<DOC> [105 Senate Hearings] [From the U.S. Government Printing Office via GPO Access] [DOCID: f:49133.wais] S. Hrg. 105-639 S. 1710--RETIREMENT COVERAGE ERROR CORRECTION ACT OF 1998 ======================================================================= HEARING before the SUBCOMMITTEE ON INTERNATIONAL SECURITY, PROLIFERATION, AND FEDERAL SERVICES of the COMMITTEE ON GOVERNMENTAL AFFAIRS UNITED STATES SENATE ONE HUNDRED FIFTH CONGRESS SECOND SESSION on S. 1710 TO PROVIDE FOR THE CORRECTION OF RETIREMENT COVERAGE ERRORS UNDER CHAPTERS 83 AND 84 OF TITLE 5, UNITED STATES CODE __________ MAY 13, 1998 __________ Printed for the use of the Committee on Governmental Affairs <snowflake> U.S. GOVERNMENT PRINTING OFFICE 49-133 cc WASHINGTON : 1998 _______________________________________________________________________ For sale by the U.S. Government Printing Office, Superintendent of Documents, Congressional Sales Office, Washington, DC 20402 COMMITTEE ON GOVERNMENTAL AFFAIRS FRED THOMPSON, Tennessee, Chairman WILLIAM V. ROTH, Jr., Delaware JOHN GLENN, Ohio TED STEVENS, Alaska CARL LEVIN, Michigan SUSAN M. COLLINS, Maine JOSEPH I. LIEBERMAN, Connecticut SAM BROWNBACK, Kansas DANIEL K. AKAKA, Hawaii PETE V. DOMENICI, New Mexico RICHARD J. DURBIN, Illinois THAD COCHRAN, Mississippi ROBERT G. TORRICELLI, New Jersey DON NICKLES, Oklahoma MAX CLELAND, Georgia ARLEN SPECTER, Pennsylvania Hannah S. Sistare, Staff Director and Counsel Leonard Weiss, Minority Staff Director Lynn L. Baker, Chief Clerk ------ SUBCOMMITTEE ON INTERNATIONAL SECURITY, PROLIFERATION AND FEDERAL SERVICES THAD COCHRAN, Mississippi, Chairman TED STEVENS, Alaska CARL LEVIN, Michigan SUSAN M. COLLINS, Maine DANIEL K. AKAKA, Hawaii PETE V. DOMENICI, New Mexico RICHARD J. DURBIN, Illinois DON NICKLES, Oklahoma ROBERT G. TORRICELLI, New Jersey ARLEN SPECTER, Pennsylvania MAX CLELAND, Georgia Mitchel B. Kugler, Staff Director Ann C. Rehfuss, Professional Staff Member Linda J. Gustitus, Minority Staff Director Julie A. Sander, Chief Clerk C O N T E N T S ------ Page Opening statement: Senator Cochran.............................................. 1 WITNESSES Wednesday, May 13, 1998 William E. Flynn, Associate Director for Retirement and Insurance, U.S. Office of Personnel Management................. 2 Hon. Roger W. Mehle, Executive Director, Federal Retirement Thrift Investment Board........................................ 4 Dallas Salisbury, President, Employee Benefit Research Institute (EBRI)......................................................... 24 Daniel F. Geisler, President, American Foreign Service Association (AFSA) I6025....................................... Alphabetical List of Witnesses Flynn, William E.: Testimony.................................................... 2 Prepared statement........................................... 75 Geisler, Daniel F.: Testimony.................................................... 25 Prepared statement........................................... 96 Mehle, Hon. Roger W.: Testimony.................................................... 4 Prepared statement........................................... 84 Salisbury, Dallas: Testimony.................................................... 24 Prepared statement........................................... 88 APPENDIX Questions and responses from Senator Durbin to OPM............... 31 Copy of bill S. 1710............................................. 33 Additional prepared statements submitted for the record: Robert Tobias, President of the National Treasury Employees Union...................................................... 59 Thomas O'Rourke, Shaw, Bransford and O'Rourke law firm....... 63 Linda Oakey-Hemphill, U.S. Department of Treasury............ 72 S. 1710--RETIREMENT COVERAGE ERROR CORRECTION ACT OF 1998 ---------- WEDNESDAY, MAY 13, 1998 U.S. Senate Subcommittee on International Security, Proliferation, and Federal Services of the Committee on Governmental Affairs, Washington, D.C. The Subcommittee met, pursuant to notice, at 2 p.m. in room 342, Senate Dirksen Building, Hon. Thad Cochran, Chairman of the Subcommittee, presiding. Present: Senators Cochran and Levin. OPENING STATEMENT OF SENATOR COCHRAN Senator Cochran. The Subcommittee will please come to order. Today we are conducting a hearing on S. 1710, the Retirement Coverage Error Correction Act of 1998, a bill which I introduced in March of this year at the request of the administration. The Retirement Coverage Error Correction Act is designed to provide an appropriate remedy for approximately 20,000 Federal employees who have been placed by the government in an incorrect retirement system. To give you some background on this situation, let me try to explain that this erroneous pension problem stems from the government's transition to the Federal Employees Retirement System, FERS, in 1984. Some employees hired since 1984 were erroneously placed in the older Civil Service Retirement System, CSRS, and later informed that they should be in FERS. Retirement coverage errors generally resulted from the difficulties government agencies experienced in applying two sets of transition rules. The CSRS is a traditional defined benefit program; participants receive an annuity based on age, years of service, and average compensation. FERS is a hybrid plan; FERS participants receive a substantially smaller annuity than CSRS participants, but they are covered by Social Security and are eligible for greater benefits under the Tax-deferred Savings Plan, TSP. To provide benefits equivalent to those payable under CSRS, it is generally considered necessary to contribute to the TSP and enhance retirement benefits by obtaining government matching. Employees erroneously placed in CSRS or CSRS-Offset, a plan which combines CSRS coverage and Social Security coverage, for a substantial period may be disadvantaged with respect to TSP benefits. For example, due to erroneous coverage they may not have contributed to the TSP in the belief that they would obtain a CSRS or CSRS-Offset benefit. Since the TSP began in 1987, employees whose erroneous coverage was detected have been allowed to obtain TSP benefits retroactively, with makeup contributions, but they may not have used the makeup opportunity for a variety of reasons, including lack of income available for savings. To remedy the situation, the administration's proposal, S. 1710, allows individuals affected by an error lasting at least 3 years to choose between being retroactively placed in FERS, which current law provides or requires, or CSRS-Offset, whichever the individual prefers. CSRS-Offset coverage provides benefits that employees expected during erroneous coverage through annuity and Social Security. Providing choice allows the equivalent of choosing FERS or CSRS, but does not disturb Social Security coverage rules. The CSRS-Offset choice makes the remedy administratively feasible for employees already placed in FERS and participating in Social Security, including retirees already receiving Social Security benefits. Employees, retirees, survivors, and certain salaried employees will have a window of opportunity to choose, and there will be an outreach program to explain this change. As Chairman of the Subcommittee with jurisdiction over this subject, I will try to ensure a careful review of all of the options for dealing with this issue. This afternoon we will hear from two panels of witnesses. The first panel will include William E. Flynn, Associate Director for Retirement and Insurance at the U.S. Office of Personnel Management, and the Hon. Roger W. Mehle, Executive Director of the Federal Retirement Thrift Investment Board. The second panel will include Dallas Salisbury, President of the Employee Benefit Research Institute, and Daniel F. Geisler, President of the American Foreign Service Association. Our first panel is at the table. We have received statements from you; we will include those in the record as if read. We also have statements from Robert Tobias, President of the National Treasury Employees Union, Thomas O'Rourke of the law firm of Shaw, Bransford and O'Rourke, and from Linda Oakey- Hemphill, U.S. Department of Treasury, which also will be included in our hearing record.\1\ --------------------------------------------------------------------------- \1\ The prepared statements of Mr. Tobias, Mr. O'Rourke, and Ms. Oakey-Hemphill appear in the Appendix on pages 59-74 respectively. --------------------------------------------------------------------------- We invite you, Mr. Flynn and Mr. Mehle, to proceed with any comments or summary description of your views on this issue, as you like. Mr. Flynn, we will begin with you. STATEMENT OF WILLIAM E. FLYNN,\2\ ASSOCIATE DIRECTOR FOR RETIREMENT AND INSURANCE, U.S. OFFICE OF PERSONNEL MANAGEMENT Mr. Flynn. Thank you, Mr. Chairman. We appreciate very much the opportunity to be here today. --------------------------------------------------------------------------- \2\ The prepared statement of Mr. Flynn appears in the Appendix on page 75. --------------------------------------------------------------------------- You provided, I think, a very good summary of the proposal that is before the Subcommittee, so I might shorten my introductory remarks even further and just talk about a couple of very brief issues regarding it. I think the first thing that I would like to say, Mr. Chairman, is that in dealing with this issue of the incorrect retirement coverage, we worked closely with the Federal Retirement Thrift Investment Board, the Social Security Administration and the Treasury Department. We also sought, Mr. Chairman, the views of other major employing agencies where these errors have occurred around government. What we tried to do was put together, in consultation with all those parties, a proposal that represents a consensus position on resolution of what are, quite honestly, very intricate and intertwined issues dealing with being in the correct or incorrect retirement system. In putting forth the proposal, we tried to satisfy four primary objectives. First, we thought it absolutely essential that this remedy should demonstrate that the government cares about Federal employees who have been disadvantaged by an error in their retirement coverage, and that the government is committed to an equitable solution not only for them, but for their families as well. Second, we wanted to make sure that employees had a choice between corrected coverage--i.e., in most cases, being in the Federal Employees Retirement System--or a benefit the employee expected to receive, without disturbing Social Security coverage laws, as you've mentioned. Third, we wanted to make sure that these options would be easy to understand for affected employees. And finally, we wanted to minimize the administrative complexity that can be associated with situations like this in order to keep the solutions simple and timely as we move forward. We believe the proposal that is before the Subcommittee meets these objectives. During our study of this matter we also considered the option of placing individuals in the Federal Employees Retirement System and making a compensatory payment to the Thrift Savings Plan to make up for the period of time of their erroneous classification. In very short order, Mr. Chairman, we realized that there were intractable basic problems that limit the feasibility of going down that road. More importantly, we concluded that the approach of offering CSRS-Offset coverage provides a make-whole solution to affected individuals. Under this approach, as you have pointed out, no one would get less than they believed they were going to receive prior to the discovery of the error. Your bill, Mr. Chairman, is largely based on the administration's proposal. Most importantly, both proposals would provide a solution for all affected groups, as you've mentioned. Many people have worked hard to develop a solution to this problem; however, none of us can move forward until legislation is enacted, and our hope is that we can move forward quickly in order to begin the work of actually delivering relief to people who have been adversely affected. Thank you, Mr. Chairman. I would be happy to answer any questions you might have. Senator Cochran. Thank you, Mr. Flynn. Mr. Mehle. STATEMENT OF HON. ROGER W. MEHLE,\1\ EXECUTIVE DIRECTOR, FEDERAL RETIREMENT THRIFT INVESTMENT BOARD Mr. Mehle. Yes, Mr. Chairman, thank you. As you noted, my name is Roger Mehle, and I am the Executive Director of the Federal Retirement Thrift Investment Board. --------------------------------------------------------------------------- \1\ The prepared statement of Mr. Mehle appears in the Appendix on page 84. --------------------------------------------------------------------------- I