This article presents a comparison of replacement rates for employees of medium and large private establishments to replacement rates for federal employees under the Civil Service Retirement System and the Federal Employees Retirement System. This analysis shows the possibility of replacement rates exceeding 100 percent for FERS employees who contribute 6 percent of earnings to the Thrift Savings Plan over a full working career. Private-sector replacement rates were quite similar for workers with both a defined benefit and a defined contribution pension plan.
Acknowledgments: The author wishes to thank Clark Burdick, Joyce Manchester, Pat Vinkenes, and Hilary Waldron for their instructive comments, and especially Mike Anzick for his generous input, suggestions, and support.
One measure of the adequacy of retirement income is the replacement rate—the percentage of pre-retirement salary that is available to a worker in retirement. This article compares salary replacement rates for private-sector employees of medium and large private establishments with those for federal employees under the Civil Service Retirement System and the Federal Employees Retirement System.
Because there is no standard benefit formula to represent the variety of formulas available in the private sector, a composite defined benefit formula was developed using the characteristics of plans summarized in the Bureau of Labor Statistics Medium and Large Employer Plan Survey. The resulting "typical" private-sector defined benefit plan, with an accompanying defined contribution plan, was then compared with the two federal systems.
The Civil Service Retirement System (CSRS) is a stand-alone defined benefit plan whose participants are not covered by Social Security. Until passage of the 1983 Amendments to the Social Security Act, it was the only retirement plan for most federal civilian employees.
Provisions of the 1983 Amendments were designed to restore long-term financial stability to the Social Security trust funds. One provision created the Federal Employees Retirement System (FERS), which covers federal employees hired after 1983. It was one of the provisions designed to restore long-term financial stability to the Social Security trust funds. FERS employees contribute to and are covered by Social Security. FERS, which is a defined benefit plan, also includes a basic benefit and a
To compare how retirees would fare under the three different retirement systems, benefits of employees retiring at age 65 with 35 years of service were calculated using hypothetical workers with steady earnings. Workers were classified according to a percentage of the average wage in the economy: low earners (45 percent), average earners (100 percent), high earners (160 percent), and maximum earners (earnings at the taxable maximum amount).
Overall, this analysis found that:
This analysis shows that replacement rates could exceed 100 percent for FERS employees who contribute 6 percent of earnings to the TSP over a full working career. Private-sector replacement rates were quite similar for those with both a defined benefit and a defined contribution pension plan. Social Security replacement rates make up the highest proportion of benefits for the private sector's lowest income quartile group. The replacement rates for
Variations in salary replacement rates for private-sector and federal government retirees are the result of the type of retirement plan in which employees participate. Retirement plans are classified as either defined benefit plans, which are based on employee earnings, or defined contribution plans, which are based on employee, and usually employer, contributions.
In 2000, 33 percent of private-sector employees in medium and large establishments participated in defined benefit plans, 46 percent participated in defined contribution plans, and 14 percent participated in both (author's calculations using data in Bureau of Labor Statistics 2000, Table 98). There is no standardized benefit formula that can represent the variety of formulas used in the private sector to calculate retirement income and replacement rates.1 However, the most prevalent method used to determine retirement benefit payments is a formula based on a percentage of average earnings during a specified number of years at the end of a worker's career (or when earnings are highest) multiplied by the number of years of service recognized by the plan. That formula, which is known as a terminal earnings-based formula, was used for about 48 percent of all full-time employees in medium and large private establishments in 2000 (Bureau of Labor Statistics 2000).2
The basic annuity is computed on the basis of length of service and the highest average basic pay earned during any 5 consecutive years of service (known as the "
The most common annual personal contribution of full-time employees in medium and large private firms (made by 48 percent of such employees) is 6 percent of salary. The most common matching provision (for 47 percent of employees) was for an employer to match half of an employee's contribution, up to the first 6 percent of earnings (Bureau of Labor Statistics 1997).5 All other factors being equal, employees who make larger contributions should receive larger benefits than employees whose contributions are lower.
The Civil Service Retirement System was created in 1920 and was the only retirement plan for most federal civilian employees until 1984. CSRS is a defined benefit retirement plan that provides retirement, disability, and survivor benefits. Agencies deduct a set percentage of basic pay (7 percent for most employees) and contribute a matching amount to CSRS.
The basic annuity is computed on the basis of length of service and the highest average basic pay earned during any 3 consecutive years of service (known as the "
Under CSRS, employees do not have Social Security coverage and, as a general rule, do not receive any Social Security benefits. However, they are allowed to participate in the Thrift Savings Plan and could contribute up to 7 percent of basic pay in 2002; however, they receive no federal government match. Any TSP benefits are in addition to the CSRS defined benefit basic annuity. In general, the CSRS annuity is larger than traditional Social Security benefits because it is supposed to reflect a combination of a Social Security-like annuity and an employer pension.
