Issue Briefs

Following is the portion of a recent Congressional Research Service report describing the role of employer and employee contributions toward federal retirement, an issue raised in a draft report from a presidential deficit-cutting commission.

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Both CSRS and FERS require participants to contribute toward the cost of their future pensions through a payroll tax. Under CSRS, employees contribute 7.0% of base pay to the Civil Service Retirement and Disability Fund (CSRDF). Under FERS, employees contribute 0.8% of pay to the CSRDF and they also pay Social Security taxes of 6.2% on salary up to the maximum taxable wage base ($106,800 in 2010). Participants in CSRS are not covered by Social Security.

Members of Congress contribute 8.0% of salary to the CSRDF if covered by CSRS and 1.3% of salary if under FERS. All members of Congress pay Social Security taxes, regardless of whether they are under CSRS or FERS.

In the private sector, employers are required by the Employee Retirement Income Security Act of 1974 (ERISA, P.L. 93-406) to pre-fund the benefits that workers earn under defined benefit plans.

Pre-funding of future pension obligations is required because there is always the possibility that a firm could go out of business. A firm that closes down will no longer have revenues to pay its pension obligations, and if these obligations were not fully funded, retirees and employees of the firm would lose some or all of their pension benefits. Private-sector employers with defined benefit pensions are required to pay premiums to the Pension Benefit Guaranty Corporation (PBGC), which insures the pensions of workers whose employer terminates a pension plan that has unfunded liabilities. For plans that terminate in 2010, the PBGC guarantees a maximum annual benefit of $54,000 for a worker retiring at the age of 65. The maximum benefit is lower for workers who retire before the age of 65. The PBGC does not insure federal, state, or local government pensions. The ultimate guarantors of government pensions are the taxpayers.

The federal government requires firms in the private sector to pre-fund employees’ pension benefits to ensure that if a firm goes out of business, there will be funds available to pay its pension obligations. Although the federal government is unlikely to "go out of business," there are other reasons that Congress has required federal agencies and their employees to contribute money to the CSRDF. First, by providing a continuous source of budget authority, the CSRDF allows benefits to be paid on time, regardless of any delays that Congress may experience in passing its annual appropriations bills. Secondly, the balance in the trust fund acts as a barometer of the government’s future pension obligations. Given a fixed contribution rate and benefit structure, a rising trust fund balance indicates that the government is incurring obligations to make higher pension payments in the future. Finally, prefunding pension obligations forces federal agencies to recognize their full personnel costs when requesting annual appropriations from Congress. Otherwise, these costs would be recognized only in the central administrative accounts of the Office of Personnel Management, and not by the agencies where the costs are incurred.

Employee Contributions

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Contributions to CSRS and FERS are not deposited into individual employee accounts. Nor is the amount of a federal worker’s pension based on the amount of his or her contributions. All contributions are paid into—and all benefits are paid out of—the Civil Service Retirement and Disability Fund. Employee contributions pay for a comparatively small part of the retirement annuities paid by CSRS and FERS. There are, however, both budgetary and actuarial reasons that federal employees are required to contribute to CSRS and FERS.

Employee Contributions from a Budgetary Perspective

Employee contributions are revenues of the federal government. These revenues reduce the proportion of pension costs that must be borne by the public. In FY2008, employee contributions to CSRS and FERS totaled $3.7 billion, equal to 4.1% of the total income of the Civil Service Retirement and Disability Fund. The other major sources of revenue to the CSRDF are agency contributions, contributions of the U.S. Postal Service on behalf of its employees, interest on the federal bonds held by the fund, and transfers from the general revenues of the U.S. Treasury.

These transfers are necessary because the costs of the older of the two federal retirement programs, the CSRS, are not fully covered by employee and agency contributions. FERS benefits are required by law to be fully funded by the sum of contributions from employees and their employing agencies and the interest earnings of the CSRDF.