have been invited to present the Board's views on S. 1710, the Retirement Coverage Error Correction Act of 1998. The proposed legislation addresses the longstanding problem of retirement system coverage errors of what the Board understands may be thousands of Federal employees. Unfortunately, upon discovery of these coverage errors, the only legal avenue for agencies at present is to reclassify the affected individuals into the correct retirement system, often entailing serious financial consequences and special problems for those about to separate from Federal service. The most common error, apparently, was misclassification of newly-hired employees into the Civil Service Retirement System when those employees should have been placed into the Federal Employees Retirement System. In that regard, Mr. Chairman, S. 1710 and H.R. 3249, comparable legislation pending in the House, wisely provide complete relief for such errors by allowing the affected employees to elect coverage under a retirement system virtually equivalent to CSRS--that is, CSRS- Offset. Since all such employees had much earlier, by law, already been offered and had rejected FERS coverage, absent any newly- legislated inducements to do otherwise, practically all such employees should opt for the retirement coverage which they already thought they had. It is difficult to conceive a more equitable and principled result, both for the employee and for the government. Both proposals, S. 1710 and H.R. 3249, however, also permit employees misclassified as CSRS to select FERS coverage, thereby triggering makeup contributions and lost earnings procedures. To implement this choice, S. 1710 adopts the well- understood makeup processes now used when TSP contributions are missed, either as a result of employing agency error or hiatus from civilian employment to perform military service. In contrast, H.R. 3249 would create special, new error correction procedures requiring complex new Board regulations and provisions to implement. In permitting employees misclassified as CSRS to select FERS coverage and to make up missed contributions, S. 1710 retains the same lost earnings calculations currently embedded in TSP mainframe computer programs, thus error correction under S. 1710 could be accomplished immediately. S. 1710 does authorize agency-paid lost earnings on makeup employee contributions, a benefit not in current law. However, lost earnings on employee contributions are now paid by agencies if, having withheld these contributions, they failed to forward them timely for investment. The computer programs that calculate such lost earnings can easily be applied to makeup contributions by misclassified employees who select FERS coverage. In contrast, H.R. 3249 would mandate an option radically different from existing law. Most notably, misclassified employees would no longer make up their own missed contributions. Instead, agencies would be required to pay an amount equal to a kind of ``proxy'' for missed employee contributions, as well as missed agency contributions, together with much differently-calculated lost earnings on the whole. There are practical limitations on the Board's ability to implement the error correction procedures of H.R. 3249, both in the manner and within the time it contemplates. First, the Board is currently halfway through a complete redesign of its entire computer software system. The existing system is to be replaced by a state-of-the-art design to permit daily valuation of participant accounts, investment in two additional funds, and greatly improved service to participants. The resources of the Board and its recordkeeper, the National Finance Center of the Department of Agriculture, not devoted to new system design and current system maintenance are committed to the exigency of making the current system Year 2000 compliant. The Board, therefore, would not be able to program or run the calculation of lost earnings called for by the House proposal which, as I said, is completely different from the calculations that would be used under S. 1710 or current law, on the mainframe computers at the National Finance Center. To do so would jeopardize both our current system integrity and our timetable for Year 2000 compliance and new system implementation. The Board, moreover, is not in a position, as contemplated by the House bill, to perform the new lost earnings calculations in some other way, nor is its recordkeeper. The potentially thousands of payroll and personnel records needed to do so, to say nothing of the myriad individual circumstances of misclassified employees, dictate that the calculations of H.R. 3249 be accomplished by employing agencies with personal computer software and guidance furnished by the Board. This accords with current agency statutory responsibility for the calculation and correctness of TSP contributions submitted by the agencies for their employees. Finally, one full year would be required to develop the new approach contemplated in the House bill, rather than the 6 months that it would allow. Chairman Mica of the House Civil Service Subcommittee invited the Board to submit legislative language that would resolve these concerns. We did so, but unfortunately the changes were not incorporated into H.R. 3249, and thus the Board continues strongly to oppose the House bill. The legislation considered by this Subcommittee creates no administrative problems for the Board nor, for that matter, should it do so for agencies as they correct retirement misclassification errors under it. Thus we would be able to implement the TSP provisions of S. 1710 soon after its enactment. We have appreciated the opportunity to work with your staff on this legislation, and we look forward to working with the staff and Members of the Subcommittee in the future. Thank you, Mr. Chairman. Senator Cochran. Thank you very much, Mr. Mehle. Let me ask Mr. Flynn some questions. One, for background, how have you gone about identifying erroneously-placed Federal workers in these programs, and how will you identify them in the future? Mr. Flynn. Mr. Chairman, as you pointed out in your opening statement, the problem of misclassification actually began in the transition to the Federal Employees Retirement System in the late 1980's. We believe, quite honestly, that virtually all of the misclassification problems that occurred, occurred during that time period. Virtually all new Federal employees hired today are automatically placed in the Federal Employees Retirement System. So you have two groups of people, the majority of whom were misclassified during this transition period. We believe that about half of them have been identified and have had, under current law, their situations corrected. We believe that there is another group, about half again, who have not yet been discovered who will need to be identified. But the provisions of this legislation would enable relief to be given to an individual at the point in time that an error is discovered, even if it is yet, prospectively, 5, 10, or 15 years from now. We hope that would not occur. Nonetheless, when these errors first began to be identified in the late 1980's and early 1990's, we worked very hard with departments and agencies across government, providing them guidance and information so as to work through their employment rolls to identify people who were in the wrong retirement system and effect these corrections. Many of the people who have not yet been discovered have been missed in that process. Some people have separated from Federal service, and so their records aren't currently subject to review, but they might come back to Federal service. Some people, quite honestly, have retired, and that error hasn't been discovered and I suspect it probably never will at this point. But what this legislation would allow is for those residual problems that are yet to be discovered to be corrected as they are found, although I do think, in terms of an ongoing basis as new appointments are made today, very, very few errors, if any, are occurring today. Senator Cochran. I know that everybody would like to be able to figure out a way to make up for any losses that anybody incurred so that no one would have been harmed by being misclassified. Is that possible? And if that is not possible, why not? Mr. Flynn. Mr. Chairman, we believe that in crafting the administration's proposal and in the elements of S. 1710 there is a make-whole provision, and that make-whole provision consists of two components: one, a component which provides any affected employee, whether they were corrected in the past or whether they are yet to be discovered and offered this opportunity, a choice. And the choice is between a retirement system that, up to that point, they thought they were in, and they've been doing their career planning, their life planning, their savings for retirement and things like that, on the basis of that understanding. So one aspect of the choice is to enable that individual to stay with that retirement system with a known, defined benefit that they have used as a basis for their planning up to that point. On the other hand, the second component of the choice involves understanding, particularly for people whose error has been discovered in the past and who have now been in the Federal Employees Retirement System--perhaps unwillingly at first, but employees pretty much figured that was the situation that they had to deal with--may have aggressively done makeup contributions, may have aggressively invested prospectively, so as to make for themselves the best of what started out as a bad situation, but which may now, after 5, 6 or 7 years, be preferable. But in providing that choice, to enable the choice to be made under existing provisions of law--not disturbing Social Security coverage, not disturbing the tax code, and things of that nature--so that employees could see clearly how they could make themselves whole, one, by providing a known, defined benefit that was what they thought they had; two, if they believe it preferable, to remain where they are and continue to invest toward their retirement that way. We think that's an appropriate way to move forward. Senator Cochran. You described in your statement how the 1990 FERS Technical Correction Act and the Thrift Board rules provide for limited lost earnings protection to misclassified employees. Why does the government require employees to make up their contributions to trigger these provisions? Mr. Flynn. That particular provision of the 1990 law was given careful consideration by both the Congress and the administration as it was approved. The fundamental rationale behind that was that this represented, for all practical purposes, money that individuals had already earned, and in order for an individual to receive the benefit of a matching contribution and lost earnings on that matching contribution by the government, it was appropriate for the individual employee, from their own resources, to make up what they otherwise would have contributed during the period of time that the erroneous coverage was there. To do otherwise, Mr. Chairman, would essentially provide dual compensation to the individuals because they have already had use of that money during the period, and any other way would not really recognize that. Senator Cochran. Can you explain how and why erroneous misclassifications affect those who have been misclassified for long periods of time and are nearing retirement? Mr. Flynn. We'll try to do that very simply. I was thinking the other day--I heard someone say that someone had asked Albert Einstein what was the greatest invention of mankind, and he said, ``Compound interest.'' And I think that goes to the heart of answering your question. In order for savings to accumulate in ways over a lifetime that provide--or provide a portion of--one's retirement income security in their nonworking years, contributions have to be made regularly over a long period of time. Earnings on those contributions have to be given time to accumulate and to compound. And over time, the magic of compound interest produces a substantial benefit. If one is nearing retirement or separates from the service, or has a very long period during which an individual, through no fault of their own, didn't believe they needed to make those contributions or were prevented from making those contributions, then the ability of that investment to grow in size and value is essentially truncated. Makeup contributions can only be made prospectively, and if you only have 6 months to go until you retire, or you are caught in a situation where you don't have a government job, you essentially have no opportunity over a long period of time to get yourself back