The Federal Employees Retirement System became effective in 1987 and automatically covers most new federal civilian employees hired after 1983.6 FERS is a three-tiered retirement plan, including:
Employees contribute 0.8 percent of basic pay for FERS basic benefits and 6.2 percent for Social Security (up to the Social Security maximum taxable base—$84,900 in 2002), for a total of 7 percent. The employing agency contributes 10.7 percent or more of basic pay to FERS. The basic benefit provides retirement, disability, and survivor benefits and may be reduced for early retirement or to provide survivor protection.
The FERS basic benefit is computed on the basis of length of service and the highest average basic pay earned during any 3 consecutive years of service. The basic benefit is computed as 1 percent of the
FERS employees also receive Social Security benefits and automatically have TSP accounts whether or not they decide to contribute. In 2002, FERS employees could contribute up to 12 percent of basic pay to the TSP, with the contribution capped at $11,000. Since January 1987, all federal employing agencies have been required by law to automatically contribute 1 percent of basic pay for every FERS employee. Federal agencies also match the employee's contribution up to 4 percent of basic pay, for a total agency contribution of 5 percent of salary. (In contrast, CSRS employees could choose to contribute up to 7 percent of basic pay to the TSP in 2002 but would receive no government match.) The TSP represents an opportunity for FERS workers, particularly maximum earners, to earn a replacement rate similar to that of their CSRS counterparts.
To compare how retirees would fare under the three retirement systems, benefits of employees retiring in January 2002 at age 65 with 35 years of service were calculated using hypothetical workers with steady earnings.7 The calculations were made for four earnings levels: low ($15,254), average ($33,897), high ($54,235), and maximum ($80,400). The comparisons are shown in Chart 1 and Table 1.
Benefit | Low earner a ($15,254) |
Average earner ($33,897) |
High earner b ($54,235) |
Maximum earner ($80,400) |
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Composite private defined benefit plan | ||||
Basic pension only | 47.3 | 47.3 | 47.3 | 47.3 |
Basic pension with Social Security | 101.0 | 87.2 | 79.8 | 72.2 |
Basic pension with Social Security and defined contribution | 146.8 | 133.0 | 123.5 | 110.2 |
Civil Service Retirement System | ||||
Basic pension only | 62.9 | 62.9 | 62.9 | 63.0 |
Basic pension with Thrift Savings Plan | 84.7 | 84.8 | 83.8 | 81.1 |
Federal Employees Retirement System | ||||
Basic pension only | 36.5 | 36.5 | 36.5 | 36.6 |
Basic pension with Social Security | 90.2 | 76.4 | 69.0 | 61.4 |
Basic pension with Social Security and Thrift Savings Plan | 146.1 | 132.4 | 122.4 | 107.9 |
SOURCE: Author's tabulations using earnings data from the Office of the Chief Actuary. Benefit examples for workers with low, average, high, and maximum wages were accessed on September 10, 2002. Thrift Savings Plan (TSP) annuity estimates using single life annuity, level payments with no additional features were accessed on April 18, 2003. | ||||
NOTES: The rates assume that employees retired in January 2002 at age 65 with 35 years of service.
The replacement rate is the percentage of the pension benefit divided by earnings in the final year of work. Since workers under all three plans are assumed to have the same hypothetical earnings and years of service, using the final year's earnings as a base allows for comparison of replacement rates across all three plans. The plans compute benefits as a percentage of terminal earnings multiplied by years of service. For federal employees, terminal earnings are the average over a |
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a. Calculated as 45 percent of average wages. | ||||
b. Calculated as 160 percent of average wages. Earnings between 1967 and 1973 are less than 160 percent of average wages, because that amount would have been above the taxable maximum amount. Earnings between 1974 and 2001 are 160 percent of average wages, because the taxable maximum was automatically increased in proportion to increases in the average wage level. |
Low earner a | Average earner | High earner b | Maximum earner | |
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Composite private defined benefit plan | ||||
13,753 | 30,562 | 48,899 | 72,600 | |
Final salary d (dollars) | ||||
Annual | 15,254 | 33,897 | 54,235 | 80,400 |
Monthly | 1,271 | 2,825 | 4,520 | 6,700 |
Monthly annuity (dollars) | ||||
Basic pension only e | 602 | 1,337 | 2,139 | 3,176 |
Social Security f | 682 | 1,127 | 1,467 | 1,660 |
Defined contribution g | 582 | 1,293 | 1,975 | 2,550 |
Total, basic pension with Social Security | 1,284 | 2,464 | 3,606 | 4,836 |
Total, basic pension with Social Security and defined contribution | 1,866 | 3,757 | 5,581 | 7,386 |
Replacement rate (percentage of final salary) | ||||
