Following are excerpts from a new Congressional Budget Office report examining a series of options for reducing the value of federal employee retirement benefits.
Change the FERS Pension Plan.
Three options would change the terms of the FERS pension:
Option 1. Increase the pension contribution to 4.4 percent of salary for all employees. (Currently that rate is 0.8 percent for employees hired before 2013 and 3.1 percent for employees hired in 2013. It is already 4.4 percent for employees hired after 2013.)
Option 2. Decrease the pension contribution rate to 0.8 percent for all employees.
Option 3. Decrease pensions by basing the retirement benefit on the five years of highest salary (instead of the three years of highest salary, as in current law).
Option 1 would reduce the federal government’s net costs for retirement for employees enrolled in FERS by 14 percent on a cash basis over the next 10 years, and by 3 percent on a present-value basis over the 75-year projection period. Because the option would affect only current workers hired in 2013 or earlier, the government’s savings would gradually decline as those workers retire or leave government. For the same reason, retirement costs for new federal employees would remain unchanged on an accrual basis. Correspondingly, CBO expects that the federal government’s ability to recruit new employees would be unaffected. However, the option would increase the number of employees who chose to leave federal service because their current pay would be reduced. The most experienced and highly qualified employees would be those most likely to leave.
Option 2 would increase the government’s net retirement costs for employees enrolled in FERS by 10 percent on a cash basis over the next 10 years, and by 13 percent over the 75-year period. On an accrual basis, the option would increase retirement costs for new employees by 22 percent. However, this option would enable the government to recruit and retain a more highly qualified workforce by increasing both current pay and the value of the pension plan (net of the employees’ contributions) for workers who were hired recently as well as those who will be hired in the future.
Option 3 would reduce the government’s net retirement costs for employees enrolled in FERS by 1 percent on a cash basis over the next 10 years, and by 3 percent over the 75-year period. The option would reduce costs by 4 percent on an accrual basis for new employees. CBO expects a small decrease in the recruitment and retention of highly qualified workers because the reduction in the pension is relatively small and because changes in retirement benefits would have less effect than would a similar change in current pay.
Replace the FERS Pension With Larger Government Contributions to TSP for New Employees
Two options would eliminate the FERS pension for new employees and replace it with larger TSP contributions:
Option 4. Eliminate the FERS pension, increase the government’s automatic TSP contribution to 8 percent of salary, and require the government to match up to 7 percent of additional contributions for new employees.
Option 5. Eliminate the FERS pension, increase the government’s automatic TSP contribution to 10 percent of salary, and eliminate the government’s matching contribution to TSP.
On a cash basis, such options would impose costs in the near term because they would require larger outlays at the time the benefit is earned, but costs would be lower in the future, when employees affected by the options retired.
Option 4 would increase the government’s net retirement costs for employees enrolled in FERS on a cash basis by 24 percent over the next 10 years and by 10 percent over the 75-year period. However, the net cash cost of this option would be lower than the cost under current law if the analysis was projected over a sufficiently long period to incorporate the full savings from reduced future liabilities. On an accrual basis, net retirement costs for new federal employees would be about 6 percent lower than costs under current law. The option would probably increase the recruitment and retention of early-career and retirement-eligible employees, though it would reduce the retention of midcareer employees.
Option 5 would increase the government’s net retirement costs for employees enrolled in FERS on a cash basis by 17 percent over the next 10 years and reduce them by about 3 percent over the 75-year period. On an accrual basis, the option would reduce costs by 29 percent for new federal employees. The effect of the option on recruitment is uncertain. CBO expects that the option would increase retention of early-career and retirement-eligible employees, but by less than Option 4.
The Role of the Federal Retirement System in the Recruitment and Retention of Federal Workers
The federal retirement system affects people’s incentives to begin working for the government or remain in ways that depend on people’s career plans and vary over the course of their careers. As a result, changes in FERS that affect workers’ current pay or retirement income can affect the government’s ability to recruit and retain qualified workers.
The amount of compensation, as well as the way it is distributed between current pay, pension payments, and TSP, can affect the government’s ability to recruit high-quality employees. Even though the size of the federal workforce has changed little over the past 10 years, the government has hired about a quarter of a million employees per year over that period, CBO estimates. Most of those people joined the government when they were between the ages of 20 and 40, and the most common starting age was 26. The majority of the new employees have replaced departing workers, although the Department of Veterans Affairs has substantially increased its number of employees to expand the services it provides, whereas the Postal Service has gotten smaller.