to where you otherwise should have been. Senator Cochran. Does OPM believe that there is any justification for the government to help employees make up their own missed contributions? One argument, for example, is that although an employee received compensation that was not deferred, they may have spent it under the false assumption that their pension benefit alone would be sufficient to assure an adequate retirement. Do you agree with that? Mr. Flynn. Well, I think there is no question but that through an inadvertent error on the part of government, as employer, employees' expectations about their need to save for their retirement weren't what they should have been. By the same token, by providing an opportunity for an individual to choose to be in the retirement system that he or she thought up to that point they were in, you preclude the requirement of making a compensatory payment to the individual because you are able to guarantee them a benefit that they reasonably expected. Senator Cochran. The FERS Act gave all CSRS and CSRS-Offset employees an opportunity to transfer to FERS during an open season between July 1 through December 31, 1987. To what extent does the government have an obligation to provide a FERS option to those employees who had an opportunity to transfer and chose not to do so? Mr. Flynn. Well, I think one could argue, Mr. Chairman, that there is not an obligation per se, but I would mention two points in response to that question. First, as we know, when the Federal Employees Retirement System was introduced, we can look back in hindsight and see that actually very few employees chose it, when in fact rational economic financial analysis would suggest that a larger number of people should have chosen it than did. I think the reason many people did not at the time was because there was great uncertainty about the program. It was new. There was a great deal of certainty about the old program, and it was well known. Second, because the government has erred here, it seems that in the process of constructing a make-whole remedy, providing people with a choice--again, that gives them the benefit they thought they were going to have, but also particularly for people whose error has been corrected and where they've got some investment experience, where they may feel it preferable to stay in FERS--it just seems that in recognition of an error committed by the government, it seems appropriate to give people a second choice this time around as we move forward in correcting this issue. Senator Cochran. One approach to the erroneous enrollment problem, it has been suggested, may be to simply allow the misclassified employees to remain in CSRS and amend the Social Security laws as necessary to accomplish this. Why was this ap- proach not taken? And do you think it would be a better solution than either of the alternatives currently being considered? Mr. Flynn. Well, Mr. Chairman, during the period of time when the Federal Employees Retirement System was created, one very important part of that debate was the application of universal Social Security coverage to Federal employees. Even though the numbers here are small in proportion to the total number of people involved, I don't believe that creating a little carve-out to Social Security coverage would be appropriate, particularly given the fact that we have this hybrid system, this CSRS-Offset system, that replicates the benefits of the Civil Service Retirement System without requiring an amendment to Social Security coverage law. Senator Cochran. Now, do you think, given the fact that there are less than 20,000 individuals involved, this would affect the principle of universal coverage under Social Security? Mr. Flynn. Well, I think it does affect the principle. As I said, it's not a large number of people, but I also believe it would create a situation where unknown situations that might occur in the future with other groups of employees--perhaps not even public employees--would look to this as a precedent and would look to, perhaps, find a way to skirt around or come out from under coverage of Social Security law. Even though the numbers are small, I think the policy issue is a large one, Mr. Chairman. Senator Cochran. The bill that we've introduced at the administration's request suggests the requirement that an error must have existed for at least 3 years at any time after January 1, 1987. Why did OPM recommend that? And what might be the effect of lowering the length of time from 3 years to 1 year? Mr. Flynn. We chose the 3 years as of 1987 for two primary reasons, Mr. Chairman. First, you had to pick some point in time. Errors that last for a very brief period of time, generally speaking in the context of a long career, are not going to be very consequential. So in choosing a point, we chose the 3-year point because that's the point at which the Thrift Savings Program's vesting provisions go into effect, and it seemed appropriate to parallel that. We chose 1987 because that was the start date for the beginning of the Thrift Savings Program. Senator Cochran. I have some other questions, but I am prepared to yield to my friend whenever he would like to ask some questions. We have been joined by the distinguished Senator from Michigan, as you can see; Senator Levin is the Ranking Minority Member of this Subcommittee. Are you prepared to ask some questions now? I'd be glad to yield to you. Senator Levin. I only have a few questions, but I'm happy to listen to yours. You're asking the right questions, as always. [Laughter.] So let me follow your line of questions. Senator Cochran. Okay. Well, let me ask one or two more, then. Some experts say that the Thrift Savings Plan, TSP, could account for as much as 50 percent of the retirement benefits for FERS employees. Do you agree with this? And how does this share of FERS retirees' total retirement benefits--how is this accounted for, or compared to the share expected at the time of FERS enactment? Mr. Flynn. I will try to do that in a couple of ways, Mr. Chairman. First, I think it is important to sort of point out at the outset that the Federal Employees Retirement System does consist of three primary components. It has a Social Security base; it has a FERS defined benefit component that sits on top of that; and then the Thrift Savings Program, which is a defined contribution savings vehicle, sits on top of that. The three together, at the point in time that the system was enacted in 1987, were in fact designed to more or less approximate the benefit that the older Civil Service Retirement System--a single, defined-benefit program--provided. And the TSP component, if I have it correctly, was considered, given rates at which employees save and rates of return of the fund, to account for approximately 20 percent of that replacement benefit. Now, if you look at the record of the Thrift Savings Program over the past 10 or 11 years, particularly the record of the Stock Fund, clearly the rate of return is beyond those predictions at that point. And so the benefit that might be payable out of the TSP in retirement could be larger, could be potentially as large as some commentators have suggested, but I want to emphasize that it is additive to the Social Security benefit and the FERS basic benefit that are the first two components of the system. So in effect, it is gravy on top more than it is a replacement for the first two components of that FERS benefit. Senator Cochran. Given the fact that that is a large difference, is it fair to employees without contribution histories to use G Fund rates of return in calculating agency contributions for lost earnings, as would be done under S. 1710 and is now done under current law? Mr. Flynn. Well, I would make one comment, and then perhaps defer to Mr. Mehle also on that one. I think the thing that I would say there, Mr. Chairman, is that the G Fund, which of course is invested in Treasury securities, will always have a positive rate of return. That's not guaranteed with either the C Fund, which is the stock index fund, or the F Fund, which is the bond fund. And while we have seen reasonably good rates of return over the past 11 years on average, there have been some years in the Stock Fund, for example, where there has been at least a negative return, and then at least 1 or 2 years of relatively poor returns vis-a-vis the rest. So there is risk. And just as we can look back on 10 years and see good performance, one could also look back, perhaps in another 10 years, and see poor performance. And so because of the risk associated with that, using the G Fund, which always guarantees a positive rate of return, seems appropriate. Senator Cochran. Mr. Mehle, what is your reaction to that question? Mr. Mehle. I couldn't have said it better. [Laughter.] Senator Cochran. Okay. We hadn't forgotten you; we know you're there, and I've got some questions specifically for you, as a matter of fact. Mr. Mehle. I'm ready. Senator Cochran. Let me ask you this. There is a House bill, and you referred to it, Mr. Flynn--or Mr. Mehle did-- would it be more advantageous to the misclassified employees to use the aggregate investment experience of FERS participants as contemplated in the House bill? Have any cost estimates been prepared on that bill, to your knowledge? Mr. Flynn. Looking at H.R. 3249, clearly, if one is using as a basis of comparison the G Fund rate of return versus the composite rate of return, it is more advantageous to look at the composite rate of return. However, that's true in the aggregate. For some employees, perhaps, who have invested aggressively, even the composite rate of return is a smaller return than their actual rate of return. By the same token, you could have some employees who have invested very conservatively for whom the composite rate of return would be advantageous. That's one of the difficulties of trying to figure out averages and then apply them to everyone. It clearly creates winners and losers, and that's one of the difficulties, I think, with that particular bill. Senator Cochran. It has been suggested that litigation be used in determining a proper remedy for employees who have been misclassified. Is that justified in the legislative history, to your knowledge? What's been the experience of the litigation avenue? Mr. Flynn. First of all, Mr. Chairman, there is no central repository of information on litigation. I do think, though, from what we have seen anecdotally in our discussions with agencies, the occasions of litigation are really quite minimal. I guess the point that I would like to make, and perhaps emphasize, is that we are here representing government as employer. I think the last thing that we want government employees and government retirees to do is to come in, sue their employer for an error that their employer inadvertently made; or, if that is to be the case, that we minimize as much as we possibly can through responsible, caring actions on our part, the grounds for future litigation. I think that the 1990 amendments were a positive step in the right direction. I think we have seen that while we have covered a lot of cases, there are some particularly sympathetic cases that still need to be dealt with, and it just strikes me that asking employees to sue their employer to get something that they really are entitled to is something that we ought to avoid as much as possible. Senator Cochran. Senator Levin. Senator Levin. Thank you, Mr. Chairman. This is kind of a complicated issue and I'm trying to get my arms around it as best I can without squeezing it to death. [Laughter.] The estimate is that about 20,000 people, as I understand it, were by mistake put into--new employees, is that correct, almost exclusively new employees? Mr. Flynn. Well, these, Senator Levin, were primarily employees who had prior Federal service. Most new employees hired since 1984 are automatically covered under the Federal Employees Retirement System. Senator Levin. Weren't the 20,000 people put into CSRS by mistake? Mr. Flynn. By mistake, that's correct, sir. Senator Levin. New employees? Mr. Flynn. Usually upon reappointment, as opposed to being a new employee. Senator Levin. All right. Well, I wasn't using the word technically. They were newly hired? Mr. Flynn. That's correct. Senator Levin. Now, after they were newly hired and put in CSRS by mistake, at some point--1 year or 2 or 3 years afterward--all CSRS people were given an opportunity, were they not, to switch to FERS? Mr. Flynn. That's correct, the original Federal Employees Retirement System open season in 1987. Senator Levin. How many of these 20,000 people would have been given that opportunity? Mr. Flynn. The easiest way to say this is that all employees who are currently in CSRS