What it means
The three-part design gives employees different kinds of security. The basic benefit is a defined benefit, meaning a pension that pays a set amount for life based on a formula.
Social Security is the national pension system, and the Thrift Savings Plan, or TSP, is a defined contribution plan similar to a 401(k), where the final balance depends on contributions and investment returns. The basic pension is calculated using the average of an employee's highest three consecutive years of pay, known as the high-3, multiplied by the years of service and a percentage.
The usual percentage is 1% per year of service. An employee who retires at 62 or later with at least 20 years of service gets a higher percentage of 1.1% per year.
The TSP gives employees a way to build their own savings. The employing agency automatically contributes an amount equal to 1% of pay whether or not the employee contributes, and it matches the employee's own contributions, dollar for dollar on the first 3% of pay and at 50 cents on the dollar on the next 2%, so total agency contributions can reach 5%.
Investments are chosen from a menu of funds, including target date funds. The age at which an employee can retire without reduction depends on the year of birth, through what is called the minimum retirement age, which has been phased in from 55 to 57.
Employees who retire at that age with 30 years of service may also get a supplement that approximates the Social Security benefit until they reach 62. Special rules apply to groups such as law enforcement officers and firefighters.
For finance professionals, FERS is a good example of a hybrid retirement design that spreads risk. The pension protects against living a long time, Social Security provides a base, and the TSP gives flexibility and growth potential.
Anyone planning on the basis of FERS should check the current rules, since contribution and eligibility details are set by law.
In practice
Real-world examples.
Example
A federal analyst earning $90,000 contributes 5% of pay to the TSP, which is $4,500 a year. Her agency adds 1% automatically and matches 4%, giving 5% of pay, or $4,500 as well. Her yearly savings in the plan are therefore 4,500 + 4,500 = $9,000 before investment returns.
Example
A federal engineer plans to retire at 62 with 25 years of service and a high-3 salary of $100,000. At 1.1% per year the basic pension would be 100,000 x 25 x 0.011 = $27,500 a year. She also expects Social Security and withdrawals from her TSP balance.
Example
A newly hired federal employee asks whether to contribute to the TSP beyond the matched level. Her adviser explains that contributing 5% of pay captures the full agency match, and anything above that is a personal choice. She decides to contribute 5% at first and raise it with each pay rise.
Formula
Calculation
Annual basic pension = High-3 average salary x Years of service x Percentage
An employee has a high-3 average salary of $90,000 and 30 years of service. At the standard 1% factor, the pension is 90,000 x 30 x 0.01 = $27,000 a year. If the employee retires at 62 or older with at least 20 years, the factor is 1.1%, so the pension is 90,000 x 30 x 0.011 = $29,700 a year, which is $2,700 higher.Case study
Seen in the real world.
Maplewood Federal Credit Advisory is an illustrative, fictional financial education firm that runs workshops for government staff. One participant, Elena, had worked for 15 years and was considering leaving for a private job.
The adviser helped her to estimate what she would give up. Her high-3 salary was $80,000, so the basic pension for her service so far was 80,000 x 15 x 0.01 = $12,000 a year, payable at retirement age. She also had a TSP balance and had been receiving the full agency match.
Elena decided to stay for another five years, which raised her service to 20 years and her expected pension accordingly. The illustrative lesson is that the value of a pension is easy to overlook when the focus is on current salary.
Watch out
Common mistakes.
- Treating FERS as only a pension, when it also includes Social Security and the savings plan.
- Contributing too little to the TSP and missing part of the agency match, which is effectively free money.
- Assuming that the pension percentage is the same for everyone, when retiring at 62 or later with 20 years raises it from 1% to 1.1%.
Questions
People also ask.
Who is covered by FERS?
Most civilian federal employees hired from the mid-1980s onwards are covered, with some groups under different arrangements.
What is the high-3?
It is the average of the employee's three highest consecutive years of basic pay, and it is used in the pension formula.
How is FERS different from a 401(k)?
A 401(k) is a savings account only, while FERS adds a lifetime pension and Social Security to its savings plan.
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