Federal Employees’ Retirement System: Budget and Trust Fund Issues

Summary: Most of the civilian federal workforce is covered by one of two retirement systems: (1) the Civil Service Retirement System (CSRS) for individuals hired before 1984 or (2) the Federal Employees' Retirement System (FERS) for individuals hired in 1984 or later. FERS annuities are fully funded by the sum of employee and employer contributions and interest earned by the Treasury bonds held by the Civil Service Retirement and Disability Fund (CSRDF). The federal government makes supplemental payments into the CSRDF on behalf of employees covered by the CSRS because employee and agency contributions and interest earnings do not meet the full cost of the benefits earned by employees covered by that system.

Summary: The Office of Management and Budget (OMB), in its FY2020 Budget, estimated that in FY2019, obligations from the CSRDF would total $88.4 billion, of which $87.9 billion will represent annuity payments to retirees and survivors. Other outlays consist of refunds, payments to estates, and administrative expenses. Obligations from the fund are projected to increase by 3.7% to $91.7 billion in FY2020, of which $91.3 billion will represent annuity payments. OPM estimated that receipts to the CSRDF from all sources would be $104.4 billion in FY2019 and $108.8 billion in FY2020. The year-end balance of the CSRDF was projected to increase from $915.3 billion at the end of FY2018 to $931.4 billion at the end of FY2019.

Summary: According to the most recent reporting from the Office of Personnel Management, the total annual income of the CSRDF will increase from $124.9 billion in FY2018 to an estimated $151.0 billion in FY2025 and to $759.9 billion in FY2090. The total expenses of the fund are projected to rise more slowly, increasing from $85.8 billion in FY2018 to an estimated $104.9 billion in FY2025 and to $506.6 billion in FY2090. Consequently, the assets held by the CSRDF also are projected to increase steadily, rising from $947.8 billion in FY2018 to an estimated $1.2 trillion in FY2025 and $10.6 trillion in FY2090. Expenditures from the CSRDF currently are about 40% as large as federal expenditures for the salaries and wages paid to federal employees. Pension expenditures are projected to decline relative to the government's wage and salary expenses, beginning around FY2020. By FY2090, the expenditures of the CSRDF are estimated to be only about 32% as large as the government's expenditures for wage and salary payments to employees.

Summary: Because CSRS retirement benefits have never been fully funded by employer and employee contributions, the CSRDF has an unfunded liability. The total unfunded liability of the CSRDF was $968.1 billion in FY2017. According to actuarial estimates, the unfunded liability of the CSRDF has already peaked, will steadily decline, and is projected to be eliminated by FY2085. Actuarial estimates indicate that the unfunded liability of the CSRS does not pose a threat to the solvency of the trust fund. There is no point over the next 80 years at which the assets of the Civil Service Retirement and Disability Fund are projected to run out.

Pensions for civilian federal employees are provided through two programs, the Civil Service Retirement System (CSRS) and the Federal Employees' Retirement System (FERS). CSRS was authorized by the Civil Service Retirement Act of 1920 (P.L. 66-215) and FERS was established by the Federal Employees' Retirement System Act of 1986 ( P.L. 99-335 ). Under both CSRS and FERS, employees and their employing agencies make contributions to the Civil Service Retirement and Disability Fund (CSRDF), from which pension benefits are paid to retirees and their surviving dependents. Retirement and disability benefits under FERS are fully funded by employee and employer contributions and interest earned by the bonds in which the contributions are invested. The cost of the retirement and disability benefits earned by employees covered by CSRS, on the other hand, are not fully funded by agency and employee contributions and interest income. The federal government therefore makes supplemental payments each year into the civil service trust fund on behalf of employees covered by CSRS. Even with these additional payments into the trust fund, however, CSRS pensions are not fully pre-funded.

Prior to 1984, federal employees did not pay Social Security payroll taxes and did not earn Social Security benefits. The Social Security Amendments of 1983 ( P.L. 98-21 ) mandated Social Security coverage for civilian federal employees hired on or after January 1, 1984. This change was made in part because the Social Security system needed additional cash contributions to remain solvent. Enrolling federal workers in both CSRS and Social Security, however, would have resulted in duplication of some benefits and would have required employee contributions equal to more than 13% of workers' salaries. Consequently, Congress directed the development of the FERS, with Social Security as the cornerstone. The FERS is composed of three elements: (1) Social Security, (2) the FERS basic retirement annuity and the FERS supplement, and (3) the Thrift Savings Plan (TSP). Most permanent federal employees initially hired on or after January 1, 1984, are enrolled in the FERS, as are employees who voluntarily switched from CSRS to FERS during "open seasons" held in 1987 and 1998.

