When the Federal Employees Retirement System was created, it included a provision that allowed all retiring employees – both CSRS and FERS – to elect to have their retirement contributions paid to them in a lump sum and, in exchange, have their annuity actuarially reduced based on their age.
Because of budgetary concerns, that option was short lived. Although attempts were made to save it in its original form, the AFA was eliminated for everyone except employees who are suffering from a life threatening condition that results in a life-expectancy of less than two years. It isn’t an option for those on disability retirement or those who have a former spouse entitled to court-ordered benefits. Nor can it be taken into phased retirement.
You can find a list of medical conditions that provide automatic proof of eligibility for the AFA at www.opm.gov/retirement-services/benefits-officers-center/reference-materials, click on Glossary. If you have one of those conditions, and wish to apply for the AFA, your application would have to be certified by a physician. With one exception, you’d also have to bear the costs associated with providing the necessary documentation. Here’s the exception. If OPM exercises its right to choose a physician, it will cover the costs.
The law requires that both the lump sum payment and the annuity contain a mix of employee and government contributions. The proportion is determined by the Internal Revenue Service and spelled out in their Publication 721, Tax Guide to U.S. Civil Service Retirement Benefits, available for download at www.irs.gov/pub/irs-pdf/p721.pdf.
In short, the government’s portion of the lump sum payment is taxable. While the taxable portion of the lump-sum distribution can be rolled over into an IRA, to avoid the 20 percent federal tax withholding, it has to be a direct account-to-account transfer. On the other hand, the annuity will be treated the same as the annuity of any other retiree. In other words, a portion of the annuity will be tax free while the rest will be taxable as regular income.
To learn more about the AFA and how the lump sum and annuity are calculated, go to www.opm.gov/retirement-services/publications-forms/csrsfers-handbook/c053.pdf and scroll down to Section 53A1 and 2. Unfortunately, the present value factors in that chapter are out of date. For the current ones, you’ll have to go to http://federalregister.gov/a/2015-07677 (CSRS) and http://federalregister.gov/a/2015-07694 (FERS).