PART-TIME
FEDERAL EMPLOYEE RETIREMENT BENEFIT INEQUITIES
Introduction:
The Federal government retirement system frequently undergoes changes. It is not uncommon that benefits are reduced or increased. In the former case, often benefits are "grandfathered" so that they only affect future portions of an employee's career or future employees. It is seldom, if not unprecedented, that rules are enacted that provide benefits to future employees and yet act to the detriment of a set of current employees under a common retirement benefit system.
This is precisely the case, however, that applies to employees with a large proportion and large segment of full-time service who converted to part-time near or after changes made in 1986 to the way part-time retirement benefits are calculated. This paper will illustrate how the two-step formula put into place in 1986 is extremely unfair to this group of employees. A simple, equitable fix permitting an alternate calculation applying current rules to an employee's career will be proposed.
How to Compute Part-Time Retirement and Changes Made in 1986
Part-time retirement benefits are governed by the CSRS and FERS Handbook. The rules for retirement benefit calculations are statutorily based and require an act of Congress for change. Prior to 1986, part-time retirement benefits were made using actual high-3 salaries received by the employee and fully counting part-time years toward length of service. Post-1986 part-time retirement benefits use deemed high-3 salaries (full-time pay) and make an adjustment by using a factor which is the ratio of actual hours worked to the total number of hours that could have been worked over an employee's career.
Rather than just change the formula for part-time retirement benefit calculations in 1986 (which might arguably have been the best solution), the rules provided for a two-step benefit calculation. Pre-1986 rules were applied to service before April 6, 1986 and post-1986 rules were applied to service after 1986.
Three examples are shown at the end of this document. [Note that all examples are written from the standpoint of CSRS employees, who constitute roughly ½ of current federal employees. FERS employees are overwhelmingly likely to have been hired since 1986 and are fairly treated with the new rules. CSRS effects are exacerbated by the fact that there are no other components of their retirement system, such as the Thrift Savings Plan or Social Security, that might mitigate adverse treatment of part-time retirement benefits. 3 day (60%) a week part-time employment is used in all examples - other part-time employment schedules are proportionately affected. For ease of calculation, a high-3 full-time annual salary of $50,000 or $30,000 part-time is used. It is assumed the career spans 30 years centered on April 6, 1986.]
Example A illustrates how the calculations work. In Example A, an employee works a constant part-time schedule their entire career. Splitting the career into two 15 year segments around 1986 and using the two-step formula, one calculates a pre-1986 pension component and a post-1986 pension component. The pension is the sum of these components.
The first calculation in Example A and other examples is a "Will Receive" amount for the particular part-time work profile. The first part of this calculation is the pre-1986 component. The actual high-3 annual salary of $30,000 is multiplied by .2625 yielding $7,875 per year. (A CSRS employee receives 1.5% of the high-3 salary for each of the first 5 years of service, 1.75% for each of the second 5 years of service, and 2 % for all remaining years of service. The first 15 years of service earn 26.25% of the high-3. The second 15 years earn 30% of the high-3.) The second component multiplies the deemed full-time rate of pay of $50,000 per year by .30 (2% each year for the second 15 years of service) and by a factor of 0.60. The factor 0.60 occurs because the employee has worked only 3/5 of the full-time schedule available over this time segment. The second component is $9,000 per year. The pension is the sum of these components, or $16,875 per year.
The second calculation in Example A and other examples is a "Should Receive" amount. It applies the post-1986 rules to the entire career. Most people would agree this is the way benefits should be calculated - that a person working an average 3/5 schedule over their entire career should get 60% of the pension amount. The full-time high-3 salary is multiplied by .5625 or the CSRS percentage for 30 years of service and by 0.60 to adjust for part-time service. The result is $16,875 per year.
The third calculation in Example A and other example is a "Could Have Received" amount. It applies the pre-1986 rules to the entire career. The high-3 actual salary of $30,000 per year is multiplied by .5625 or the CSRS percentage for 30 years of service. The pension through this method is $16,875 per year.
Why Were the Rules Changed if the Pension is the Same?
Indeed, the pension calculated by all three methods in Example A is the same. But that is not necessarily so. Let us look at Example B, which is the reason for the change. In it, a career part-time employee takes advantage of the old way the part-time pension is calculated to game the system. The person changes to full-time for the last three years of their career to obtain benefits that most people would agree are not earned.
Focus initially on the third "Could Have Received" calculation using the pre-1986 rules in Example B. By converting to full-time, an actual high-3 annual salary of $50,000 is multiplied by .5625 (the CSRS percentage for 30 years of service). The pension the person could have received is $28,125 per year.