Basic pension only | 47.3 | 47.3 | 47.3 | 47.3 |
Basic pension with Social Security | 101.0 | 87.2 | 79.8 | 72.2 |
Basic pension with Social Security and defined contribution | 146.8 | 133.0 | 123.5 | 110.2 |
Monthly defined contribution g (dollars) | ||||
Personal contribution over 35 years | 15,716 | 34,924 | 55,103 | 78,150 |
Employer match over 35 years | 7,857 | 17,462 | 27,552 | 39,075 |
Account balance | 82,183 | 182,635 | 279,011 h | 360,260 |
Civil Service Retirement System (CSRS) | ||||
14,478 | 32,174 | 51,478 | 76,400 | |
Final salary d (dollars) | ||||
Annual | 15,254 | 33,897 | 54,235 | 80,400 |
Monthly | 1,271 | 2,825 | 4,520 | 6,700 |
Monthly annuity (dollars) | ||||
Basic pension only j | 799 | 1,776 | 2,842 | 4,217 |
TSP l | 278 | 618 | 944 | 1,218 |
Total, basic pension with TSP | 1,077 | 2,394 | 3,786 | 5,435 |
Replacement rate (percentage of final salary) | ||||
Basic pension only f,k | 62.9 | 62.9 | 62.9 | 63.0 |
Basic pension with TSP | 84.7 | 84.8 | 83.8 | 81.1 |
Monthly TSP annuity l (dollars) | ||||
Personal contribution over 35 years | 11,263 | 25,029 | 39,490 | 56,008 |
Account balance | 39,265 | 87,259 | 133,305 h | 172,124 |
Federal Employees Retirement System (FERS) | ||||
14,478 | 32,174 | 51,478 | 76,400 | |
Final salary d (dollars) | ||||
Annual | 15,254 | 33,897 | 54,235 | 80,400 |
Monthly | 1,271 | 2,825 | 4,520 | 6,700 |
Monthly annuity (dollars) | ||||
Basic pension only m | 464 | 1,032 | 1,651 | 2,451 |
Social Security f | 682 | 1,127 | 1,467 | 1,660 |
TSP n | 711 | 1,580 | 2,414 | 3,116 |
Total, basic pension with Social Security o | 1,146 | 2,159 | 3,118 | 4,111 |
Total, basic pension with Social Security and TSP | 1,857 | 3,739 | 5,532 | 7,227 |
Replacement rate (percentage of final salary) | ||||
Basic pension only | 36.5 | 36.5 | 36.5 | 36.6 |
Basic pension with Social Security | 90.2 | 76.4 | 69.0 | 61.4 |
Basic pension with Social Security and TSP | 146.1 | 132.4 | 122.4 | 107.9 |
Monthly TSP annuity n (dollars) | ||||
Personal contribution over 35 years | 15,716 | 34,924 | 55,103 | 78,150 |
Agency match over 35 years | 13,096 | 29,103 | 45,919 | 65,125 |
Account balance | 100,446 | 223,221 | 341,013 h | 441,317 |
SOURCE:Author's tabulations using earnings data from the Office of the Chief Actuary. Benefit examples for workers with low, average, high, and maximum wages were accessed on September 10, 2002. Thrift Savings Plan (TSP) annuity estimates using single life annuity, level payments with no additional features were accessed on April 18, 2003. | ||||
NOTE: TSP = Thrift Savings Plan. | ||||
a. Calculated as 45 percent of average wages. | ||||
b. Calculated as 160 percent of average wages. Earnings between 1967 and 1973 are less than 160 percent of average wages, because that amount would have been above the taxable maximum amount; earnings between 1974 and 2001 are 160 percent of average wages, because the taxable maximum was automatically increased in proportion to increases in the average wage level. | ||||
c. Assumes this is the average of the highest 5 consecutive years of basic pay earned during any 5 (known as the " |
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d. Assumes this is the final salary, because the replacement rate is defined as a pension benefit divided by earnings in the final year of work. | ||||
e. Formula is 0.015 × (years of service) × |
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f. Assumes that workers have had steady low, average, high, or maximum earnings since age 30 and that they worked from 1967 to 2001, or 35 years. | ||||
g. Assumes an annual personal contribution of 6.0 percent of salary, the most common (48 percent), and an annual employer match of 3 percent of salary (50 percent of the contribution), the most common (47 percent), based on BLS statistics for medium and large private establishments in 1997. Assumes an ultimate average nominal portfolio yield of 7.9 percent, net of administrative costs (assuming an asset allocation of 50 percent in equities, 30 percent in corporate bonds, and 20 percent in U.S. Treasury long-term bonds), based on the Office of the Chief Actuary's (OCACT's) assumptions for the President's Commission to Strengthen Social Security. | ||||
h. Earnings between 1967 and 1973 are less than 160 percent of average wages, because earnings of 160 percent of average wages would have been above the taxable maximum amount, so the account balance is only 153 percent of the average earner's account balance. | ||||
i. Assumes this is the average of the highest 3 consecutive years of basic pay earned during any 3 (known as the " |
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j. Formula is the sum of 0.015 × (up to 5 years of service) × |
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k. Replacement rate refers to the percentage of the pension benefit divided by the final salary. Generally the CSRS basic annuity cannot be more than 80 percent of |
