the productivity of the current federal workforce, we also run the real risk of damaging the government’s ability to recruit and retain high quality workers, who are simply unwilling to put up with this type of nonsense. I put the word nonsense because I wanted to keep this podcast clean. Okay? It is insane to believe that highly qualified people, high quality workers out in the private sector would ever want to join the government if they thought they were gonna be jerked around like this, and kind of the rug pulled out from them in the eleventh hour. If this is the way the government workers are treated, why would a high quality worker want to come work here? I have a big morale problem that will not have an opportunity to be corrected, I think for many decades if these proposed changes were to go through.
Chris: Now, as a business owner in the private sector, I can appreciate the desire to control costs both in the short and the long term. Okay? I get that. As someone who works every day to empower federal employees to make smart money decisions, I can tell that these types of proposals are destroying the very fabric of the federal workforce. We hear about it in our workshops, that employees don’t feel valued. They don’t feel that their work is respected. When all of these folks feel like they have a target on their back for all these cuts, it’s simply demoralizing. How likely is someone to perform at their best when they are consistently berated and their pay and benefits are under attack?
Chris: Scott, let me also share with you, I know at ProFeds, I have a number of really amazing people that work with me, and I bet that they would not perform at their best if I treated them poorly, and I threaten to take away their pay every day. Right?
Chris: You know, at the most basic level, regardless of which side of the aisle you sit on, whether you work in the government sector, the private sector, everyone wants to be treated fairly, and with dignity.
Scott: Right. Yes, you make some good points here, Chris.
Chris: Excellent. So, speaking of employee satisfaction, my final insight is, addressing a comment from Ms. Weichert with the Office of Management and Budget. She cited a data point in the 2017 federal employee viewpoint survey that found that 61% of respondents said that they were ‘satisfied’ with their level of compensation. Her comment was, “That’s actually above levels that you would see in the private sector pay.” Here’s what I found really troubling about this statement, and kind of the context in which this statement was said. She’s siting a survey that is supposed to honestly assess employees’ viewpoints, and she’s using their responses to justify reducing pay and benefits to be more like the private sector. Almost as if she’s saying, “Hey, let’s keep cutting benefits until federal workers are equally as dissatisfied as the private sector is.” That really struck me as odd.
Chris: What I find also odd about both Weichert and Pon is saying that they want to have this more open dialog between the administration and federal unions. A Congressman from Maryland sums up his views, and he shares this, and I thought this was really well stated. He said, “[This is] a scandalously irresponsible budget proposal in terms of a cut of more than $140 billion of salaries, pensions, and other benefits. It seems to me …” this is the part that I found really fascinating. He said, “It seems to me that it’s not a good operating premise to go into the room with unions, or with the workforce as a whole and say, we’re going to take a baseball bat or a meat cleaver to the budget supporting your operations. And after we do that, let’s have a constructive discussion about all the ways to find new efficiencies and streamline things.”
Chris: I thought that was really a brilliant comment here because it speaks to the human nature, and everyone’s basic need to feel valued. And again, regardless of the political party that our listeners might associate with, I think we can all agree that there is a lot that doesn’t feel right in these proposed changes. It’s like the saying in the military, “the beatings will continue until morale improves”. We have simply got to find another way other than dismantling the federal workforce through these changes.
Scott: You know, the one thing, Chris, we can count on, is that it will be interesting to see how this proposal unfolds, and what makes it through or doesn’t make it through the legislative process.
Chris: Right, right.
Scott: Well Chris, thanks a lot for coming back with us and giving us a great amount of detail on these topics that are of high concern to federal employees and retirees. As always, I really enjoy your perspective on these topics.
Chris: Yeah. Loved being here with you today, Scott. We’ll be sure to keep everyone posted on what does and doesn’t change, but thanks so much for having me.
Scott: Well, it’s always a great pleasure to be joined by Chris Kowalik of ProFeds. We’d like to ask everyone to stay tuned to the FedImpact podcast to get straight answers and candid insights on your federal retirement.