Retirement plans are classified as either defined benefit (DB) plans or defined contribution (DC) plans. In a DB plan, the retirement benefit typically is based on an employee's salary and years of service. Under federal law, a DB plan must offer participants the option to take their benefit as a life annuity. A DC planâfor example, a 401(k)âis much like a savings account maintained by the employer on behalf of each participating employee. The employer or the employee or both contribute to an account, which is invested in assets such as stocks and bonds. In some DC plans, the amount of the employer contribution depends on how much the employee contributes from his or her pay. When the worker retires, he or she receives the balance in the account, which is the sum of all the contributions that have been made plus interest, dividends, and capital gains (or losses). This is usually paid as a lump-sum, but the employee sometimes has the option to receive benefits as a series of fixed payments over a period of years or as an annuity.

An important difference between DB plans and DC plans is that the employer bears the financial risk in a DB plan, whereas the employee bears the financial risk in a DC plan. In a DB plan, the employer promises to provide retirement benefits equal to a certain dollar amount or a specific percentage of the employee's pay. Under federal law, employers in the private sector are required to pre-fund these benefits by setting aside money in a trust fund, which is typically invested in stocks, bonds, and other assets. The employer is at risk for the full amount of retirement benefits its employees have earned. If the assets held in the pension fund are worth less than the present value of the benefits that have been accrued under the plan, the employer is required by law to make up this deficitâcalled an unfunded liabilityâthrough additional contributions over a period of years.

In a DC plan, it is the employee who bears several types of risk, including the risk that markets will decline ( market risk ), the risk that specific investments he or she chooses will fall in value ( investment risk ), and the risk that the employee may outlive their retirement assets ( longevity risk ). If the contributions to the account are inadequate, or if the securities in which the account is invested lose value or increase in value too slowly, the employee risks having an income in retirement that is too small to maintain his or her desired standard of living. If this situation occurs, the worker might find it necessary to delay retirement.

Pre-funding of Pension Benefits in the Private Sector

Private-sector employers are not required to provide retirement plans for their employees, but those that do must comply with the Employee Retirement Income Security Act of 1974 (ERISA; P.L. 93-406 ). ERISA sets standards that plans must meet with respect to reporting and disclosure, employee participation and vesting, plan funding, and fiduciary standards.

Because employers cannot be certain that their revenues in future years will be sufficient to pay the pension benefits they owe to retired workers, ERISA requires companies to pre-fund DB pension obligations. Pre-funding of DB pensions protects employees who have earned the right to receive a pension, even if the firm goes out of business. Employers in the private sector pre-fund their DB pension liabilities by establishing pension trusts, which are invested in assets such as stocks and bonds. ERISA also established the Pension Benefit Guaranty Corporation (PBGC), which pays pension benefits (up to limits set in law) in the event that a company goes out of business with an underfunded pension plan. The PBGC is funded by premiums paid by employers that sponsor defined benefit pensions. It does not insure defined contribution plans.

Pre-funding DB pension benefits is consistent with the principles of accrual accounting, in which a firm's assets and liabilities are recognized in its financial records as they accrue, as opposed to waiting until cash is received or paid out. By providing for future pension liabilities as they are incurred, the firm is recognizing that the pension benefits that it must pay in the future are part of the cost of doing business today. When an employer fails to set aside enough money each year to pay the retirement benefits accrued by its workers that year, it accumulates an "unfunded liability." ERISA requires any employer that develops an unfunded liability in its defined benefit pension plan to make additional contributions over a period of years until the plan's assets equal the present value of its liabilities.

