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How to trump early federal retirement part III: 'alternative fines'

So far in this series we have reviewed the budget and workforce proposals from the new administration, we outlined the basic eligibility requirements for retirement, and explored the additional options available to FERS employees with five or more years of service.

*Please note that Part IV was erroneously published before Part III*

So far in this series we have reviewed the budget and workforce proposals from the new administration, we outlined the basic eligibility requirements for retirement, and explored the additional options available to FERS employees with five or more years of service. 

There are enough complex moving parts in these scenarios that no article series will suffice to provide the “right answer” for each individual’s situation. This series is meant to help enlighten you to the options available but when retiring early it is especially critical to find an expert with whom to further discuss coordinating these moving pieces.

Early Distribution Penalty

Let us first look at the Early Distribution Penalty. This is an IRS enforced rule that is designed to protect your retirement assets from being utilized before retirement age. It is a 10 percent penalty assessed on Qualified Money (tax deferred funds from IRAs, 401(k)s, the TSP, and other qualified plans) accessed by the account owner prior to attaining age 59 1/2. When tacked on to both federal and state Income Taxes, this penalty often causes pre 59 1/2 distributions lose 40 percent plus of the withdrawal. So when retiring early, it is important to realize that relying on qualified funds comes at a very hefty price — as it should —being that early utilization is not the intended use of those funds.

But in a pinch, many federal employees are unaware of the acceptation the IRS has made for TSP participants that separate from service in the year they turn 55 (or after). Participants meeting that simple requirement can receive funds from the TSP without the 10 percent penalty. If they rolled those funds over into an IRA and then took a distribution from the IRA then the 10 percent penalty would be assessed—it is only TSP distributions to retirees age 55 or over that are exempt. 

For those who have funds in other qualified plans, there is another way of averting the 10 percent penalty. This is a more complex strategy, but for someone under 59 1/2, who had funds in a qualified plan, they could avoid the 10 percent penalty through the use of SEPPS (Sequentially Equal Periodic Payment Schedule) also known as the 72(t) rule. As the name implies, this is a payment plan that allows you to receive those funds penalty free (although normal income taxes are still assessed) so long as you follow the specific rules for SEPPs.

Special Retirement Supplement

The Special Retirement Supplement (FERS Supplement) is a supplemental income complimenting a FERS pension to bridge the gap between MRA and age 62. This payment comes from OPM and is calculated based on a percentage of your anticipated Social Security benefit at age 62. Receiving this additional income does not reduce your Social Security benefit though, it is “free money!” The benefit ends when you first qualify for Social Security, regardless of whether your elect to begin receiving Social Security benefits or not. This “free money” is not available to those that take an MRA+10 retirement, a postponed retirement, nor a deferred retirement.  For those that do qualify for it, keep in mind that it is wage earnings tested in the same way your Social Security benefits are prior to your full retirement age (more on this in part 4). When considering an early retirement that would forfeit the SRS, understand that over the course of 5-6 years (MRA to 62) we are often giving up thousands of dollars of “free money”.

The calculation for your SRS payment is:
(# years of service/40) x (SS monthly benefit at 62).

Forfeited Colas

With each of the aforementioned early retirement options, COLAs are suspended until age 62. Giving up years of compounding COLAs can have a bigger long term impact than you think, especially when you consider that your retirement election decisions can impact the compounded COLAs for your survivors as well!  Since 1999 the FERS COLA has averaged 1.75 percent and since 1999 inflation has averaged closer to 2.5 percent, meaning the cost of “life” is growing faster than the COLAs and obviously has a much more erosive effect on the spending power of your pension payments without any COLAs.

If your early retirement is indeed the end of your working career, you are asking a truncated retirement nest egg to provide a larger portion of your retirement income (due to pension reductions, forfeited SRS, losing the FEHB subsidy, and suspended COLAs) stretched thinner over additional years of retirement with the additional penalties for accessing qualified funds early… drats!

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