Retirement planning is different if your career has been as a government employee. The mainstream advice about 401(k) plans and Social Security benefits doesn't apply to you. Here’s a look at the top strategies for government employees to plan for a successful retirement.
Know Your Benefits
Federal government employees are covered by different retirement systems depending on when they were hired.
If you’re an older civilian service employee of the federal government who was hired before 1984, you may have been grandfathered into the Civil Service Retirement System (CSRS), which provides retirement, disability and survivor benefits. Because you haven’t had Social Security taxes deducted from your paycheck, you won’t be eligible to receive Social Security benefits unless you’ve earned them through another job or qualify through your spouse. If you do qualify for Social Security, your CSRS pension may reduce your benefits.
If you’re a civilian service employee who was hired in 1984 or later, you’re covered by the Federal Employees Retirement System (FERS). It provides Social Security benefits, a basic benefit plan (pension), and a thrift savings plan (TSP) that consists of automatic government contributions, voluntary employee contributions and matching government contributions. The retirement benefits you’ll receive from these plans are structured as annuities based on your age, years of service and plan contributions. (Read What Is the Federal Employees Retirement System and How Does It Work? to learn more.)
Thrift Savings Plan
The TSP is a defined-contribution plan, meaning that you decide how much to put in and how to invest the money. How much you end up with in retirement is based on those decisions.
Employee contributions to a TSP can be pretax or post-tax. If you contribute pretax dollars, you don’t pay any taxes until you start withdrawing money from your TSP. If you contribute post-tax dollars, you don’t have to pay taxes when you withdraw the money in retirement. Either way, your contributions grow tax deferred.
TSPs offer a handful of investment choices for different risk appetites, from low-risk funds that invest in U.S. Treasuries to higher-risk funds that invest in international stocks. You can even choose a life-cycle fund that is composed of a set of investments that changes as you get older and is designed to help you meet your retirement goals with little effort.
Both CSRS and FERS employees can contribute to a TSP. However, only FERS employees receive employer contributions. If you’re covered by the FERS, your employer will automatically kick in an additional 1% of your salary, and if you make employee contributions, you are eligible to receive a matching contribution from your employer, too. You should contribute enough to maximize your employer match, and make sure you accrue enough years of service for the automatic 1% match to vest. The most you can contribute to a TSP for 2016 is $18,000, plus an additional $6,000 in catch-up contributions if you are 50 or older. You may also want to roll over funds from a retirement account you had with a previous employer into your TSP.
One of the best reasons to take advantage of a thrift savings plan is that the plan’s investment funds have extraordinarily low expense ratios. In 2016, TSP participants paid just 38 cents in expenses for every $1,000 invested. Outside of a TSP, even the industry leaders in low expense ratios charge six-and-a-half times as much. Vanguard’s average expense ratio is currently 0.12%, meaning investors pay $1.20 per $1,000 invested. Low expenses are a key factor in achieving high long-term investment returns, and seemingly small differences in expenses add up as your nest egg grows and the years go by. (Read Pay Attention to Your Fund’s Expense Ratio to learn more.)
“The investment options associated with the thrift savings plan are well-known for being low-cost and very well diversified. This savings in terms of cost, compounded over someone’s entire career, is tremendous. Just like the principle of compound interest is powerful in terms of returns, it is equally important when it comes to cost. The less you pay, the more you receive,” says Mark Hebner, founder and president, Index Fund Advisors, Inc., in Irvine, Calif.
Find Specialized Professional Help
One of the biggest problems federal government employees face is that their benefits are confusing, and it is difficult to find a competent financial advisor who understands these benefits, says Richard E. Reyes, a certified financial planner with the Wealth and Business Planning Group, a registered investment advisor in Maitland, Fla. “Employees have to make an active effort to find good counsel and advice, and often they just depend on other employees who are just as clueless in this matter,” he says.
One professional qualification to look for in a financial adviser is the Chartered Federal Employee Benefits Consultant (ChFEBC) designation. Advisers who have earned this designation have studied and passed an exam on all federal employee benefits, including CSRS and FERS annuities (pensions), TSPs, life insurance, health insurance and Social Security. If you find a potential financial adviser with this qualification, the next step is to make sure they are a fiduciary, meaning that they are required to put your best interests ahead of their own; not everyone with the ChFEBC designation is. Some advisers without the designation may also be qualified to help you, but research them even more carefully. (Read 7 Steps to Evaluate a Financial Adviser to learn more.)
Other Government Employees
If you work for a state, county or municipal government, you may be entitled to a pension. Pensions are typically based on years of service, final salary or the average of your highest years of earnings, and a multiplier. In Pennsylvania, for example, most members of the state employees retirement system receive 2.5% of their final average salary for each year worked, with a year defined as 1,650 hours of work.
Each state has a different system, and even within that system there are variations. Your line of work and the year when you were hired will typically affect your retirement plan. The key is to learn how the system works as soon as possible after being hired so you can plan accordingly. If your employer offers a 457(b) plan, you should strongly consider contributing so you'll have more than one income source in retirement.
The Bottom Line
Understanding how your retirement plan works, contributing to a TSP (if you can) and seeking professional advice are just a few of the strategies government employees should consider when planning for a successful retirement. You’ll also need to learn what pension maximization is and the pros and cons of pension maximization.
If you’re married, research how your spouse’s retirement benefits – or lack thereof – will interact with your benefits and affect your joint retirement plan. It’s never too early to start educating yourself about the complexities of a government employee’s retirement benefits and planning to make the most of them.