or CSRS-Offset have been given the opportunity at least once to switch, some during the open enrollment period that occurred in 1987, others upon reappointment because they have that election opportunity at any point if they meet certain conditions. But most of them are 1987---- Senator Levin. Let's assume there are 20,000 people out there who were put into a category by mistake. How many of them would have been given an opportunity at least some point after that mistake was made of putting them in the wrong category, would have been notified that they were in CSRS and they could switch to FERS? Mr. Flynn. All of them have had that opportunity at least once. Senator Levin. They weren't told that they were put in CSRS by mistake, they said, ``You are in CSRS''---- Mr. Flynn. That's correct. Senator Levin [continuing]. ``You can switch to FERS should you choose to do so''? Mr. Flynn. That is correct. Senator Levin. And the people we're talking about are exclusively those who did not use that opportunity, is that correct? Or would this legislation also in some way make up some funds or benefits to people who did use that opportunity and switch to FERS? Mr. Flynn. You are correct, Senator Levin, in that all of these people believed they were in CSRS or Offset, and had the opportunity to switch to FERS with full knowledge of the provisions of that system. Senator Levin. But that's not quite my question. Mr. Flynn. Sorry. Senator Levin. My question is, does this bill provide a correction only for people who did not switch from CSRS to FERS when they had that opportunity? Mr. Flynn. Only those who did not switch? Yes. Anybody who switched to FERS is now in FERS, and so would not be benefitted by this. Senator Levin. Even though they may have switched a number of years after they came in? Mr. Flynn. That's correct. Senator Levin. And even though the mistake would have perhaps cost them for that period of time that they were erroneously in the CSRS system? Mr. Flynn. With the exception, Senator Levin, of anybody who, for whatever reason, was in the wrong system erroneously for a period of 3 or more years after January 1, 1987. So it is conceivable that you could have employees who were in the wrong system for 3 years who at some point later were given the opportunity to voluntarily switch to FERS--in other words, they didn't know there was an error--who did, and who are now there of their own volition. If that prior error is discovered and it meets those two conditions, then they would also have an opportunity to make an election under this proposal, that's right. Senator Levin. And about how many of the 20,000 would fall into that category? Could it be as much as 10 or 20 percent of the 20,000? Mr. Flynn. Well, let me try to comment on the 20,000 just for a second. The numbers have grown over the course of the past year from an estimate that I provided to the Civil Service Subcommittee a year or so ago, of about 10,000, to about 20,000 now. I think the important point to make here is that no one really knows how many people have had themselves placed in the wrong retirement system. Senator Levin. Have had themselves placed in it? Were placed in it. Mr. Flynn. Well, were placed in the wrong system, you are correct. We know that based on the activities that agencies have engaged in to identify those that they could identify, that several thousand people have been identified and corrected. In order to provide some rough order of magnitude, we figured there might be as many as twice that number who were put in the wrong system, because there are obviously, then, some people that you don't know about, plus we have individuals who have come into government service and who have since separated. So that will affect the number, and that got us to about 10,000. Then, because the House bill has differing standards for eligibility for its provisions, the number--for example, the period of error in the House bill is 1 year, and in this bill it is 3 years. If it is 1 year, you have a larger number of people who might be affected by the bill's provisions, and so the number grew from there. But whether it's 20,000 or 10,000, the provisions of the bill would apply if anybody was ever erroneously covered during the period of time defined by the bill. Senator Levin. My question, though, is whether you can give us an estimate of the percentage, roughly, of people who switched from CSRS to FERS on their own? Mr. Flynn. There is no way that I would know an internal number to that, Senator Levin. But I will say that this bill will cover them if they have the error---- Senator Levin. I understand that. You don't know whether it's a small minority or a majority or what? Mr. Flynn. Off the top of my head, I would suspect that that's a relatively small number. The reason for that is because as we have seen, most people--except those who have aggressively invested in the Thrift Savings Program--are going to believe that the Civil Service Retirement System, or its hybrid, the Offset, is going to provide them with a well-known, defined, reasonable benefit. So I would suspect that very few people would have switched to FERS because of that. Senator Levin. The next question is this. What percentage of Federal employees who were given the option to switch from CSRS to FERS exercised that option? Mr. Flynn. I believe the correct number in 1987 is about 4 percent during that open enrollment period. Senator Levin. That was in 1987? Mr. Flynn. That was in 1987, yes. Senator Levin. And then, say, in the next 5 years, how many would have switched? Mr. Flynn. I really can't answer that. We may be able to get at that by looking at some Central Personnel Data File numbers, and I will try and go back and see if we can get to that. Information for the Record Workforce Information has advised us that there were 12,208 individuals employed during the 5-year period following the 1987 FERS Open Season who would have had an opportunity to elect to switch to FERS. Of these 12,208 total employees, 893 (or 7.3 percent) actually did switch to FERS. (Source: Central Personnel Data File.) Senator Levin. Would it be a majority? Someone is shaking their head ``no'' behind you, I want you to know--I think she's shaking her head ``no,'' or maybe it's that she doesn't know. I'm not sure. No way of knowing? All right. Anyway, she's shaking her head; I want to put you on judicial notice here that somebody is shaking their head behind you. [Laughter.] Mr. Flynn. The only thing that I would say is that if someone had gained title, if you will, to a Civil Service Retirement System benefit, they would have to be looking at a pretty substantial career ahead of them under FERS in order for them to select FERS and to have that selection be advantageous to them. Senator Levin. Okay, if you could get us a figure for how many made the original switch and how many, say, 5 years after, made that switch, that might be helpful to us, too. Finally, could you give us a couple examples of what the difference in benefit this bill would make to an average employee? How much of a benefit would they get without this change? Or if it were not made retroactively, how much they would get if they were placed in FERS retroactively now? Could you somehow or other give us a feel? The CBO estimate apparently is that this bill will cost--the House bill, excuse me--would cost around $240 million. We don't know what the cost of the Senate bill, if any, would be; apparently we are still waiting for the CBO estimate. Is that correct? Mr. Flynn. I have not seen a CBO estimate. I know that our own internal estimates would be that both this bill and the administration's bill, for all practical purposes, are essentially budget-neutral, particularly in comparison to the $200-million-some. Senator Levin. This bill and the administration's bill? What bill? The bill that we're having the hearing on? Mr. Flynn. There's a very slight difference between---- Senator Levin. I thought this was the administration's bill, the one that we're having the hearing on. Mr. Flynn. This has a provision for payment of lost earnings on employee contributions that was not part of the administration's original bill. But other than that, that's the only difference. Senator Levin. All right. In any event, could you put this in kind of ``layman's terms'' for me? What would a typical Federal employee--under the House bill, what difference would it make? Under the Senate bill, what would that benefit be? Could you give us an estimate? Mr. Flynn. I will try to do this as quickly as I can. Senator Levin. Just dollar figures, that's all I want. [Laughter.] Take all the time you want, but at the end of it, it will be $300 a month this way, and $250 this way. Mr. Flynn. Okay. Senator Levin. So we'll wait until you get to that, if you get to that. Mr. Flynn. Okay. Well, I'll do the best I can. Senator Levin. Well, you may not be able to do it. You can do it for the record. Mr. Flynn. I am going to try and give a sense of this, and then maybe I'll want to amplify it for the record. Both bills offer employees choices---- Senator Levin. Both bills? Mr. Flynn. Both the House bill and S. 1710 offer employees choices. If the employees choose to remain in Civil Service Retirement System-Offset and get the benefit they always expected to receive, there are no differences between the two bills in that regard. Where the difference comes in is if an employee under S. 1710 chooses to be in FERS, the Federal Employees Retirement System, and makes that same choice under the House bill. Under S. 1710, the individual employee would then be placed in the Federal Employees Retirement System, would be given an opportunity to do makeup contributions on the basis of current law, and on the basis of their choice for makeup contributions under S. 1710, would have deposited to their account the 1 percent automatic agency contribution, any matching contributions authorized given the employee's makeup contribution, lost earnings on the government contribution, and lost earnings on the employee's contribution. Under the House bill, in lieu of that, a payment would be made to the individual's Thrift Savings Program that attempts to replicate, in a composite way, what the employee would have contributed had he or she been in the FERS all along; the lost earnings on those contributions; all of the government matching contributions; and the lost earnings on that. So over time, the benefits produced by either of those choices would more or less approximate one another, although it is also true that depending upon the investment performance, the net retirement result could be higher in the long run.\1\ --------------------------------------------------------------------------- \1\ The charts containing examples 1 to 4 appear in the Appendix on pages 55-58. --------------------------------------------------------------------------- That's the best I can do right now. I don't know that I can say that it works out to $200 per month per individual because so much of that is a function of what is deposited on the individual's behalf for retroactive contributions, and the choice that an individual makes then in terms of prospective contributions to the Thrift Savings Program--which, I might add, probably need to be somewhere in the 5 to 10 percent range going forward, and if they're not doing that now, that could be a difficult issue for them. Senator Levin. Well, I won't ask you about a prediction of the future. It is difficult enough to figure out, looking backward, what difference this would make. So for the record, if you would, tell me this. A person who is retiring tomorrow, if this bill passed--retiring tomorrow, was rehired in 1987 or 1983 or whatever that year was, if that person stayed in the CSRS, give me a typical person--take an average length of time that they previously were on the payroll, however you want to do it in a way that you think is fairly illustrative. How much would that person get if they stayed in the CSRS system, how much would they get under the Senate bill, how much would they get under the House bill? Just that one person. And then one other thing I would like you to tell me for the record is this. The Senate bill uses the G Fund, is that correct? It assumes that the person who is going back into FERS was a G Fund person, 100 percent? Mr. Flynn. Unless that person has a contribution history, in which case the contribution history of that person would be used. The G Fund is the default---- Senator Levin. Excuse me. How long does the contribution history have to be? Mr. Flynn. I'd defer to Mr. Mehle on that. I think it's any contribution. Mr. Mehle. Any history. Mr. Flynn. Right. Senator Levin. Well, so if somebody has a contribution history