Federal Employees' Retirement System: The Role of the Thrift Savings Plan

Publication Date: June 2004

Publisher: Library of Congress. Congressional Research Service

Author(s):

Research Area: Government

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Abstract:

Prior to 1984, civilian federal employees did not pay taxes to Social Security, nor were they eligible for Social Security benefits. Federal employees were instead covered by a separate pension plan called the Civil Service Retirement System (CSRS). The 1983 amendments to the Social Security Act (P.L. 98-21) required federal employees first hired after 1983 to participate in Social Security. Because the CSRS was not designed to coordinate with Social Security, Congress directed the development of a new retirement plan for federal workers. The result was the Federal Employees' Retirement System (FERS) Act of 1986 (P.L. 99-335). The FERS has three elements: (1) Social Security, (2) the FERS basic retirement annuity (a defined benefit plan), and (3) the Thrift Savings Plan (a defined contribution plan).

The FERS basic retirement annuity is determined by three factors: (1) the salary base, (2) the accrual rate, and (3) the employee's years of service. The salary base is the average of the highest three consecutive years of pay. Under FERS, the accrual rate is 1.0% of the salary base per year of service. A worker with 30 years of service will have accrued a pension benefit equal to 30% of the average of his or her highest three consecutive years of pay. The Thrift Savings Plan (TSP) is a defined contribution retirement plan similar to the "401(k)" plans provided by many employers in the private sector. The income that a retired worker receives from the Thrift Savings Plan will depend on the balance in the account. In 2004, employees covered by FERS can make voluntary contributions equal to the lesser of 14% of pay or $13,000. Employee contributions of up to 5% of pay are matched by the federal government. Federal workers covered by CSRS also can participate in the TSP, but they receive no matching contributions from their employing agency.

One measure of retirement income adequacy, called the replacement rate, is the ratio of first-year retirement income to the worker's salary in the last year of employment. For an employee retiring at age 62 after 30 years of service, the FERS basic annuity will provide first-year retirement income equal to 32% of final salary. Social Security replacement rates decline as a worker's income increases because the Social Security benefit formula is "tilted" in favor of low-wage workers. Because of this tilt, higher-wage federal workers need to contribute more to the TSP in order to reach the same rate of income replacement as lower-paid workers can achieve from just the FERS retirement annuity and Social Security. For a federal worker retiring at age 62 at the GS-4 level after 30 years of federal employment, monthly Social Security benefits will replace an estimated 25% of final salary. For a worker retiring at the GS-15 salary level, Social Security will replace just 14% of final annual pay.

The TSP is a key component of FERS, especially for workers in the middle and upper ranges of the federal pay scale. These workers are unlikely to achieve adequate retirement income -- as measured by the replacement rate -- from just Social Security, the FERS basic annuity, and the government's automatic contribution of 1% of pay to the TSP. Even at a modest annual rate of return of 6.0%, income from the TSP can replace about 44% of final pay for a worker who contributes 10% of pay over 30 years.