Contrast that amount with the second "Should Receive" calculation using post-1986 rules. This calculation adds the factor adjusting amount of time actually served over the 30 years to the amount of time that would have been served had the person been a full-time employee. In this case, the percentage is slightly higher than 60% because the person works full-time for 10% of their career. The resulting factor is .64 and the pension the person should receive is $18,000 per year.
The "Will Receive" calculation in Example B shows how much the employee will receive though use of the two-step computation. It is higher than the "Should Receive" amount because the early years get treated as if the employee is full-time. The second portion of the career gets the should receive treatment. The changes in 1986 preserved the ability of this employee to take advantage or game the system to the time of the changes, but prevented this in the future. The pension is an intermediate amount between what the person should have received using the new rules and could have received using the old rules.
Comparing Example B to Example A, one could come to the conclusion that the changes in 1986 allowed a permanent part-time employee to take advantage of the system and receive a pension greater that they deserved by converting to full-time, but offering no penalty if they did not. They essentially end up in a win/no-lose situation and should have been happy with the two-step computation method. In the short term after 1986, this may have even made a degree of sense. This employee may have planned their career with this in mind, and an abrupt change at the last minute may not have allowed time to adjust. The further one gets from 1986, however, the greater the potential negative effect of these changes on another group of part-time employees who have earned benefits and have nothing to gain but much to lose from the changes.
Those Unfairly Treated by the Post-1986 Two-Step Retirement Benefit Formula
Example C part-time employees fare much worse from the changes made in 1996. These are employees who have worked a significant number of years full-time prior to 1986 and who converted to part-time either shortly before 1986 or any time after 1986.
Calculation 1 in Example C shows the "Will Receive" benefits they will obtain upon retirement. They receive proper credit for the work they perform subsequent of 1986. However, the actual salary applicable to the first part of the two-step benefits calculation formula comes from the part-time work segment. Inflation, cost of living adjustments (almost 50% cumulative since 1986), step increases, and promotions make their actual part-time end salary greater than their full-time salary 15 years earlier. Using the $30,000 per year part-time actual salary in the first part of the calculation undervalues this full-time work.
Comparing Calculation 1 of Example C and Example A, one should observe that they are the same. A full-time employee who converted to part-time with this work profile receives the same retirement benefit ($16,875 per year) as the permanent part time employee retirement - despite the fact the full-time employee who converted to part-time has worked 33% more during the course of their career than the permanent part-time employee.
Calculation 2, the "Should Receive" value, shows that an employee with this work profile should receive $22,500 per year at retirement. This calculation is arrived at by applying the fair post-1986 formula to the employee's entire career. The amount this employee will receive ($16,875 per year) is 25% less than what they should receive ($22,500 per year).
Calculation 3 shows what this employee "Could Have Received" if the pre-1986 rules had been applied to their entire career. This employee would have had the opportunity to take advantage or game the system and receive benefits of $28,125 per year or 25% greater than what they should receive -- but only in the purely hypothetical situation that assumes the rules had not been changed in 1986 and the old rules were applied to post-1986 part-time employment.
An employee in this situation could return to work full-time at the end of their career. In this case they would receive the "Should Receive" benefits. (The actual amount is about 4% higher than in calculation 2, but it is derived from having worked 4% more actual time). There is no guarantee, however, that the employee will have this opportunity. The employer is under no obligation to allow the worker to return full-time. And the employee (by virtue of health, family, or many other reasons) may be precluded from this option.
It ends up that the best that a part-time employee who converted from full-time around mid career when system changes were being made can do is adopt a strategy (not always available - people convert to part-time employment for reasons) that allows them to break even and obtain what they should obtain. If they cannot, for some reason, return to work full-time at the end of their career, their pension is reduced by 25% from what they should receive.
The old system would also have resulted in the same "Will Receive" amount for this employee, which was also arguably unfair. The difference is that at least the employee may have had an opportunity for gain (the "Could Receive" calculation) and hence an element of fairness was present. The "Will Receive" calculation represented the risk and the "Could Receive" represented the reward in this win/lose scenario. Chart 1 illustrates the range of risk/reward depending on the proportion of full-time versus part-time work performed in the early segment of an employee's career. Someone converting to part-time after April 6, 1986 will always find their pension reduced from what they should have earned for service performed prior to this date.