of 1 month, they were smart enough to go into the Stock Fund--or presient enough, whatever that word is, to go into the Stock Fund--and it had a 25 percent annual jump during that month or whatever it is, that's a contribution history, and then that would mean they would be in the Stock Fund all the way back to 1983 or 1987? Mr. Flynn. No. It's the actual history. In other words, if an employee who was CSRS--mistakenly, CSRS--nevertheless chose to contribute to the Thrift Savings Plan, as CSRS employees can do---- Senator Levin. I see. But for how long would that history be, then? Mr. Flynn. His employment period. Senator Levin. Okay. Well, I may be a little bit confused-- -- Mr. Flynn. I might be able to shed some light on that. There are actually two issues. One is the allocation itself; the other is the investment performance. Senator Levin. Okay. Well, I think I probably missed something here in terms of my understanding, but let me not take up the Subcommittee's time with that. We are using a G Fund unless there's a different history-- -- Mr. Flynn. Right. Senator Levin [continuing]. And then we're assuming that if there is no such history, that that is what the typical person would have used? Why G Fund? Mr. Flynn. The G Fund default is a provision of current law, and it is there because it is the only fund that guarantees a positive rate of return. The Bond Fund and the Stock Fund don't provide such guarantees, and it is at least arguably just as likely that there could be a negative rate of return. So use of the G Fund as a default was guaranteed always to provide a positive rate of return. Senator Levin. So that's not a new provision of this bill, that we use the G Fund? Mr. Flynn. No. That's correct. Senator Levin. This bill doesn't make that choice? It builds on existing law? Mr. Flynn. It builds on existing law, that's correct, Senator. Senator Levin. Okay. Thanks so much. Senator Cochran. Let me ask you to assume that Congress surprises everybody and passes this bill. What difficulties, if any, do you foresee in implementing it? Mr. Flynn. If this bill were to be implemented, clearly, we would have some work ahead of us in terms of correcting and giving election opportunities to people who have already been corrected, and then in terms of those that are discovered prospectively. I do think, however, that this bill meets those objectives that I talked about earlier in terms of simplicity of understanding and simplicity of administration. So I would not foresee any problem in terms of moving forward, providing people with the information they need to make an informed election, processing those elections, and then letting those individuals sort of get on with their lives and their retirement planning on the basis of knowns rather than unknowns. Senator Cochran. Mr. Mehle, what is the logic for and the evolution, if you can tell us, of the Thrift Board's rules to provide for correction of misclassification errors by agencies? Mr. Mehle. Well, Senator, when the Thrift Savings Plan was created, effectively in 1987, we recognized that there were going to be mistakes made as to employees' contributions by their employing agencies, and these mistakes would be discovered subsequently, and there had to be some mechanism whereby the missed contributions that the employee did not get to make would be made up. So we adopted a regulation in 1987 that called for employing agencies to give their employees an opportunity to make up their missed contributions; and, in connection with the employees making up their missed contributions, for the agencies to contribute the appropriate matching contributions that would have gone with those if the employee had been able to make them; as well as, in the instances that the employee was not even recognized as being a FERS participant, the 1 percent automatic contribution that every FERS employee is entitled to receive, regardless of whether he or she contributes any money voluntarily. At that time, we also recognized that there was the issue of earnings on those contributions that had been foregone. Because the monies had not been put on account when they should have been, they did not earn anything. So at the time the error was to be corrected, there should be also a payment made by the agency, equitably, to make up for the lost earnings on the contributions. However, the General Accounting Office in 1989 issued an opinion of the Comptroller General that there was no authority in existing law for Federal agencies to make up earnings on missed contributions, whether they be earnings on the 1 percent automatic amount, whether they be earnings on the matching contributions that were not made, or indeed--but it's sort of a different fundamental proposition--on the employee amounts. We noted that problem, and we at the Thrift Investment Board forwarded draft legislation to Congress, asking Congress to pass a law that would permit agencies to make up the lost earnings on the 1 percent amount and on the matching contributions. Congress passed this law, and agencies thereby were permitted at the time that they make up the matching contributions and the 1 percent contributions, to make up the earnings attributable to those amounts. The law that was passed by Congress, however, did not call for agencies to make payments in respect of earnings on foregone or missed employee contributions. The rationale for that was that the employee, however unfortunately not having had the contributions taken from his paycheck and deposited into the Thrift Savings Plan, nevertheless got the money; it was in his or her paycheck, and the employee did something with it, spent it or saved it. Therefore it was thought that equitably it would not be appropriate for the government to pay any lost opportunity costs on these monies as it would be, conversely, on the 1 percent and on the matching contributions, because the employee actually had the money to spend or to save, as the case may be. That rationale is invested, imbedded, in our current regulations, which reflect that Congressional decision in 1990 when the legislation was passed, authorizing agencies to make up lost earnings. Senator Cochran. You mentioned in your statement the different approaches in these bills, S. 1710 as compared with the House bill. Would you say that the largest difference or the most significant difference between the two bills is found in the triggers for makeup contributions and lost earning procedures? And if that's right, does the Thrift Board have a preference for either approach? Mr. Mehle. Clearly the most significant difference between the House bill and S. 1710 is the requirement under the House bill that the agencies--the Federal Government itself--make a payment that is a kind of a proxy for the contributions that the employee himself would have made, but did not. That is, I think, the heart of the difference between the two bills. In the one case, S. 1710 calls for employees to choose--if they like, CSRS, which is what they thought they had and which, as I noted in my prepared testimony, seems like perfect equity, certainly for those whose errors have not yet been discovered, but they do have a choice. They are given the choice to take CSRS or to stay with--or to go with--FERS. If they go with FERS, rather than going with CSRS--the system you would intuitively think they would go with because that's the one they thought they had, and that's the one that denial of membership in is promoting all of the hardship for-- you would think that unless they were biased some way, induced in some way, perhaps financially, to go into FERS, they wouldn't. But if you look at S. 1710, you can see that, with the single exception of the notion of the agency paying lost earnings on employee contributions--lost earnings, not the contributions themselves, but earnings on the contributions--it is neutral. S. 1710 is neutral. It won't bias an employee to game between two retirement systems by saying, ``Maybe there's something that I can exploit in making my choice.'' If one chooses to be in FERS, under H.R. 3249, as I have observed in my testimony in the House and a bit here, there is an enormous amount of money potentially that the employee may get in making that choice. It is the debated double payment that we're talking about. I do have some examples of that. We have furnished these examples in the past, as requested, and I can give you some figures that would indicate why an employee might be biased, if you like. But I think at the heart of the two is the notion that under H.R. 3249, payments will be made by the agency that otherwise, under current law and S. 1710, are called for to be made by the employee. And then, of course, there are the very significant administrative provisions with which we are quite vitally concerned that I outlined in my prepared remarks. Senator Cochran. There's one aspect of the House bill that is unclear to me. It involves the situation of the misplaced employee who elects the FERS option and has a history of participating in TSP, the Thrift Savings Plan. As we understand the proposal, in the case that the employee has an investment history, that history is to be used in determining the rate of return or makeup contribution. If there is no participation history, a proxy is to be used that reflects the aggregate investment history of all participants. Is that correct? Mr. Mehle. Yes. Senator Cochran. What happens to an employee, then, who has made poor investment decisions resulting in a lower rate of return than an average investor? Will any difference be made up? And if so, by whom? Mr. Mehle. This may be reaching the question that Senator Levin asked. If an employee who thought he was in CSRS ignored the Thrift Savings Plan, even though he has an opportunity to invest in it up to 5 percent--if he ignored it because he was comfortable with the prospect of the ample defined benefit, he would have no investment history in the Thrift Savings Plan. H.R. 3249 gives to such an individual an amount of money that is calculated upon the investment behavior--that is to say, the deferral rate, the amount of savings from one's paycheck--that the broad FERS and CSRS Federal employee group historically had, together with the historic rates of return associated with that investment history of all CSRS and FERS employees. As to the individual himself, I can't perceive any relationship between the amount of money he will get and any judgment that the individual had that influenced him not to contribute to the Thrift Savings Plan. It's a great windfall, in a sense. He made no investments in the Thrift Savings Plan, so he has no history in it. Consequently, the history of all will be used, and the investment results associated with the history of all. If, however, the employee, despite the generosity or the adequacy of the defined benefit due him under CSRS, decided that he would save even a little bit in the Thrift Savings Plan--let's say, in the G Fund--and he put away 1 percent of his paycheck into the G Fund every payday, as he certainly could do, that is his investment history. And in that case, that employee, who wanted to go into FERS under H.R. 3249, would have the rate of the G Fund used with the deferral rates of the average employee experience. It's a lower rate. So the differences between the two are quite arbitrary, depending on the individual employee's behavior, and certainly his behavior foresaw absolutely none of this. Our view is that this works some very arbitrary results. I thought that they were unintentional when I testified in the House, and I raised them as apparent unintentional consequences, or unintended consequences. But I think that these consequences are, in fact, expected or intended, or at least they are tolerated under H.R. 3249. So it creates quite a disparity. Senator Cochran. What about the employee who contributed the maximum allowed as a CSRS or CSRS-Offset participant? Would this individual receive the historical average contribution also? And will any difference between this amount and the maximum allowable under the FERS be returned to the individual, along with any earnings? Mr. Mehle. No. As I understand H.R. 3249, the individual who contributed 5 percent, which is the maximum amount a FERS employee may contribute, will receive this payment that I outlined based on his investment history, but limited by 10 percent per annum, because that's the FERS limitation. So that person will not get the same amount of money from his agency that a person who had not contributed 5 percent would get from his agency. Senator Cochran. What would the tax treatment of such a distribution be? Mr. Mehle. Well, in that case there would not be any distribution. It would simply be that the