Pre-funding of Federal Employee Pension Benefits

When CSRS was established in 1920, it was not pre-funded. Benefits paid to federal retirees were paid from current contributions to the plan. Because the federal government is not likely to go out of business, it could have continued to pay the pensions earned by federal employees on a pay-as-you-go basis. Nevertheless, when Congress established FERS in 1986, it required all pension benefits earned under FERS to be fully pre-funded by the sum of employer and employee contributions and the interest earned by the U.S. Treasury bonds held by the Civil Service Retirement and Disability Fund. Congress required pre-funding of FERS retirement benefits so that federal agencies would have to recognize these costs in their budgets. Pre-funding promotes more efficient allocation of resources between personnel costs and other expenses because it forces federal agencies to recognize the full cost of employee compensation when they prepare their annual budget requests.

The assets in private-sector pension funds represent a "store of wealth" that firms can use to meet pension obligations as they come due. The CSRDF, however, is not a store of wealth for the federal government. The fund is required by law to invest exclusively in U.S. Treasury bonds. These bonds represent budget authority , which is the legal basis for the Treasury to disburse funds. When the CSRDF redeems the Treasury bonds that it holds, the Treasury must raise an equivalent amount of cash by collecting taxes or borrowing from the public.

If the CSRDF held assets that earned a higher average rate of return than U.S. Treasury bonds, some of the future cost of civil service retirement annuities could be paid from these higher investment returns. However, in the short run, allowing the CSRDF to invest in private-sector securities such as corporate stocks and bonds would result in higher federal expenditures, which would be required to purchase such private-sector securities. The trust fund's two main sources of income are employee contributions and contributions from federal agencies on behalf of their employees. Employee contributions are income both to the federal government and to the trust fund. Agency contributions, however, are income to the trust fund, but they are not income to the federal government. Agency contributions to the CSRDF are intragovernmental transfers that have no effect on the government's annual budget deficit or surplus.

Currently, most outlays from the trust fund are benefit payments to annuitants. If the CSRDF were to purchase private-sector assets rather than U.S. Treasury bonds, an outlay from the trust fund would be required to purchase these assets. If employee contributions were used to purchase private-sector assets, they would no longer be income to the Treasury, and they would increase the federal budget deficit by the amount diverted to purchase private-sector assets. Agency contributionsâcurrently an intragovernmental transferâwould instead be used to purchase private-sector assets and would be a new outlay of funds from the Treasury.

Over the long run, however, purchasing private-sector assets would not increase the budget deficit, and could reduce it. Outlays would be moved from the futureâwhere they would have occurred as benefit paymentsâto the present, where they would occur to purchase assets. If the net rate of return on private-sector securities exceeded the rate of return on Treasury bonds, the extra investment income earned by the trust fund would reduce the amount of tax revenue that would have to be raised from the public in the future to pay pension benefits under CSRS and FERS. Such a change in policy, however, would raise important questions about the federal government owning private-sector assets, and also could result in greater volatility in the value of the assets held by the trust funds.

Financing Retirement Annuities for FederalÂ Employees

Under both CSRS and FERS, retirement annuities are based on (1) the employee's years of service, (2) the average of the employee's highest three consecutive years of salary, and (3) the benefit accrual rate. Workers covered by CSRS accrue benefits equal to 1.5% of pay for their first five years of service, 1.75% for the next five years, and 2.0% of pay for each year of service beyond the 10 th year. Under CSRS, an employee with 30 years of service will have earned an annuity equal to 56.25% of the average of his or her highest three consecutive years of pay. Employees enrolled in FERS accrue benefits equal to 1.0% of pay for each year of service. If they have worked for the federal government for 20 or more years and retire at age 62 or older, the accrual rate under FERS is 1.1% for each year of service. With 30 years of service, an employee enrolled in FERS will have earned a pension equal to 30% of the average of his or her highest three consecutive years of pay, or 33% if the individual is 62 or older at retirement.

Federal agencies pre-fund employee pensions by deferring some of their budget authority until it is needed to pay pensions to retired workers. Federal agencies defer this budget authority by transferring it to the CSRDF. The Treasury credits the fund with the appropriate amount of budget authority in the form of special-issue bonds that earn interest equal to the average rate on the Treasury's outstanding long-term debt. The CSRDF can redeem these bonds to pay pensions to retirees and survivors.

Federal employees have mandatory contributions to the CSRDF deducted from their paychecks. Employees who are under the CSRS contribute 7.0% of basic pay to the CSRDF. