Federal employees have one of the best benefits packages available in today’s workplace, and the FERS annuity is a big part of it. The FERS annuity is a pension provided to federal employees that started their career on or after January 1, 1984. The pension is based on a retiree’s years of service and high three years of salary, but what is the FERS annuity really worth?
The specific value of the annuity may not matter to some people, but for others that are looking to design the appropriate investment allocation, it can be vitally important. It makes sense to take all streams of income, like your FERS annuity and Social Security, into account when you develop your asset allocation, but how do you value a stream of income?
How do I value my FERS annuity?
Possibly the simplest method used to value a stream of income is by first determining what percentage of income you expect to withdraw from your investments. Most studies on this topic have found that a 4% withdrawal rate is ideal. Simply put – if you only withdraw 4% of your investment assets per year there is a high chance of your investments lasting the rest of your lifetime. This is exactly what retirees are looking for – a stream of income that will last for the rest of their lives. If you decide to take a withdrawal higher than 4%, your chances of running out of money significantly increase. Once you have determined the appropriate percentage, all you need to do is figure out what value it would take to produce the given income.
For an example we are going to look at a newly retired federal employee with the following:
- 60 year old retiree
- FERS annuity = $24,000 a year
- Social Security = $20,000 a year
- Thrift Savings Plan balance = $400,000 (this could be IRA dollars as well)
A lot of retirees want to invest conservatively in their TSP when they retire, but they also only look at their TSP balance when they determine their allocation. The typical 50/50 (50% stocks and 50% bonds) retiree portfolio changes significantly if we add in the value of the FERS annuity. If we are using the 4% rule for investment withdrawals, then the value of the above FERS annuity is $600,000. Since the annuity is guaranteed, it would be considered very conservative, therefore all $600,000 would be considered fixed dollars.
Additionally, if we were to include the value of Social Security in the investment allocation, it would be worth $500,000. With these two income streams accounted for, the investor’s allocation looks very conservative, even if the entire TSP balance of $400,000 were invested in stocks.
- Total value = $1,500,000
- Fixed portion = $1,100,000
- Aggressive portion = $400,000
Does this mean all federal employees should invest their entire TSP in the stock funds? If we look at investing from strictly a logical perspective, then most federal employees probably could, but investing is a lot more than just numbers and math.
Emotion plays a huge role in an individual’s investment decisions, and emotion causes a lot of bad decisions. There have been many studies on the emotional side of investing and they have all come up with a similar thesis: everyone wants to buy stocks at a market top and everyone wants to sell at a market bottom.
If you doubt this thesis you may want to think back to 2009 and try to recall workplace conversations about TSP. I can’t tell you how many federal employees told me in 2009 that they were getting out of the stock funds because they couldn’t handle anymore; that year turned out to be the absolute worst time in the last few decades to exit the market. Why did so many people exit the market in 2009? Emotion was involved.
What does this mean to me?
My goal in this article is to point out that there is more to consider than just your investments or TSP balance when coming up with an allocation. From a logical investment perspective, most feds can afford to take significant risk in their TSP. HOWEVER, logic doesn’t always prevail, and anyone investing in stocks should understand the risks involved. There is always a chance of another 2008, and if you can’t stand the thought of seeing your account value go down then the stock funds may not be appropriate for you.
If you aren’t sure how you should be invested, and would like to discuss your TSP, you can email me at email@example.com.