amount of payment made to him by his agency under H.R. 3249 would be reduced relative to the amount the agency would pay to a person who had not contributed 5 percent. Therefore there would be no necessity for any distribution to that person. In short, there would not be an overpayment made to him. The agency payment would be adjusted, so that together with his payment it would not exceed 10 percent. Senator Cochran. An employee who participated while in FERS might make different investment decisions than he or she would have made if they had been a CSRS participant. The decisions might be more or less conservative. How can using the investment history for an individual while that individual was a CSRS participant be an accurate reflection of what the individual's FERS participation might have been? Mr. Mehle. Well, I honestly don't think it can. I don't think you can turn back the hands of time, put the individual in a position with no ability to predict the future, what the markets would have done. And likewise, you cannot say that that person who was looking to a CSRS defined benefit would or would not have saved the same amount. Presumably, a person who was in FERS--since the message is very strong to such persons that they need to contribute to the Thrift Savings Plan to have adequate retirement benefits or the same kinds of retirement benefits that CSRS participants do--it's very likely that a TSP participant as a FERS employee would have contributed more, maybe contributed in different proportions. So I don't think you can just flatly say that this is what the individual would have done if he knew he was in FERS to begin with. Senator Cochran. If you assume that the House bill is adopted, do you think that those who made the effort to participate, on average, are going to be worse or better off than those who didn't participate in TSP? Mr. Mehle. Well, what I can say is that those who did not participate in the TSP would have a return, as we calculated it, given what we understand H.R. 3249's prescriptions are, of about 9.5 percent over the period of 1987 to 1997. Of course, a person whose error wasn't that long would not necessarily have that rate of return because it's applicable to that period, 1987 to 1997, about 9.5 percent. By the same token, a person who had contributed, let's say, to the G Fund only--in other words, he had an investment history--would have about 7.5 percent over that same time span. So the vicissitudes of contributing or not contributing work quirky results under H.R. 3249. Senator Cochran. Senator Levin. Senator Levin. Just a couple more questions. I'm a little unclear on a very basic point that I probably should know, and that is, putting aside your choice under the Thrift Savings Plan, do you also make a choice which affects your FERS benefit as to whether you go G Fund or C Fund or S Fund or F Fund? Mr. Mehle. You may choose among the three funds to make your contribution. Senator Levin. Not just on your thrift savings, but also as it relates to the non-thrift savings part of FERS? Mr. Mehle. No. Senator Levin. Am I speaking your language or not? Mr. Mehle. I think I know what you are getting at. Whether you are a CSRS-covered employee or a FERS-covered employee, you may participate in the Thrift Savings Plan, and in either case you may make choices among the three funds. Senator Levin. But how does your choice among the three funds for the Thrift Savings Fund affect your FERS benefit? Mr. Mehle. It does not. It does not explicitly affect the defined benefit or annuity portion of your FERS benefit. Senator Levin. Then how does the investment history in the Thrift Savings Fund affect your FERS benefit for the purpose of this bill? Mr. Mehle. It affects your FERS benefit in a global sense, if you think of your FERS benefit as comprising the basic annuity, the Thrift Savings Plan balance that you have when you leave government, and your Social Security payments. That's the total benefit package that you have as a FERS employee. It affects that benefit because you may well have, based on your investment history, a FERS TSP balance that is lower than it would have been if you knew you were in FERS to begin with and you contributed more to it. Senator Levin. In other words, you might have contributed more to your Thrift Savings Plan had you known---- Mr. Mehle. Had you known you were in FERS. It is important that you contribute to your Thrift Savings Plan, because the defined benefit portion of the total FERS package is much smaller than that under CSRS. Senator Levin. And if under the bill we give people the option to switch to FERS, what are we assuming their contribution to the Thrift Savings Plan is? Not whether it's bonds or stocks or government securities, but--up to 5 percent, what are we assuming that contribution was for those people? Mr. Mehle. Actually, what H.R. 3249 does is invent a contribution. Senator Levin. What percent contribution? Mr. Mehle. It is the average history of all Federal employees. Senator Levin. So if that's 2 percent, they assume it's a 2 percent contribution? Mr. Mehle. That's right. Senator Levin. And does the House bill assume the return on that? Mr. Mehle. It uses the return for the periods--the actual returns for the periods in question. Senator Levin. The average return of the three funds? Mr. Mehle. Yes, as reflected by broad Federal employee investment behavior. Senator Levin. The total return of Federal employees on the average contribution. Mr. Mehle. Yes. That's H.R. 3249. So it has nothing to do with an employee's own choices or pocketbook decisions that the employee might actually have made if he knew he were in FERS back then. Under S. 1710, in contrast, when the error is discovered, the employee is given a choice to stay in CSRS or be in FERS. In other words, he was mistakenly in CSRS, the juncture comes, the error is found, he is told ``You can be in CSRS, you can stay in it; you thought you were in it, you can stay in it or you can be in FERS.'' That person then is given the opportunity to make payments, contributions, that he could have made, as the present system calls for it, and get matching contributions that he's entitled otherwise to get, and the 1 percent automatic agency contributions, together with, in the case of the 1 percent and the matching contributions, earnings as if earned from the date that his contribution would have been made. The employee chooses to make up to the Thrift Savings Plan as much as 10 percent--that's the limit--of his paycheck in respect of the year in question. Senator Levin. I just have one other question. Can you conceive of somebody who is retiring tomorrow, on whom this mistake was made, who would not be better off under either the House or Senate bill than under--exercising the option to join FERS under either bill, can you imagine anyone who would not exercise some option to get into FERS, who is retiring tomorrow? Could someone be better off under CSRS? Mr. Mehle. Absolutely. I would actually expect that it's almost inconceivable--unless you offer them a pot of gold to retire under FERS. He thinks he's in CSRS; he's going to retire tomorrow; he hasn't contributed a nickel to the Thrift Savings Plan. If he is forced into FERS, he has an annuity that's half of the amount, starting tomorrow, that he thought he was going to have. It's quite plain that such a person, if given the opportunity to be in FERS or CSRS, would say, ``Well, I want to be in CSRS. I want the generous annuity. The fact that I don't have a TSP account and I don't have enough time to make it up, if I'm going to retire tomorrow, means I clearly want CSRS.'' If on the other hand you say, ``Well, we've got a different deal; we're going to give you $1 million if you retire under FERS tomorrow. We're going to give it to you. How about that?'' He says, ``Well, let me think about it.'' That's the kind of choice that I think H.R. 3249 is presenting, because the employee does not have to pay any of his own money. Senator Levin. Okay, but I want to assume an employee who can put the money in, make up the money. Mr. Mehle. Who can do it? Senator Levin. Who can do it. Would any of those employees be better off staying in CSRS? Mr. Mehle. If you retire tomorrow? Senator Levin. I'm talking about just retiring tomorrow. Mr. Mehle. If you retire tomorrow, you plainly don't have enough time under S. 1710 or under current law to put in money of your own to earn and to fetch in the match, over the 1 percent. You don't have enough time left. A person, let's say, who might retire in 10 years, on the other hand, is given the opportunity to choose between CSRS or be in FERS. Looking forward, knowing that there is a difference between the annuities--much heavily weighted toward CSRS--he might say, ``Well, I want to be in FERS. The reason I want to be in FERS is that I think the markets are really going to do well. I like the idea of getting the 1 percent contribution. I like the idea of getting the matching contribution, and I like the idea of putting in 10 percent of my own money--not just 5, but 10 percent--and relying on the markets for the next 10 years.'' So that would not be an irrational choice, to stay in FERS. One complicates these---- Senator Levin. To stay in FERS, you say? Mr. Mehle. Yes. I say it would not be irrational for such a person to want to be in FERS for---- Senator Levin. You said to go to FERS. Mr. Mehle. I'm sorry, to go to FERS, stay in FERS--it's a little difficult to say where the person is. He was mistakenly, by hypothesis, told he was in CSRS. Senator Levin. I understand. Mr. Mehle. So the question is, is he staying in FERS or going into FERS, or exactly what. Senator Levin. Thanks a lot. Senator Cochran. Thank you both for being an excellent panel of witnesses for our hearing. We appreciate your being here, Mr. Flynn and Mr. Mehle, and your contributions to our understanding of these issues. Mr. Flynn. Thank you, Senator Mr. Mehle. Thank you, Senator. Senator Cochran. Our next panel will include Dallas Salisbury, President, Employee Benefit Research Institute, and Daniel F. Geisler, President, American Foreign Service Association. We welcome you and thank you for your attendance. We have copies of your statements, which we will place in the record. We encourage you to make whatever summary comments as introductory remarks that you would like to make, and then we will have a chance to ask you some questions. Mr. Salisbury, we will start with you. STATEMENT OF DALLAS SALISBURY,\1\ PRESIDENT, EMPLOYEE BENEFIT RESEARCH INSTITUTE (EBRI) Mr. Salisbury. Mr. Chairman, Members of the Subcommittee, it is a pleasure to be here. Since the full statement is being included in the record, I will be even more brief than my summary. --------------------------------------------------------------------------- \1\ The prepared statement of Mr. Salisbury appears in the Appendix on page 88. --------------------------------------------------------------------------- I was asked to deal with the question of private sector practices. One of the primary issues in this legislative issue relates to Social Security, and I would note that in the private sector the Social Security coverage/noncoverage would be a nonissue. It might be in a few State and local situations, but given the inability currently of States to opt out of Social Security, we were unable to find any situations, in looking up research on the States, of a similar situation. Second were issues related to employee contributions and whether the catch-up contribution issues would normally arise in the private sector. On the one hand, there is nothing in the law that would disallow an employer, as best as we can tell, from making these catch-up contributions and allocations. In fact, we did find, as is documented in my full testimony, provision in revenue procedures that would allow employers to do so. On the other hand we were unable, in going through data bases, to find any situations or evidence where that had in fact been done. The second set of questions dealt with the issue of Federal employees being given a chance to switch, and whether there would be a private sector counterpart. Again, we were unable to find situations where that type of a situation in the private sector would generally occur. Employers in the private sector frequently find themselves freezing a given defined benefit plan, and then doing a replacement plan; or totally terminating one defined benefit plan and creating replacement plans, but seldom would they be running simultaneously, the two systems, as is done in the Federal case. One could also ask questions about the benefit accrual and employee choices. I would prefer, rather than going through all that, to deal with it in the Q&A period. But