The pension payments provided through FERS and the government’s contributions to employees’ TSP accounts are both attractive to potential employees. In recent years, lawmakers increased employees’ required contributions to the pension plan, which had the effect of reducing the amount of current pay that agencies can offer to potential employees.
To analyze the effect of those changes on recruitment, CBO estimated the value employees place on retirement income relative to current income. That estimate is subject to considerable uncertainty, and other estimates could reasonably be made that could lead to different conclusions about the effect that the amounts of current pay and the pension plan have on recruitment. (For additional details, see the appendix.)
Effect of Current Pay on Recruitment. The average quality of newly-hired employees tends to rise or fall depending on the amount of current pay, in CBO’s judgment. The amount of current pay that federal workers receive is reduced by the contributions they must make to the FERS pension plan and the contributions they elect to make to their TSP accounts.
One way to assess the effects of changes in current pay is to examine what occurred after the required pension contribution was raised from 0.8 percent of salary in 2012 to 3.1 percent in 2013. (Data on the effects of the more recent increase to 4.4 percent were not readily available at the time of the analysis.) CBO found that two measures of new employees’ performance declined following the 2013 reduction in current pay. First, workers hired in 2013 were less likely than those hired in 2012 to have their performance rated as “fully successful” or better by their supervisors. Second, they were more likely to be dismissed, or “involuntarily separated,” early in their careers. Those results suggest that decreases in current pay may affect recruitment, but the analysis encompasses a short period and cannot account for every factor that might have contributed to the differences in employees’ performance. Other research found that a 1 percent decrease in the average federal salary relative to the average private-sector salary was associated with a 2 percent decrease in the number of federal job applicants meeting the minimum qualifications for federal positions. However, it is not clear that a reduction in federal salaries would have led to a shortage of highly qualified recruits because data on the number of applicants who met more stringent qualifications were not examined.
Although changes in current pay that result from changes in the required contributions to the FERS pension plan may affect recruitment, changes in current pay that result from changes in a worker’s voluntary contributions to the TSP probably do not. That is both because those contributions are voluntary and because money in a TSP account can be accessed in ways that money contributed to the pension plan cannot. To maximize the amount of money that the government contributes, employees would have to contribute 5 percent of salary to their TSP accounts. However, many employees choose to contribute less and thus forgo less of their income but still receive most of the government’s contribution. Moreover, funds contributed to TSP are more accessible than the sums contributed to the pension plan. Employees can borrow from their past TSP contributions but cannot borrow from past contributions to the pension plan.
Effect of the Pension Plan on Recruitment. The incentive that the pension plan provides to prospective employees depends on whether a worker anticipates spending much of his or her career in federal service. The pension plan can be a substantial draw for prospective employees who plan to work in the government for many years. For example, 26-year-old job candidates who anticipate working for the federal government until they are 57 would receive annual pension payments equaling 31 percent of their average salary over the last three years of their federal career. On the basis of the average life expectancy of federal workers, such candidates could expect to receive pension payments for 31 years and cost-of-living adjustments for 26 of those years. After adjusting for inflation and the tendency for people to value future income less than current income, the present discounted value of that pension is about $160,000, CBO estimates. After accounting for the $70,000 worth of contributions (4.4 percent of pay over 30 years) that workers would make toward the pension plan during their years of service, the net value of the pension is about $90,000 (see Figure 3). The net value of the pension was much larger when employees contributed 0.8 percent of their salary toward it, and thus was a larger draw for prospective employees.
The pension plan is likely to be less appealing to prospective employees who do not anticipate long federal careers for at least two reasons. First, they must contribute 4.4 percent of their salary to it even if they do not expect to work for the government long enough to be eligible for a pension. (However, those employees can receive a refund, with interest, on their contributions when they leave the government.)28 Second, those who leave federal service before age 62 will have the value of their pension eroded by inflation until they become eligible for a cost-of-living adjustment at age 62.
The combination of reduced pay and the effects of inflation can make federal service less appealing to potential employees. For example, 26-year-old job candidates are likely to value the pension payments they would receive less than the contributions they would have to make unless they expect to serve 20 years or more (see Figure 3). In contrast, the pension plan can be attractive for older job candidates who plan to retire within 10 years because they start federal service closer to the age at which they would be eligible to receive a pension.
