So, you’ve received an Analysis on what you can expect to receive from your pension in retirement. The amount is much higher than you anticipated and all sorts of ideas for things you want to purchase are swirling in your head.
Stop right there.
I hate to be the bearer of bad news, but the gross amount you will receive from your pension is most likely going to look quite different from the net amount.
I’m going to detail the Top 5 possible reductions that could come out of your pension. Not everybody will have all 5 reductions taken out of their pension, but there are some who will.
Thought you may be able to get away from the IRS did you?
Not so fast, as a famous man once said,
In this world nothing can be said to be certain, except death and taxes. – Benjamin Franklin
When planning, it’s important to calculate not just the gross, but the net. Calculating the amount of taxes that will be taken out of your pension when deciding the right time to retire is a perfect example.
The majority of your federal retirement WILL BE TAXABLE.
Most likely, the percentage will be around 90-98% and the rate in which it will be taxed will be at ordinary income rates.
A general rule of thumb for estimating how much tax will be taken out of your pensions is to use around 20% for planning purposes. Granted, everyone’s financial situation and thus, their tax situation are different. But for the majority of you reading this, I would plan with the idea that 20% of your pension will be taken out for taxes.
Also of note, for those in states that has a state income tax, make sure that’s something you calculate when deciding your after-tax pension amount.
2. Survivor Annuity Plan
Ahh, the Survivor Annuity Plan.
This is a benefit that I think is talked about less than any other, but can truly have a large impact on your retirement.
What is the Survivor Annuity Plan you may ask?
I plan to go over the Survivor Annuity Plan in much more detail in a future post, but to give a basic definition, the Survivor Annuity Plan allows you to leave a portion of your Pension to your spouse if you are to pass away before they do.
That being said, in order to leave a portion of your pension to your spouse, it will cost you a percentage of your pension each month. In the majority of cases in order to provide a full survivor annuity, that cost is 10% of your gross pension amount, and could be even higher if your surviving spouse is what’s called an “insurable interest.”
In leaving a Full Survivor Annuity, your spouse can actually expect to receive 50% of your pension if you pass before them. I guess the “Full” part of the Full Survivor Annuity can be a little deceiving.
Something you may have heard about in replacing the Survivor Annuity Plan is “Pension Max.” Using a Pension Max can be a good idea, but it relies on many factors that I will save for a future article.
3. Federal Employee Health Benefits (FEHB)
This is a reduction that will affect many reading this.
When planning what reductions will come out of your pension, make sure FEHB premiums are included in that planning. This is a great benefit to have in retirement, but it will cost you.
If you don’t have your health insurance premiums factored in what will be coming out of your pension, than you could be in for a bad surprise come time for retirement. Especially if you’re looking at the larger family plans.
I would also factor in the costs of Federal Employees Dental and Vision Insurance Program (FEDVIP) and Federal Long Term Care Insurance Program (FLTCIP.)
Though these are not used nearly as much as FEHB, some reading this may still have these plans, and thus it’s important to not forget to leave them out.
4. Federal Employee Group Life Insurance
Federal Employee Group Life Insurance is cheap..
when you’re very young.
However, as you increase in age, your life insurance premiums also increase, except they increase in price, and much more rapidly than the number associated to your age.
You can see more about the pricing on FEGLI through OPM’s website here. Specifically look at the price for ages 55 and 60. These two years have some of the largest increases percentage wise. At 55 the cost almost doubles and then at 60 the cost more than doubles. Yikes!
Typically though, when federal employees get into retirement and see how much their premiums are going to cost, they end up dropping their life insurance.
But, some people still decide to keep it because they’re unable to qualify for commercial life insurance or don’t mind paying the high prices. in this case, make sure you’re including the cost of FEGLI in your pension planning.
If you’re interested in learning more about FEGLI, click here to watch me explain the “Basic Life Insurance Basics.”
5. Early Retirement Reduction Penalty
Deciding when to retire can be a big task. One of the biggest mistakes you could make would be to retire too early without knowing that your pension will be reduced.
For CSRS employees who are offered an early out from service, your federal retirement pension is going to be reduced by 2% for every year you’re under age 55.
For FERS employees, if you decide to retire early also known as taking an MRA+10 Retirement, then there will be a 5% penalty for each year you’re under 62 years old.
I’m going to only give an example for FERS employees because those that are CSRS are over the age of 55.
Because this penalty can be so large, some FERS employees opt for a Postponed FERS Retirement. A Postponed FERS Retirement is when you separate from service and have at least 10 years of credible service, and you have at least reached your Minimum Retirement Age, also known as MRA. Instead of immediately withdrawing your Pension, you wait to withdraw it later.
We’re going to combine all of these reductions and see just how big of a hit the pension can take.
Let’s use our friend Larry Steinfeld from our previous example.
Larry is a FERS employee.
Larry’s Pension Amount before any reductions is $2500
Similar to the previous example, Larry is going to be taking a 25% Permanent Reduction for retiring under MRA+10 rules.
Larry is going to be taxed at an effective 20% rate.
Larry has a family so he’s estimating he’s going to pay $450 for his Family FEHB Plan.
Larry is also going to pay for a Full Survivor Benefit which amounts to 10% of his Reduced Annuity Amount.
Let’s put this all together:
|Gross Pension Amount:||$2,500/month|
|Minus Early Retirement Reduction of 25%||($625)/month|
|Reduced Pension Annuity Amount:||$1,875/month|
|Minus Taxes (20% Effective Rate)||($500)/month|
|Minus Survivor Benefit Cost (10%)||($187.50)/month|
|Net Pension after Reductions:||$737.50/month|
My recommendation is to begin planning now! I don’t care if you’re just starting or you’ve just sent off your exit paperwork. The sooner you can begin dialing in the amount you need to have in retirement, the better.
If you need specific help, click here to find out how we can work together.