Phased Retirement Q&A

Last month, I wrote about the new phased retirement option for federal employees, enabling them to work part time while they start to draw retirement benefits.

That column sparked a series of questions and comments about how the new provision will be implemented. I thought I’d tackle some of them this week.

Will the phased retirement also forestall required minimum distributions from the Thrift Savings Plan?

My associate, Bob Leins (a certified public accountant with NITP Inc.), posed this question to TSP officials and they pointed him to a section of the law that enacted the phased retirement option, which states that for certain defined purposes, “a phased retiree shall be deemed to be an employee.”

According to the TSP, this means no employee is entitled to treat phased retirement as a separation for plan withdrawal purposes. That in turn means employees will not be subject to required minimum distributions (which are compulsory after participants are age 70 ½ and retired) until they are fully retired.

Employees in phased retirement can continue to make contributions to the TSP and are eligible to make any withdrawals they are allowed to make as employees (whether age-based or due to financial hardship). Also, employees in phased retirement will remain eligible to receive TSP loans and to repay them through payroll deduction. If an employee has a TSP loan upon entering phased retirement status, he or she will not have to prepay the loan, nor will it be declared a taxable distribution.

Could the phased retiree qualify for a Federal Employees Retirement System supplement? If so, would it be prorated?

I’m not sure on this one yet, but since the FERS supplement is tested for outside earnings, it most likely would be reduced to nothing as a result of the partial earnings of the phased retiree.

The earnings limit is $14,640 for 2012. The supplement is reduced by $1 for every $2 earned above this limit. So if a phased retiree was receiving 50 percent of a $70,000 salary ($35,000), this would be $20,360 above the earnings limit and would reduce the supplement by more than $10,000 -- most likely eliminating it altogether. The supplement is worth approximately $35-$40 per month for every year worked as a civilian federal employee under FERS. Thirty years of service would provide a supplement of around $1,200 a month. If it was paid at 50 percent, it would be cut to $600, whereupon the earnings limit would reduce it to zero.

What's good for the government is not always good for the employee. A retirement-eligible worker with 36 years of service and making $80,000 per year is eligible to receive roughly $56,000 in retirement pay if fully retired. An employee taking half-time phased retirement would get $28,000 (half retirement pay) and $40,000 (half of regular salary) for a total of $68,000, which is $12,000 more than collecting full retirement. That means the employee is earning $11.50/per hour ($12,000 divided by 1,040 hours) for the part-time work for which he or she was paid $38.40 per hour while fully employed. I don’t think many employees will take the offer to get paid roughly 30 cents on the dollar for the same work. No wonder the bill was passed. It’s another no-win for the employee.

I see what you’re saying, but the reasons for taking a phased retirement would be more comprehensive than just looking at the difference between one’s full retirement benefit and the amount being paid for partial retirement and partial salary. Even employees who continue to work full time when they are eligible for retirement are working for the difference between their retirement benefit and their full salary. Yet many continue to do so because they can increase the amount of their lifetime retirement benefit and make additional contributions to the Thrift Savings Plan. This allows them to have a more comfortable retirement once they make the decision to fully retire.

Sometimes, a partial retirement can make the mental transition to full retirement a little easier on the employee. Kevin Cahill, a research economist, has written an article called “Thinking About Phased Retirement?” that explores some of the benefits of the phased approach.

I predict phased retirement will not be popular and little used.

Have ye no faith, my friend? My prediction is the option will be welcomed by many federal employees who are eligible to retire, but just not ready to jump in head first. I’ve been polling people at my preretirement seminars, and in most cases I’m getting a better than 50 percent favorable response to the idea.