How the reconciliation bill may impact federal employee retirement planning

Terry Gerton: You know, we have been talking a lot about the federal benefit provisions that may or may not be in the reconciliation bill as it ultimately gets signed. But you’ve got a different angle here on what feds can do, not just worry, but what they can do to prepare. So let’s start there. Where should their mind be as they think about all of these different potential cuts to benefits?

Thiago Glieger: In financial planning, we have something called “sequence of returns risk.” And this is a component of when the market does something in years that you need to use your money. So, namely, retirement, someone that’s approaching or going to be leaving service, either because they’re retiring or they’re heading to another gig. And the long and short of it is that if the market is having a bad year, like it did earlier this year, and it’s also a year that you need to be using some of your money, this is actually one of the greatest risks in a financial plan. And this is called sequence of returns risk. And so if we combine the fact that when markets are volatile, plus we have a potential of needing to rely on our own portfolio or Thrift Savings Plan (TSP) more because we have reduced pension or we have loss of the supplement, then it stands to reason that federal employees need to be thinking a little more carefully about what they’re going to do if the markets misbehave again.

Terry Gerton: So the sequence of risk is not anything that’s in the bill, but kind of sets the stage for everything. Let’s take the potential benefit reductions kind of one at a time. First, supplement removal. What is that? What does it mean for people? And who might be most affected?

Thiago Glieger: So this is the Social Security light benefit that a federal employee may be eligible to receive if they’re retiring on an immediate basis, right? So if your income is going away, you’re gonna need to start generating that retirement paycheck. If you can’t file for Social Security because you’re not 62 yet, this is where that supplement is gonna be very valuable. And for a lot of feds, this could be something like 10, $20,000 a year. And so it’s quite significant. Now, there’s a couple of really important details. Actually, I think yesterday, we just got another update about this, where we thought that originally it was going to be effective immediately, but now we’re looking at a potential date of 2028, which is really great for anyone who was looking at separating later this year. But the key fact is, in financial planning, the way we want to be thinking and be prudent about this is always to be worrying about a worst case scenario, right? We want to plan for in case something doesn’t work out, the way that we anticipate it to be, we have a way to fall back on what we’re going to do to take care of ourselves. And so perhaps we need to be thinking about adjusting our budget for the loss of benefit a little bit sooner. And what is really important for someone is to focus on cash flow. So I often refer to our to cash flow as the heartbeat of financial planning. If the dollars going in and dollars going out can be matched, that’s the most important thing. So dollars that are going out or what we’re spending. So how are we gonna meet our spending needs? Well, taking money from our TSP is a big way of doing that, and if we have a reduced first supplement, bigger amounts need to come from the TSP. And we wanna be careful about where we take that money from. So things like the G Fund, it’s a really safe investment and allows a federal employee to not have their portfolio drop so that if the markets go down and they also go to take their money out, they’re doing it from a bucket that hasn’t lost value in the year and of course making that loss permanent.

Terry Gerton: But that budget adjustment for retirement is a big challenge to some people. Maybe best to start sort of working that in early before the retirement actually happens?

Thiago Glieger: Yeah, I’m so glad you brought that up. That’s a really important planning tactic that we often use with people. It’s to start thinking, maybe 12 months ahead of time, how can you start reducing your income, or rather your expenses, slightly? And even in small things. I mean, challenge yourself to live on maybe 10 or 15% less of your expenses. Obviously, we have mortgages and things like that that don’t go away. But if you can start to focus on having greater control of your expenditures. It may be your wants and desires, not necessarily your needs. That allows you to become more comfortable in doing that kind of thing if you head into retirement and all of a sudden now you no longer have a supplement you were planning on before.

Terry Gerton: So this might not be the year for that around the world cruise expense.

Thiago Glieger: That’s right, especially in years that the portfolios are really heavily impacted. It’s a year where we look to those extra activities and thinking about, do we really need to take Could we wait on this, as opposed to having a greater security around our retirement? And I think too, the other thing I want to caution feds about this is, the market started out a little rough in the year and you look at portfolio balances, everyone seems to be really happy again. It’s like everything is back to normal again. But we also have this idea of what we call a “bull trap.” A bull market is when the markets go up. And even though a year could end in a negative at the end of the year, there’s a lot of moments in that year where it seems like the markets have come back again and everything is fine. And so you wanna be careful that you don’t overexpose yourself back into stocks again, like the CS&I funds, just because it seems everything is okay, could still mean that the markets are still volatile later in the year.

Terry Gerton: So let’s take the second point that’s in this bill, which is a change from the high three to the high five. What does that mean for folks and how should they factor that into their retirement plan?

Thiago Glieger: So now that we’re pretty confident that this change is going to be ones that are going to make the final bill, there’s some important considerations around this one. Obviously, it means that anyone retiring is going be looking at a lower pension amount, possibly thousands of dollars each year. So this is going very greatly depending on salary and especially if anyone was promoted over the last five years, since the formula is going to now include five years worth of your salary. So the key thing here is to focus on cash flow. How much more? Are you going to need to support your lifestyle and how much lower is that guaranteed income going to be? So if your pension is lower and maybe you no longer earn the supplement like we talked about, you now have to fill those gaps yourself. So that’s X dollars more per year that you’re going to from your portfolio. And I really like to have federal employees focus on those five first years of retirement. The reason being is on average, that’s about two negative cycles where the markets return back to normal again, about two and a half years is how long it takes. So five years covers two of those. And so when you set up your investment buckets, you want to have at least five years worth of income so that you can support yourself regardless of what’s happening in the markets. If you’re going to need an extra $10,000 per year as a result of these changes, now you’re looking at $50,000 more in that conservative bucket in your TSP.

Terry Gerton: So you’re talking about a lot of math here and a lot estimations. There’s another big cost, though, that federal employees could face, and that’s health care inflation. How is that rolled into this sort of benefit calculation?

Thiago Glieger: That’s a really important thing, Terry, because the challenge with health care inflation is that it is not like any other inflation. When we see regular inflation around food, gas and other things for health care, it is usually twice as fast in terms of the cost growing, and that becomes really challenging over time. One of the big changes that were being proposed and so far, it looks like it may not actually make it to the bill is changing to the voucher model. The government covers about 73 percent of the premium for Federal Employees Health Benefits Program, which is important because health care providers like Blue Cross Blue Shield and all of the other carriers, they’re going to adjust those premiums based off of the cost of health care. If health care rises twice as fast in cost compared to everything else, then those premiums are going to be rising twice as faster as well. And a lot of times people thinking about their retirement and their cost to take care of themselves aren’t really factoring in how much more expensive that health care going to be. Then there’s the long-term care side of things as well, which as we know, federal long- term care insurance is not an option anymore for anyone’s not in the program, so this healthcare and taking care of yourself as you progress through retirement, it’s a big expense we can’t ignore.

Terry Gerton: And no matter how healthy you are at that point of retirement, the big expenses are for sure in your future, right?

Thiago Glieger: That’s right. If we don’t have your health, you don’t have anything at all.