one can find history, particularly in situations like the Unisys case, on issues of litigation where employers have chosen to essentially make some makeup of investment earnings or contributions where they felt that an action was as a result of their own fiduciary action. But again, the number of cases that we were able to document in the private sector was relatively limited. Finally, one would ask the question of the most complicated issue being related to the participant's asset allocation. You've had a substantial discussion of that. I will simply note that in the extensive work that we've done, what one finds in most defined contribution plans is a relatively skewed distribution; about 25 percent of participants put all of their money into the equivalent of the G Fund, about 25 percent of participants put all of their money in the equivalent of the Equity Fund, and the vast majority do some mix. So to do it based on averages would not generally represent what public or private employees have done. The equitable treatment issue that was discussed at some length in terms of what one would do and what a private employer would generally do, is they would generally try to have an approach that treated all employees, should we say, equally, rather than some of the treatments that can arise under these pieces of legislation, where an individual who did choose to save, as was documented in the last panel, could find themselves penalized relative to individuals who had not chosen to save in the Federal Thrift Plan. Employers in the private sector generally would try very hard to avoid that type of what they would deem to be inequitable treatment. Finally, I would simply note vis-a-vis the last testimony and the question that Senator Levin was asking, if one takes the revenue-neutral legislation being discussed in the Senate bill, the estimate of roughly $240 million as the revenue cost of the House bill, and the estimate of 20,000 affected parties, it would appear that the average dollar value of the House bill is about $12,000 per participant, if you assume that everybody went over, which is substantially larger than the hypothetical $300 or $400 as the Senator was trying to get at that number. But I believe, as the representative of OPM noted, that's the type of number that they could readily go back and calculate. Thank you for the opportunity to be here. Senator Cochran. Thank you, Mr. Salisbury, for your statement. Mr. Geisler. STATEMENT OF DANIEL F. GEISLER,\1\ PRESIDENT, AMERICAN FOREIGN SERVICE ASSOCIATION (AFSA) Mr. Geisler. Thank you, Senator. --------------------------------------------------------------------------- \1\ The prepared statement of Mr. Geisler appears in the Appendix on page 96. --------------------------------------------------------------------------- Senator, I am here to speak on behalf of the 23,000 retired and active duty foreign service officers and specialists that we represent. We appreciate the opportunity to testify before you today on this issue. We alerted our members to this situation over the past couple of months, asking them to let us know if they think they've been misclassified. We also warned them that if they alert their agency that they've been misclassified, they may have to be switched immediately, so we've told them to ``tell, but don't ask.'' [Laughter.] I can report to you that so far the number of people who have come back to us has been quite modest. We don't anticipate a large-scale corrective action for the foreign service agencies. Mr. Chairman, I personally experienced the sort of situation that this legislation deals with. I joined the government back in 1984 as an engineer in the Civil Service, and I was put into the interim system at that time. Three years later I was serving abroad in the foreign service, and I wanted to switch into the new system. I guess I was one of the 4 percent that Mr. Flynn said were ``rational,'' and I was told that I didn't have to do that, that it was automatic. I had no choice, I had to be in FERS--or the Foreign Service Pension System, equivalent. In November of 1987 I got my first statement from the Thrift Savings Plan and I saw that I wasn't getting government matching, and I went into the administrative section of the Embassy and asked them why. They said, ``Oh, you didn't tell us that you wanted to be switched.'' I said, ``You told me that I didn't have to tell you, that I had no choice.'' I was lucky that they made that correction right there, so I didn't suffer any damage. But some other people in the foreign service haven't been so lucky. I think, in our case, one of the reasons people were misassigned is that because 60 percent of our people are serving abroad, while the foreign service agencies run these retirement issues out of headquarters here in Washington. Washington is where they have the specialized personnel who know how to deal with these issues. In embassies, we don't have that kind of expertise. Ten years ago, when these big changes were taking place, nobody had fax machines; nobody had e-mail; international calls were very expensive. You generally weren't allowed to make them if you were a staff person. And in some of the countries--like where I served, in Zaire, in Jamaica--the connections were hard to make. So it was very hard to get that kind of information out in the field. Today it's a little bit easier to do that, so we don't think we're getting classification problems now in the foreign service. Mr. Chairman, from our point of view corrective legislation should have three features. First, it should include the foreign service. H.R. 3249, the House corrective measure, does include the foreign service, and we thank Congressman Mica for acceding to our request that it do so. And we also ask you, Mr. Chairman, as you mark up S. 1710, that you also include our people. Second, like the people who spoke before, Mr. Flynn and Mr. Mehle, we think that employees who have been victims of administrative error should have options. And this bill, S. 1710, does give options to employees, as does the House bill, H.R. 3249. We think that's important. But third, Mr. Chairman, we think that the option should be financially viable, and in particular this means providing corrective measures for employees who opt for the new system. It seems that on this point, as people have said, the Senate bill diverges from the House bill, particularly with respect to the Thrift Savings Plan contributions. We have seen examples of how this operates now. A couple months ago I got an electronic mail from one of our officers who is serving in a developing country in Africa. He has been on duty since 1987 in the foreign service, and he was in the Offset system. Last year his agency told him that they had misclassified him, and that they had to put him immediately into the new system. Under the current law, to catch up on TSP, he would have to come up with somewhere between $65,000 and $70,000 very quickly in order to make up his retroactive contributions, and he would have to do that while he is also putting aside money to make his current contributions. Mr. Chairman, most of our people don't have that kind of cash available to them. In fact, in the foreign service we have an ``up or out'' system where if you are not promoted at regular intervals, you have to retire, like they do in the uniformed military services. So we have a lot of people who are retiring in their mid-50's. They have children in college, and if they are asked to make this kind of switch without any kind of relief, we are essentially asking them to choose between their retirement and their children's education. We think that's unfair. Mr. Chairman, we think that the changes that you are proposing to the current law do much to correct this situation. Certainly, the proposal to pay to the TSP an amount equal to the earnings on makeup contributions will bring the TSP to a healthy balance faster than the current law does. As to the differences on TSP between the two bills, Mr. Chairman, I will confess that we do not have a lot of institutional expertise in the financial area in my organization, so we are going to leave that up to the experts. We are happy to see that Members of the House and the Senate are taking this problem seriously and that they're trying to do something to correct it quickly. I am happy to have had the opportunity to testify before you on how important it is. My main point, Mr. Chairman, for being here today is to ask you to include the foreign service in whatever you come up with as corrective legislation. Senator Cochran. Thank you very much, Mr. Geisler, for your comments. Let me ask Mr. Salisbury, if there is any history in the private sector that is similar with what we're confronting now with this issue in the government retirement programs. Mr. Salisbury. Not on any point-by-point type of basis. Most private employers would not, if you will, have ``companion'' comprehensive retirement systems. The one real of similarity would be that there are, in fact, at times problems of benefit calculation and classification. Senator Grassley has held hearings here in the Senate on that topic. In those cases, the most common private sector practice would be basically to try to follow a policy of ``do no harm'' and a policy to help those to whom harm had been done. If I put that into the situation of this legislation and the discussions here, that would fall in the category, but it would be quite unlikely that a private employer, if they had a legal option, would, upon discovering 10 or 15 years after the fact that someone was in a situation and was ``misclassified,'' that the employer would move them out of that situation against, in essence, their desire, to their disadvantage. That's the type of thing in the private sector that would lead to bad headlines and, potentially, to lawsuits. Senator Cochran. Does ERISA have requirements that are more costly to employers or more generous to employees than those provided in the legislation that we're considering? Mr. Salisbury. First, you would note, as one of the cost items here--a private employer under ERISA would never face the Social Security issue that you face here, which is one of the cost items. Beyond that, there really is not a comparison in the private sector, and ERISA would not create that type of a situation. Senator Cochran. You mentioned that employees in the private sector may consider litigation to try to redress their grievances if they have been wronged in any way. Is there any proof that granting employees a specific right to sue the employer for lost contributions is a useful or valid option? Mr. Salisbury. There's no real record on that that we were able to find as we researched all of these issues. We do believe that if you were to ask that question of the Department of Labor, which engages directly in litigation related to ERISA, they might be able to find you essentially a count of how aggressively those litigation options have been used. Senator Cochran. What considerations should be taken into account when you're trying to correct erroneous pension coverage? How do you meet the individual employee's expectations? Why can't we allow misclassified employees to remain in the wrong system? Mr. Salisbury. Well, as a practical matter, being the Congress of the United States, you have the unique power to do exactly that, should you choose to do so. And against the types of equity issues involved, one might argue that with some that would be an appropriate way to do it. The issue that was raised earlier with the first panel in one of your questions about, ``Well, what about the Social Security implications vis-a-vis universal coverage,'' the initiatives now in the States for seeking Congressional ability to opt out of Social Security, the precedent value--as a personal statement, not a lobbying statement but as a personal statement as a taxpayer, my comment would be that to essentially disadvantage large numbers of Federal workers through no fault of their own because of some discussion of precedent, when essentially workers hired before 1984 are still outside of the Social Security program, exceptions have always been made by the Congress. So I believe that you should make an effort to fairly accommodate the Federal worker. As from a private employer experience perspective, probably the closest to this that we could think of as an application really relates to retiree medical areas, and litigation where an employer has implied, as in the General Motors litigation, has implied that there will be a retiree medical benefit, and then essentially it isn't there--that type of situation, the courts have come down and found in favor of the individual in the event that the employer