Effect of TSP on Recruitment. The contributions agencies make to employees’ TSP accounts are probably more appealing than the pension plan to people who do not anticipate long federal careers. Though the benefits of the pension plan are heavily skewed toward older employees with long tenures, new employees are eligible to receive agency TSP contributions of up to 5 percent of their salary, regardless of their age or career horizons. It is less clear how the appeal of those contributions compares with that of the pension plan for prospective employees anticipating long federal careers. On the one hand, the pension provides a guaranteed amount of income for life to employees who remain in federal service long enough, whereas the amount of income available from their TSP accounts depends on the uncertain returns of the assets employees invest in. On the other hand, when employees unexpectedly leave federal service early, they often receive none of the income they anticipated from the pension plan, whereas they keep most or all of the contributions their agency has made to their TSP account.
The amount of compensation and its composition also affect retention. By enticing its employees to continue their service, the federal government retains the expertise that those workers have accumulated. That expertise can be particularly difficult to replace because the tasks performed by federal employees often differ substantially from the tasks performed for other employers. Thus, the quality of the federal workforce would decline and the costs of training new employees would rise if agencies were not able to retain a high percentage of their employees from one year to the next. But very high retention rates can be inefficient for at least two reasons. First, high retention can leave agencies with too little flexibility to hire workers with new or different skills that might be needed if demands on those agencies change over time. Second, high retention rates among older employees may reduce workforce quality because workers’ productivity eventually declines.
Federal retention rates differ substantially from those for private-sector firms, where pensions have become rare (see Table 4). The separation rate among midcareer employees in the private sector is about eight times higher than the rate for federal employees. Many factors probably contribute to higher rates of retention for federal employees. For instance, federal workers can relocate and yet continue to work for the government, as the federal government is a large employer with offices in many parts of the country. However, the pension plan probably plays a substantial role. It most likely contributes both to the higher rates of retention among midcareer employees and to lower retention rates after 30 years of service.
Effect of the Pension Plan on Retention. The pension plan boosts retention among workers who are nearing the point in their service at which they become eligible for a pension immediately upon separation and reduces retention among workers who have passed that point. The pension plan’s effects on the retention of workers who are many years away from receiving one are unclear.
The pension plan appeals to workers as they get closer to becoming eligible for a pension immediately upon separation, in CBO’s judgment. CBO examined workers who were hired at age 26 in 1984 and therefore would have become eligible for a pension if they completed 30 years of service. Almost all of the workers in that group who completed 20 years of service continued their federal employment until they were eligible to draw a pension. The FERS pension plan probably played a central role in that absence of separations. By staying the additional 10 years, employees earned additional pension payments worth a total of about twice their annual salary. In particular, by serving the 30th year those workers became eligible to receive pensions at their current age of 56 instead of age 60, thus accruing four more years of pension payments. Each of those years of payments amounts to about 30 percent of their annual salary. The employees examined here were required to contribute 0.8 percent of their salary to the pension plan, whereas employees hired more recently have to contribute 4.4 percent of their salary. But even when contributing 4.4 percent of salary, workers who complete 20 years of service after being hired at age 26 will receive additional pension payments worth a total of almost twice their annual salary by staying an additional 10 years.
The pension plan reduces retention among workers once they become eligible for a pension immediately upon retirement. That is because employees who are eligible to receive pension payments forgo those payments if they continue serving, and the value of those forgone payments can exceed any increase in future pension payments from the additional service. For instance, among federal employees who were hired at age 26 in 1984 and still employed by the government at age 56, when they became eligible to retire, about 15 percent retired before turning 57. That is the last year of data on separations available to CBO for that group, but people who were hired at older ages can be followed to higher ages. Among workers who were hired at age 40 in 1984 and served until age 60, when they could start receiving a pension, about half left before turning 65. The increase in employees’ contributions in 2013 is likely to further reduce retention among retirement-eligible employees because they would have to contribute 4.4 percent of their salary in addition to forgoing pension payments.
It is unclear how the pension plan affects retention among employees who were hired recently. Retention rates are lower early in workers’ careers in part because that is when they are most likely to conclude that a job is a poor fit for them. The pension plan might have a modest effect on those retention rates, but the direction of that effect is unclear. On the one hand, the design of the pension plan provides only a limited retention incentive for early-career employees because it will typically be many years before they will receive pension payments. On the other hand, the large pension payments available to workers who remain in federal service for many years probably attract employees who are likely to stay through the early years to eventually receive those payments.
Effect of TSP on Retention. The effects of TSP on retention are roughly consistent over most of workers’ careers. In 2014, about 85 percent of employees received agency contributions equaling 4 percent to 5 percent of their salary. Employees of all ages and tenures receive substantial agency contributions. The lowest average contribution CBO measured, 3.5 percent, was for 39-year-olds with 22 years of service. That additional compensation generally increases retention but can reduce retention for older workers by making retirement affordable at a younger age, in CBO’s judgment.