Employee Contributions in Actuarial Terms

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Actuaries calculate the cost of defined benefits pension plans in terms of "normal cost." The normal cost of a pension plan is the level percentage of payroll that must to be set aside each year to fund the pension benefits that participants have earned. Normal cost is based on estimates of attrition and mortality among the workforce, future interest rates, salary increases, and inflation.

OPM has estimated the normal cost of CSRS to be 25.8% of payroll in FY2009. The federal government’s share of the normal cost of CSRS is 18.8% of payroll. The Civil Service Retirement Amendments of 1969 (P.L. 91-93) require participating employees and their employing agencies each to contribute an amount equal to 7.0% of basic pay to the CSRDF to finance retirement benefits under CSRS. The combined contribution of 14% of employee pay does not fully finance the retirement benefits provided by the CSRS. The costs of the CSRS that are not financed by the 7.0% employee and 7.0% agency contributions are attributable mainly to increases in future CSRS benefits that result from (1) employees’ annual pay raises, and (2) annual COLAs to CSRS annuities. In actuarial terms, the employee and agency contributions totaling 14% of pay are equal to the static normal cost of CSRS benefits. This is the benefit that would be paid if employees received no future pay raises and annuitants received no future COLAs. The dynamic normal cost of CSRS pensions includes the cost of financing future benefit increases that result from pay raises and COLAs provided to annuitants.

Contributions from employees and their employing agencies meet about 54% of the normal cost of CSRS. (14.0/25.8 = .543) The remaining 46% of the cost of CSRS is paid from the interest earned by bonds held by the retirement and disability trust fund, special contributions by the U.S. Postal Service for retired postal workers, and transfers from the general revenues of the U.S. Treasury. If each federal agency were to pay the full cost of CSRS benefits on an accrual basis, as is done under FERS, they would contribute an amount equal to 18.8% of payroll. This represents the dynamic normal cost of CSRS minus the required employee contribution of 7.0% of pay.

OPM has estimated the normal cost of the FERS basic annuity to be 12.3% of payroll in 2009.

Federal law requires agencies to contribute an amount equal to the normal cost of FERS minus employee contributions to the program. Employees contribute 0.8% of pay toward their FERS annuities. Consequently, the normal cost of the FERS basic annuity to the federal government is equal to 11.5% of payroll (12.3-0.8=11.5). The federal government has three other mandatory costs for employees enrolled in FERS: Social Security, the 1% agency automatic contribution to the TSP, and agency matching contributions to the TSP. Social Security taxes are 6.2% of payroll on both the employer and the employee up to the maximum taxable amount of earnings ($106,800 in 2010). All agencies must contribute an amount equal to 1% of employee pay to the TSP. The normal cost of FERS to the federal government is therefore at least 18.7% of pay.

Federal matching contributions to the TSP can add up to 4 percentage points to amount. For an employee enrolled in FERS who contributes 5.0% or more of pay to the TSP, his or her employing agency must finance retirement costs equal to 22.7% of employee pay.

CSRS and FERS differ in the way that each federal agency must budget its contributions toward employee pension benefits. Under FERS, each agency must include the full normal cost of the FERS basic benefit (11.5% of pay in 2009) in its annual budget request. In addition, each agency must include in its budget request the cost of the employer share of Social Security payroll taxes, the 1.0% automatic contribution to the TSP, and employer matching contributions to the TSP.

Under CSRS, each agency must budget only a 7.0% contribution to the CSRDF, even though this is less than the full cost of the program. The costs associated with CSRS that are not paid by the employee contribution of 7.0% and the agency contribution of 7.0% are treated as a general obligation of the U.S. Treasury.

In both CSRS and FERS, government contributions to the Civil Service Retirement and Disability Fund result in the Treasury issuing securities that are credited to the fund. The contributions for both programs are commingled, and benefits for retirees and survivors in both programs are paid from the CSRDF. In contrast, government contributions to the TSP are deposited into individual accounts for each TSP participant. The accounts are managed by the Federal Retirement Thrift Investment Board. The TSP is not a trust fund of the U.S. government.

TSP accounts are individually owned by the participants in the TSP in the same way that 401(k) accounts are owned by workers in the private sector.

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