The major change in federal retirement benefits being considered in Washington—giving newly hired employees no annuity benefit but an enhanced TSP benefit—probably won’t happen. Most proposals on retirement, even relatively minor ones, don’t.
But sometimes they do.
Ask someone who was a federal employee before about 1980, for example, if they ever expected at that time that the Civil Service Retirement System, the traditional bedrock of federal benefits, would be replaced by a hybrid involving Social Security, a smaller civil service annuity and a tax-favored savings plan. Yet it was, by the Federal Employees Retirement System.
That’s the best precedent for what’s being considered. The administration’s budget proposal, in its own words, “funds a study to explore the potential benefits, including the recruitment benefit, of creating a defined-contribution only annuity benefit for new federal workers, and those desiring to transfer out of the existing hybrid system.”
Defined contribution plans are those like the TSP, in which the individual—and commonly, but not always, the employer—invests money over a career and the payoff at the end depends on how long, how much and how successfully the individual invested. Defined benefit programs, on the other hand—CSRS and the FERS civil service annuity portion are good examples—also involve contributions from both but the employer is on the hook for making a stream of payments to the retiree for life.
Anyone who has followed this issue knows that increasingly in the private sector, employers have been replacing defined benefit plans with defined contribution plans, mainly because that’s an advantage for the employer.
Contrary to what some websites (that present themselves as more knowledgeable about federal employee benefits than they really are) reported before the budget came out, the White House does not specifically recommend switching to a defined contribution program for those newly hired, only studying the issue. It doesn’t say who would do the study or what their portfolio would be, but since the administration likely would appoint most or all of its members, would you be surprised if it concludes that it would be a good thing to do?
Some study already has been done. Last year the CBO looked at how such a system might be structured and presented two options. In one, the government’s automatic contribution to their TSP accounts could be increased from the current 1 percent of salary to 8 percent, and maximum matching contributions increased from the current 4 percent additional to 7 percent additional. Under another, the government contribution could be set at a flat 10 percent regardless of whether the individual invested personally.
That actually could be attractive to younger potential employees, CBO said, because they would be seeing more money upfront—at a time in life when cash flow can be especially tight, what with student loans, first mortgages and the rest. Also, at that point they might not expect to stick with the government long enough to earn a substantial defined benefit—and one far into the future, at that.
One feature of the administration’s proposal that the CBO didn’t consider would be to allow current employees to switch into the new system—as the budget language put it, “those desiring to transfer out of the existing hybrid system.”
Again, let’s look to the transition from CSRS to FERS for precedent. At the time FERS came on line in the late 1980s—there was a transition period between when it took effect on paper and in actuality—CSRS employees were given the opportunity to switch to the new system. The government strongly encouraged it, arguing that with good investment habits, employees could come out ahead in FERS.
Very few switched, on the order of low single-digit percentages.
After a change in law involving Social Security policy that may have tipped the scales for some individuals, the government offered another opportunity. Again, about only a relative few switched.
At the time, employees voiced suspicion that the government’s motivation was to save money on their eventual benefits—coming, of course, at their own cost. The government denied it at the time.
This time, at least there is a little more honesty. Again, quoting from the budget: “The federal defined benefit plan, according to CBO, is the single greatest factor contributing to the disparity in total compensation between the federal and private sector workforce. To better align with the private sector, the budget reduces federal personnel compensation costs, primarily the annuity portion.”
Now, if you have a number of years in already, you may be thinking this has nothing to do with you. Only newly hired employees would be compelled to be in the revised system, and there’s little likelihood that a long-time employee would see an advantage of joining it—even if time served up to that point would be credited as always, as it was for people who left CSRS for FERS.
But if you asked those same people who were working even as FERS was being set up if they ever thought that it would be the dominant federal retirement program during their lifetimes, they likely would have said no.
And yet with normal turnover it didn’t take long for FERS to become the majority plan in the workforce; now it covers some 95 percent of federal employees. Then it became the dominant plan among new retirees, now accounting for about 70 percent of new retirements.
Which means, among other things, that almost no one is paying into CSRS anymore—and of the CSRS contingent still working, 90 percent already are eligible to retire—while the vast majority of those under it are drawing out benefits. Think about the math behind that for a while, and what kind of policy implications it may have in a time of staggering federal deficits.
Then think about the future of FERS if everyone hired after a certain point is put under a defined contribution-only plan. If you’re tempted to feel comfortable about it, consider what your predecessors thought about the future of CSRS.