January 7, 2013

New federal employees joining government service after January 2013 will receive a reduction in pay relative to their longer-serving peers. Those who begin their government service this year will now pay 3.1% to their pensions. This compares to current FERS employees, who pay 0.8% to their pensions.

For someone making $50,000 a year, a 3.1% contribution totals $1,550 or about $130 a month. This is an increase of $1,150, over the previous 0.8% contribution rate.

New employees paying this increased 3.1% pension contribution now fall under the designation “Federal Employee Retirement System Revised Annuity Employee,” or “FERS RAE.” The new contribution rate was part of the “Middle Class Tax Relief and Job Creation Act of 2012,” signed early last year. The change also applies to new members of congress and new congressional employees. More information can be found in OPM’s Benefits Administration Letter.

This cuts contributions by employing agencies, which is the primary goal of the new law. Employing agencies as of 2012 pay 11.9% into the pension scheme for current FERS employees, but this will go down to 9.6% with the implementation of “FERS RAE” in 2013. Thus for new employees making $50,000, to use the example above, employing government agencies will contribute $4,800 for new employees under FERS RAE, compared to $5,950 under the previous plan. (Employing agencies also contribute an additional 6.2% to Social Security, which in this case would be $3,100.)

But the trends underlying the new contribution rate point to more changes ahead, including for current employees in the traditional FERS system. The agency contribution amount has risen steadily over the years, and because the employee contribution was set at 0.8% (for reasons discussed below), the agency contribution rate had to increase to make up the difference to keep the pension scheme funded as required by law. In 2012 the agency contribution for employee pensions was 11.9%. In 2011 it was 11.7%. In 1997, however, the agency contribution for employee pensions was 10.7%. The contribution rate continues to increase steadily over time.

There are multiple causes for the steady increases, which are mandated by law to match expected expenses. The first is the relatively low retirement age, coupled with increasing life spans enabled by medical advances. It could become commonplace to encounter retirees who have spent more time in retirement than in their professional lives. The second is the relative expansion in the retiree-to-worker ratio over the coming years, as retiring baby-boomers join relatively healthy retirees from the 1980s and 1990s. There will be more retirees relying on current payments from FERS and agency contributions, requiring a static number of current employees to pay into a pension system supporting an increasing number of retirees.

The original 0.8% FERS contribution rate points back to the historic employee contribution rate since before FERS (and the TSP) was created in 1984. When the Civil Service Retirement System (CSRS) was created in 1920, only employees contributed to CSRS retirement. That changed in 1956, when legislation was enacted requiring employing agencies to contribute an amount equal to the employee contribution amount to the Civil Service Retirement and Disability Fund (CSRDF). In 1969, that amount as set at a 7% contribution rate for employees, and a corresponding 7% contribution rate paid by employing agencies. CSRS employees did not contribute to – and were not eligible for – Social Security. (For more details, see the CRS September 2012 Report “Federal Employees’ Retirement System: Budget and Trust Fund Issues.”)

With the creation of FERS in the early 1980s, government employees were enrolled in and eligible for Social Security, while their pensions were cut almost in half. (FERS also created the Thrift Savings Plan that matched contributions up to 5% of based salary.) Thus FERS employees now contribute 6.2% to Social Security, the same as wage earners in the private sector. The 0.8% represents the difference between Social Security payments and the traditional 7% employee contribution.

Now with the higher contributions required of new “FERS RAE” employees, that 7% individual contribution to FERS and Social Security has effectively increased to 9.3% of salary.

Proposals to raise individual contributions to CSRDF did not end with new employees. Both Congress and the White House last year proposed higher employee contributions to pensions by long-serving employees, and we can expect that similar proposals will surface this year as well.

The White House proposal sought to decrease the unfunded liability in the CSRDF by raising employee contributions an additional 1.2%:

“[T]he Administration proposes to increase the employee contribution toward accruing retirement costs by 1.2 percent over three years beginning in 2013. While Federal agency contributions for currently accruing costs of employee pensions would decline, these Federal employers would pay an additional amount toward unfunded liabilities of the retirement system that would leave total agency contributions unchanged. Under the proposed plan, the amount of the employee pension would remain unchanged.”

In other words, under this proposal, the increase in individual contributions would account for the pensions of current FERS employees as required by law, and employing agencies would continue to pay the same amount to CSRDF with a corresponding 1.2% going toward the unfunded liability of $622 billion as of FY2010 (see “Federal Employees’ Retirement System” cited above). This unfunded liability consists almost entirely of CSRS employees and retirees. (Actuarial estimates project the unfunded liability will peak in 2023, and then begin to steadily decline and result in a surplus of $716 billion by 2085 – but then again, the federal budget surplus in 2000 was projected to increase by as much as $1 trillion in ten years…that was more than $10 trillion in debt ago…Can we really believe in long-term estimates?)

Multiple proposals in Congress called for an increase in individual contributions anywhere from 1.5% to 5%, and a few members of congress called for the elimination of future FERS pensions altogether.

Moreover, both the White House and Congress have called for the elimination of “FERS Special Retirement Supplement” for new employees, and in some instances, for its elimination altogether.

In all of these proposals, the TSP benefit would be untouched.

Thus the trend is clear. While we do not know the amount by which individual contributions will increase, some sort of increase will likely be enacted. There is a chance that the FERS Supplement will disappear. It is conceivable that the Minimum Retirement Age (MRA) will be increased. Continuing massive budget deficits will be the proximate cause.

While effective pensions most likely will not change, the cost of funding them already has. Those costs are now being passed on to individual workers.