Academic journal article Social Security Bulletin

Comparing Replacement Rates under Private and Federal Retirement Systems

Academic journal article Social Security Bulletin

Comparing Replacement Rates under Private and Federal Retirement Systems

Article excerpt

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.

Summary and Introduction

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 401(k)-type plan known as the Thrift Savings Plan (TSP).

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:

* Excluding Social Security benefits and TSP and defined contribution annuities, CSRS retirees have a higher pre-retirement salary replacement rate than either FERS or private-sector retirees. Private-sector retirees, however, have a higher replacement rate than their FERS counterparts.

* Including Social Security benefits but not TSP and defined contribution plan annuities, CSRS retirees who are maximum earners have a higher preretirement salary replacement rate (despite receiving no Social Security benefits) than FERS retirees with the same earnings. Private-sector retirees in all earnings categories have a higher replacement rate than federal retirees with the same earnings.

* Including Social Security and TSP and defined contribution plan annuities, private-sector retirees in all earnings categories have a higher replacement rate than all federal retirees, but their rate is close to that of FERS retirees. The rate is higher for FERS retirees than for CSRS retirees in all earnings categories.

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. …

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