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l. Assumes an annual personal contribution of 4.3 percent of salary, an average based on TSP's experience between 1988 and 2000. Assumes an ultimate average nominal portfolio yield of 7.9 percent, net of administrative costs (assuming an asset allocation of 50 percent in equities, 30 percent in corporate bonds, and 20 percent in U.S. Treasury long-term bonds), based on OCACT's assumptions for the President's Commission to Strengthen Social Security. | ||||
m. Formula is 0.011 × (years of service) × |
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n. Assumes an annual personal contribution of 6.0 percent of salary, an average based on TSP's experience between 1988 and 2000, and annual agency match of 5 percent of salary (4 percent match and 1 percent automatic). Assumes an ultimate average nominal portfolio yield of 7.9 percent, net of administrative costs (assuming an asset allocation of 50 percent in equities, 30 percent in corporate bonds, and 20 percent in U.S. Treasury long-term bonds), based on OCACT's assumptions for the President's Commission to Strengthen Social Security. | ||||
o. Assumes the FERS worker has retired in 2002 with 35 years of service, although most FERS employees have been in government service less than 20 years unless they are transferees from CSRS. Because the FERS program has been in existence less than 20 years, no federal employee has been employed under FERS for 35 years at this time. However, the employee could have been covered by Social Security employment for 35 years. |
A comparison of employee contributions to defined contribution plans shows that private-sector employees made the same contribution as FERS employees and that those contributions were higher than the ones made by CSRS employees (Table 2). For example, a private-sector or FERS employee who was a maximum earner retiring in 2002 with 35 years of services would have contributed $78,150 over 35 years compared with $56,008 for a CSRS counterpart. This finding applies across all earnings categories.
Note that this analysis uses a nonintegrated benefit formula, because almost three-fifths (59 percent) of all employees in defined benefit plans are in plans without an integrated benefit formula (Bureau of Labor Statistics 2000, Table 60). The analysis does not examine replacement rates using an integrated benefit formula, in which private pension amounts are reduced if the retiree receives Social Security benefits.
A study conducted in 2000 by the Employee Benefit Research Institute (EBRI) and the Investment Company Institute (ICI) provides further perspective on replacement rates (Holden and VanDerhei 2002). It estimates replacement rates (including Social Security) for workers who participate in a "typical"
The EBRI/ICI study found that a combination of
Assuming continuous coverage and equity returns based on the performance of the Standard & Poor's 500 between 1926 and 2001, the study estimated a replacement rate of 103 percent for low earners and about 85 percent for the other three earnings categories. These findings are comparable with the replacement rate of 147 percent for low earners and a range of 133 percent to 110 percent for the average, high, and maximum private-sector earners reported in this article. However, unlike the EBRI/ICI study, this analysis estimates replacement rates (including Social Security) for workers who participate in a "typical"
The analysis presented here shows that replacement rates could exceed 100 percent for FERS employees who contribute 6 percent of earnings to the TSP over a full working career. Replacement rates for hypothetical private-sector workers were quite similar for those with both a defined benefit and a defined contribution pension plan. Very few private-sector workers are likely to receive such high replacement rates, however, because only 14 percent of employees in medium and large firms participate in both types of plans, and even fewer will be covered by both types of plans for their entire career.
Since private-sector employees are more likely to have a defined contribution plan as their primary plan, whereas federal civil service employees' primary plan is a defined benefit plan, the results from the new EBRI/ICI study are particularly relevant. It found that a combination of
In this analysis, Social Security replacement rates also account for the highest proportion of benefits for the private sector's lowest income quartile group. However,
One possible reason for the similar replacement rates for private-sector and FERS retirees is that although FERS was originally designed to replicate a typical large-company retirement plan when it was enacted in 1986, it is more generous than the plans offering only a defined contribution that private companies have established in recent years. However, federal employees with defined benefit coverage have to contribute to its cost (FERS employees contribute 0.8 percent of basic pay toward their benefits), and the benefits of the majority (95 percent) of participants in medium and large private firms in 2000 were paid for entirely by their employers.