was not very, very clear about the fact that these benefits might be taken away. One could argue in this particular case that the Federal employee will not have been given fair warning as to the consequences of the misclassification. Senator Cochran. What about the employees who have already been corrected? Are there any equity implications in providing further opportunities for correction or benefits? Mr. Salisbury. Not that we were able to clearly assess as we looked against the legislation. In the private sector it would normally be that once an individual had been given the option to change, that unless the Congress came and said, ``You must give them another chance, or you have to tell them you made the wrong choice,'' you have to push them in one direction. Senator Cochran. And is there any precedent for mandating an employer to make up the employee's contributions during the period of erroneous coverage? Mr. Salisbury. Not a precedent on a mandate basis that we were able to find. Senator Cochran. So which one of these bills, if you had to make a comparison, would more closely follow private sector practice in correcting errors in coverage? Mr. Salisbury. For the most part, as we looked at that against private sector practice, it would most readily appear to be the Senate bill, with one potential exception, which is the issue of what type of investment crediting would be done, and that ends up being somewhat of a mix of the two bills, because in essence a private employer would generally attempt, in essence, to treat all of the affected parties with a totally consistent investment crediting as opposed to, if you will, one of the side effects of the House bill that was discussed by the last panel, that again, the individuals who chose to save might well find themselves being given a lower rate of return than the individual who had chosen not to save. Senator Cochran. And is there any precedent in the private sector for making up for lost earnings attributable to the employee's share of contributions? Mr. Salisbury. As I noted in the full testimony, vis-a-vis revenue rulings, there is apparently the legal ability for employers to do that should they choose to do that. We were not able to find examples of cases in which they had done that. Senator Cochran. Mr. Geisler, let me ask you your view about what could constitute immediate and complete relief for misclassified employees who elect FERS. We've heard about the measures that some of the employees have had to take because of harm that has been done to them. Mr. Geisler. Well, Senator, we think that people should be given the assurance immediately that when they reach the point where they're ready to retire, they will be in the same position that they would have been had the government not made its mistake to begin with. Senator Cochran. What do you think accounts for the majority of these misclassifications? Experiences like yours, where---- Mr. Geisler. In the foreign service? Senator Cochran. Right. Mr. Geisler. I think it's two things, Senator. I think the cases of people who entered during that period, between 1983 and 1987, who had prior Federal service added a new level of complexity to a difficult and somewhat confusing situation, and some of our retirement people--particularly those abroad-- didn't know how to deal with those situations. I don't think it was widespread. I don't think there are many instances of just sheer administrative slip-up, people losing forms or writing dates wrong--I don't think we had much of that. I think it was mostly because people were serving abroad where there was not a lot of deep expertise in retirement issues, and we had people entered the foreign service with prior Federal experience that provided an added dimension to consider. Senator Cochran. We have had some groups who say they prefer one proposal over the other. Why would different groups have conflicting views over the appropriateness or fairness of these two remedies? Some say that it is fair compensation for the harm that's been done, while others say that agencies should not be made to bear the financial burdens of other agencies' mistakes, and high agency costs might result in layoffs. What's your impression of these concerns? Mr. Geisler. Well, I've heard both of those concerns, Senators. On the first one, about which agency should be made to bear the costs, frankly, sir, my members really don't care about that. This was a government mistake, and it's really irrelevant to us which organ or agency of the government is charged with rectifying the error. In terms of this resulting in layoffs, I heard that when we were discussing H.R. 3249 2 months ago. I said then, and I still believe now, that that's simply not credible. I can't believe that the only way the U.S. Government can correct its own errors is by firing its employees to pay for it. Senator Cochran. What is your impression of the bill we are introducing here in the Senate, S. 1710? Do you think that is a satisfactory resolution of the issue, or not? Mr. Geisler. Well, as it stands now, Mr. Chairman, I didn't find any mention of the foreign service, so from our point of view---- [Laughter.] Senator Cochran. It needs the foreign service. Yes, we heard that. I've got that written down. [Laughter.] Mr. Geisler [continuing]. It seems that the nub of the matter here is, who is going to pay for the contribution that the employee would have made had they been put in FERS between 1987 and now? And that's a tough issue. It's a tough issue for us, too. There is an equity side to that; why should you give a windfall to these people who have not been contributing for 10 years, who had that money available? They either consumed it or they saved it. If they saved it, they have it available, and they can invest it. On the other hand, Mr. Chairman, if you look at the way people might reimburse the TSP, they're always going to be behind. It's sort of like if there is a race going on, and you are going to put somebody in that race in the middle, where do you put them? To us, it seems that H.R. 3249 puts them in the middle of the pack and says, ``Go forward.'' The way S. 1710 does it, where the employee has to make up all of his own contributions, given his current resources, you really put them a couple of steps behind, because their TSP balance is never going to be, today, where it would have been today had they been investing for the last 10 years. So they're never going to be getting the growth that they would have gotten. Senator Cochran. And what about the question of fairness, having those who were misclassified and who elect FERS to receive earnings from contributions that they did not make? Is that a problem? Mr. Geisler. As I said, Senator, we understand that concern. It was a concern that I raised in the beginning when I first heard the proposal in H.R. 3249. I was concerned about that, but my feeling was, ``Everybody in the Civil Service is going to get this; I can't see why we would want to exclude the foreign service.'' Senator Cochran. Well, your presence has been helpful, and your testimony has been very helpful in our understanding of the issues involved. We will continue to review the legislation and the record, and hopefully we will come to some decision that will be fair and equitable for all concerned. Senator Durbin's questions and responses to OPM follows: OPM RESPONSES TO ADDITIONAL QUESTIONS FROM SENATOR DURBIN Tax Consequences Question. To what extent will an employee [who was misclassified and then automatically shifted to FERS when the agency detected the error] who then elects, if this legislation becomes law, to go into CSRS Offset, incur tax consequences? Are the House and Senate bills different on this aspect? S. 1710 follows current law in regard to excess TSP contributions. (Excess contributions are those that exceed the 5 percent contribution limit for CSRS employees.) Any excess contributions would be returned to the employee by the employing agency, and treated as taxable income in the year that the excess contributions are returned. Attributable earnings on all employee contributions would remain in the TSP account. Government contributions, and earnings attributed to government contributions, would be removed from the employee's TSP account. H.R. 3249 would permit all FERS employees who elect retroactive CSRS Offset coverage to retain any excess TSP contributions, and earnings, in the TSP account. All government contributions, and earnings attributed to government contributions, would be removed from the employee's TSP account. Question. For example, will such an individual be required as part of that election to withdraw any contributions previously made to TSP as a FERS enrollee that exceeded the 5 percent annual cap allowed for CSRS enrolless? S. 1710 and current law require removal of excess TSP contributions from the employee's TSP account. The employing agency is required to determine the amount of any excess contributions and return that amount to the employeee. Question. Will that transaction be a taxable event? Contributions returned to the employee are taxed as income in the year the excess contributions are paid back to the employee. This transaction is not, as H.R. 3249 incorrectly presumes, an early distribution from a qualified retirement plan that is subject to a penalty tax. Excess contributions are simply treated as salary. Question. Might that aspect deter persons from shifting out of FERS into the CSRS Offset option? Not necessarily. In choosing a retirement plan, employees must evaluate not only their current financial situation, but also their long term plans. The amount and taxability of any refunded excess TSP contributions would be among the many factors the employee must consider in choosing a retirement plan. Likely Behavior Question. Have any projections been made as to how many individuals who were shifted to FERS already (to correct the problem once their agency uncovered it) would elect to go into CSRS Offset? Under H.R. 3249, we estimate that the percentage of previously corrected employees who elect to return to CSRS Offset would be 20 percent, as a result of the overcompensation under the TSP provisions of that bill. Question. Does OPM (or others) presume that many persons whose misclassification has previously been detected and shifted to FERS as required under current law will elect the CSRS Offset option if it is made available under legislation such as S. 1710? We believe that employees who were more recently corrected to FERS or have not had an opportunity to contribute large amounts to the TSP would be more likely to elect CSRS Offset. Given the performance of the TSP investment funds, it is less likely that an employee who has been covered by FERS for a longer period of time and maximizing TSP contributions would choose to leave FERS. Question. What benefits are there to a corrected FERS employee making such an election rather than staying in FERS? Certainly not all employees are able to substantially contribute to the TSP. To receive a comparable benefit under FERS, the employee must generally contribute 12-17 percent of salary. Under CSRS Offset, the employee need only contribute 7 percent of salary. For many employees, the additional 5-10 percent required under FERS makes CSRS Offset more attractive. Improving Discovery of Problems Question. Are there any mechanisms of ``best practices'' in place in any agency that would make it easier to locate those active, separated, or retired employees who may be in the universe of misclassified individuals so that necessary corrections can be made more promptly? Retirement coverage determinations are made by reviewing all of the employee's service history and prior retirement coverage. Since this information is not automated, verifying a retirement coverage determination is usually done by reviewing individual employee records. There is, however, some information maintained in an automated format that will assist agencies in identifying groups of employees that are more likely to be affected by a coverage error, such as employees with prior service hired during the 1984-1987 transition period. Because the employment records for separated or retired employees are not kept with the last Federal employer, it is very difficult to identify separated employees with a coverage error. Question. Is this problem one that is government-wide in its range? Is it known whether particular agencies have significantly higher percentage of affected employees? A retirement classification error can occur at any Federal agency. Generally, the larger the agency, the more opportunity for error. With that, the hearing will stand adjourned. Thank you. 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