Most people would choose not to gamble with their retirement, however. Worse still, a number of employees were put in a no-gain/lose situation by the 1986 changes. In effect, the potential risk was grandfathered for these employees and the potential reward was taken away. No rational person or retirement compensation system would choose to operate in such a manner.
The Solution
Fortunately, there is a fair and simple solution to the dilemma in which part-time employees of this type are placed. The CSRS and FERS Handbook should be modified to allow an alternate calculation which applies the new proration factor for part-time employees to their entire career. This allows them to obtain retirement benefits equivalent to what is deemed fair by today's standards -- which they have earned.
The cost of such a change to the retirement system would be insignificant. Part-time workers constitute only about 3% of the federal workforce and only a fraction of this number would be affected by changes permitting an alternate computation.
Although the numbers are small from a system standpoint, they are big to the people involved. Asking a part-time employee, who already receives benefits that are reduced by virtue of their part-time employment, to take a further cut of 25% or more from what they have earned because of unfair computation procedures is unprincipled. It is time to do the right thing and permit part-time workers to receive the retirement benefits they have earned. It is time to sponsor and pass the Part-Time Federal Employee Retirement Benefit Fairness and Equity Technical Corrections Act of 1999!
Example A
Career Part-Time Employee
This employee works 3-days a week part-time their entire career.
1. "Will Receive" - Retirement Benefits Calculation as the Two Part Formula is Currently Applied:
Pension = $30,000/year x .2625 + $50,000/year x .30 x .60
= $7,875 + $9,000
= $16,875 per year
2. "Should Receive" - Retirement Benefits Calculation if the Pension is Calculated Using the Post-1986 Formula Applied to the Entire Career:
Pension = $50,000/year x .5625 x .60
= $16,875 per year
3. "Could Have Received" - Retirement Benefits Calculation if the Pension is Calculated Using the Old Pre-1986 Formula Applied to the Entire Career:
Pension = $30,000/year x .5625
= $16,875 per year
Example B
Part-Time Employee Who Converts To Full-Time at Career End
This employee works part-time their entire career and
converts to full-time at the end.
1. "Will Receive" - Retirement Benefits Calculation as the Two Part Formula is Currently Applied:
Pension = $50,000/year x .2625 + $50,000/year x .30 x .69
= $13,125 + $10,350 (The employee averaged .69 years of employment each year over the last 15 years of the career .)
= $23,475 per year
2. "Should Receive" - Retirement Benefits Calculation if the Pension is Calculated Using the Post-1986 Formula Applied to the Entire Career:
Pension = $50,000/year x .5625 x .64
= $18,000 per year
3. "Could Have Received" - Retirement Benefits Calculation if the Pension is Calculated Using the Pre-1986 Formula Applied to the Entire Career:
Pension = $50,000/year x .5626
= $28,125 per year
Example C
Full-Time Employee Who Converts to Part-Time at Mid-Career
This employee works full-time and then converts at mid-career
to three days a week part-time until the end of their career.
1. "Will Receive" - Retirement Benefits Calculation if the Person Converted to Part-Time slightly before the1986 changes as the Two Part Formula is Currently Applied:
Pension = $30,000/year x .2625 + $50,000/year x .30 x .60
= $7,875 + $9,000
= $16,875 per year
2. "Should Receive" - Retirement Benefits Calculation if the Entire Career Uses the Post-1986 Formula Applied to the Entire Career:
Pension = $50,000/year x .5625 x .80 (The employee averaged 4/5 of full-time employment over the entire career resulting in the .80 factor)
= $ 22,500 per year
3. "Could Have Received" - Retirement Benefits Calculation if the Employee Converts Back to Full-Time for 3 years at the End of the Career and the Old Pre-1986 Formula Had Been Applied to the Entire Career:
Pension = $50,000/year x .5625
= $28,125 per year
Chart 1
Potential Percentage Loss and Gain from the Earned "Should Receive"
Component of the Pension for the First 15 Year Career Segment
This chart is constructed for a full-time employee converting to three days a week part-time service with 15 years of the employee's service occurring before April 6, 1986. The number of years of full-time service out of the total of these 15 years is shown on the x-axis.
For example, with the change from the old computation rules, an employee with 15 years of full-time service out of the 15 years prior to April 6, 1986 has the risk of the pension amount received for this 15 year segment being reduced by 40% ($13,125 per year to $7,875 per year) and no opportunity for gain. An employee with no full-time service under the old rules has no potential loss and could gain up to 67% ($13,125 per year from $7,875 per year) more than they should receive. An employee with 10 years of full-time service out of this 15 year segment, has the potential for a 31% loss and a 15% gain.