If you’re a Federal Government employee planning on retiring in your early 60s or even sooner, you should be familiar with the FERS annuity supplement. The supplement, officially known as the special retirement supplement (SRS) is designed to provide a replacement for Social Security until you become eligible for Social Security at age 62. For early retirees, the supplement can be a key source of income in the initial years of retirement, so if you’re planning on early retirement, read on for key information, including who is eligible for the supplement, how the supplement amount is determined, how it is taxed and potentially reduced and what to do when the supplement ends.
Supplement Eligibility Understanding FERS
To be eligible for the FERS supplement, you need to be eligible to draw the immediate, unreduced FERS basic benefit when you retire. Most Federal employees will meet this criteria either because they have 30 years of creditable service and have reached the minimum retirement age or because they have turned 60 and have at least 20 years of service. Note that if you’re in this latter group, you’ll draw the supplement for just a few years since the supplement ends at age 62 when you become eligible for Social Security. Lastly, if you retired involuntarily before reading your Minimum Retirement Age or voluntarily because of a major reorganization or RIF, you may be eligible to draw the supplement once you reach your minimum retirement age.
The supplement can be particularly valuable for special provision employees who must retire early — typically by age 57. This group includes air traffic controllers, firefighters, law enforcement officers, Capital and Supreme Court Police and nuclear materials couriers. If you fall in this group, you could retire and begin drawing the supplement at age 50 if you have 20 years of service, or if you complete 25 years of service at an even earlier age, you may be eligible for the supplement
The supplement isn’t applicable for you if:
• You retire at age 62 or later, as the supplement is only available until age 62
• You aren’t eligible for an immediate annuity when you retire
• You retire under an MRA+10 provision or you retire at age 60 or 61 with less than 20 years of service
• You are on disability retirement, as disability retirement pays out under special disability provisions until you reach age 62
How to Calculate the FERS Supplement Amount for Retirement
The FERS Supplement is meant to replace Social Security until you can start drawing Social Security, so the supplement amount is based on your Social Security benefit. The actual calculation is complex, but as a rough estimate, the supplement can be calculated as if you were age 62 and fully insured for Social Security. Fully insured is terminology specific to Social Security, but it’s highly likely that if you’ve worked full time for more than 10 years and paid into Social Security, you will be fully insured.
Assuming you are fully insured, OPM’s calculation will approximate your Social Security benefit at age 62 and then use that estimate as the basis for your FERS Supplement
calculation. If you’re wondering how your Social Security benefits are calculated, here’s a brief summary:
• The Social Security Administration bases your benefit on your lifetime earnings, and they adjust earnings in all years to account for inflation. This makes sense, as $50,000 in earnings in 1980, for example, go much further than $50,000 in earnings in 2020 so this adjustment allows for an apples-to-apples comparison.
• After earnings for each year are adjusted – or “indexed” in Social Security Administration terms – your 35 highest earning years are identified.
• A formula is applied to the earnings from those 35 years to determine your Primary Insurance Amount (or PIA). The PIA is what you would earn in Social Security were you to begin taking Social Security at your full retirement age (which is usually between 66 and 67 for most who are retiring now).
• You can begin drawing Social Security as soon as age 62, but for each year you begin drawing before you reach full retirement age, your Social Security benefit is reduced, and the reduction versus the PIA amount if you draw at 62 is 30%. Thus, if your full retirement age is 67 and you would have drawn $2400 per month at 67, if you begin drawing at age 62, you’ll receive $1680 ($2400 reduced by 30%).
Once OPM has run the calculations above, they’ll know what your Social Security benefit would be at age 62. They will then divide that amount by 40 and multiple the resulting number by the number of years you’ve been employed under FERS (note that this does not include military time except in limited circumstances outlined in Section 51A2.1-3 here). So, if
your monthly Social Security benefit at age 62 would be $1800, and you had 30 years of creditable service, your FERS supplement would be $1,350.
This calculation – multiplying your age 62 benefit times your creditable service divided by 40 – reflects that fact that a normal working career spans 40 years. So, the FERS supplement is designed to pay you based on how much of your career you worked under the FERS system.
Can the Amount I Earn from the FERS Annuity Supplement be Reduced
The full amount of the annuity supplement is subject to Federal taxes and taxation at the state level varies by state. This differs from Social Security Income, which isn’t fully taxed. At most, Social Security benefits are taxed at 85% of their value and if your income is very low, Social Security benefits aren’t taxed at all.
Beyond taxes, the other reason the supplement can be reduced is because the amount you can earn while you draw the benefit. More specifically, for every $2 your earned income is above a specified limit ($18,240 in 2020), your annuity supplement will be reduced by $1. Going back to the example above, if your annual annuity supplement in 2020 is $16,200 ($1350 per month) and you have earned income of $25,000, your annuity supplement will be reduced by $3,380 since your earned income is $6,760 over the earned income limit.
There are a couple of things to note when it comes to the earned income limit as follows:
• It only applies to earned income – think of earned income as income you receive for working, typically in the form of a salary, hourly or project-based wages and any income you earn from self-employment. What isn’t included is retirement income, including your FERS basic benefit, income from your investments or any gifts or inheritances you receive.
• It only applies to your earned income – the income limit is based only on your earned income. Even if you are married and jointly file taxes, your spouse’s earned income won’t count towards the earned income limit.
• If you are a retiring Special Provisions employee and you are retiring before the Minimum Retirement Age, the earnings test will not apply until you reach minimum retirement age.
• If you exceed the minimum earnings level and your supplement is reduced, you can file to restore the supplement amount if your earnings level decreases in a subsequent year. It’s worth noting that it will likely take some time to restore benefits, both because any change lags changes in income by a year and because the reinstatement process moves at a stately pace.
So what should you do about the earnings test if you think it will apply to you? When it comes to Social Security, we usually recommend clients forego beginning benefits before their Full Retirement Age if they think they might exceed the income limit. As with the FERS supplement, Social Security has an earnings limit if you are drawing benefits before full retirement age. Unlike the supplement, as we outline below, the earlier you draw Social Security before Full Retirement Age, the lower the Social Security benefit is. The reduction in the benefit amount is permanent. So, if you opt to draw early and then lose those early benefits because of the income limit, you are giving up higher benefits in the future in exchange for a reduced benefit – or even zero – benefit now. It’s a poor trade-off if you’re in a position to make early retirement work without starting Social Security.
The same isn’t true, however, for the FERS annuity supplement. The reason is there are three key differences between the FERS SRS and Social Security, and they are the following:
• Unlike Social Security, the amount of the supplement does not increase if you decide to forego drawing the supplement for a time. Thus, electing to draw the benefit immediately doesn’t reduce your future benefit.
• Your future benefit is limited since the supplement is only available until you reach age 62. That means most Federal employees will be able to take advantage of it for a few years.
• While this doesn’t impact the decision about whether to draw the supplement, it’s worth noting that the supplement does not have a cost-of-living adjustment. However, for most recipients the supplement is typically in place for just a few years, so the lack of a COLA has a minimal impact on the retirement plan.
When it comes to actually applying to receive the supplement, there is no separate application. If you qualify to receive it, OPM will include it when you begin drawing your FERS basic benefit.
What Should I Do When the Benefit Stops?
The answer to this question depends on your particular circumstances. While the benefit is meant to be a stand-in until you are eligible for Social Security at age 62, if your goal is to enjoy a long, financially stable retirement, it can often be best to wait to draw Social Security. As we mentioned above, the earlier you draw Social Security, the lower the benefit will be. Your Social Security benefit is focused on full retirement age, and for most people still working, that is between age 66 and 67.
If you begin drawing Social Security before your full retirement age, the Social Security Administration applies a benefit reduction formula to calculate your lower benefit. Bear in mind that the minimum age at which you can begin drawing your Social Security retirement benefit – which differs from survivor benefits – is age 62, so at most, there are 60 months between when you could begin drawing your Social Security retirement benefit and your full retirement age. The formula used to calculate your reduced benefit is as follows:
•Your benefit is reduced by 5/9ths of one percent for each month before normal retirement age, up to 36 months.
•For each month beyond 36 months, your benefit is reduced by 5/12ths of 1%.
Based on the formula above, if your full retirement age were 67 but you elected to draw as soon as you could, your benefit would be 30% lower at age 62. Additionally, as with your special retirement supplement, prior to Full Retirement Age, the benefit would be subject to an earnings test and reduced if your earned income was above the limit. The Social Security Administration has a helpful chart here that provides more detail on the impact of beginning your retirement benefits early.
At the other end of the spectrum, if you elected to delay your benefit beyond Full Retirement Age, you receive a credit for each year you delay until you reach age 70. Assuming
you were born in 1943 or after, that delayed retirement credit is 8%, meaning you get an 8% increase in your benefit for each year you delay beginning Social Security through age 70.
For a sense of how much difference these adjustments to your Social Security income can make, take a look at your Social Security statement. Assuming you’re under age 62, you’ll see estimates of your benefit at age 62, your full retirement age and age 70. Not everyone can afford to wait to draw Social Security, and in cases where life expectancy is short, not everyone should delay drawing benefits. However, you shouldn’t assume that just because your FERS supplement ends at age 62 that you should immediately begin Social Security either.
How Does the FERS Supplement Fit in My Retirement Plan? We find it’s helpful to think of approaching retirement as building a retirement paycheck. As a Federal Government employee, a sizable percentage of this “retirement paycheck” will likely come from predictable, guaranteed retirement income. In early retirement, the FERS SRS will be part of that paycheck, and in fact, the SRS coupled with FEHB retiree benefits can be the difference between being able to retire early and having to continue to work.
While the supplement stops early in retirement, there is a good chance your income later in retirement will be higher if you delay taking your Social Security benefits beyond age 62. Early retirees often have a good bit of fluctuation in income early in retirement and that brings both challenge and opportunity. The challenge is to build a plan that allows you to cover the gaps during periods of lower income, perhaps by taking planned TSP withdrawals.
The opportunity is that periods of lower income in retirement offer the opportunity to save thousands in income tax over the course of retirement. By carefully planning when to recognize income and shifting assets – and growth in those assets – from IRAs to Roths, you can
substantially reduce taxes later in retirement. This type of planning is more complex, but it is worthwhile if you expect your retirement to include low-income periods and you have saved a substantial amount in pre-tax accounts – like the traditional option in the Thrift Savings Plan.
I Understand How Much the FERS Supplement Will Be and How it Works. What Do I Do Next? Important Planning Question for Federal Employees.
Your FERS supplement is just one piece of your retirement puzzle, so you’ll want to begin assembling the other pieces and putting the whole picture together. In addition to the supplement, you’ll have the FERS basic benefit, Social Security and likely some retirement savings. If you’re retiring particularly early, you may even have earned income from a second career or part-time job.
On the other side of the ledger, there are expenses you’ll need to cover. Once you have that baseline established, you can move on planning for taxes, any portfolio withdrawals you might need to make, and stress testing your plan for poor market returns. There are tools to help you build your financial plan on your own. However, if you’d like professional assistance, we are financial advisors with extensive experience with Federal retirement benefits. Our process starts with a complimentary introductory call, and we would be happy to talk with you about your plans and how we might be able to help.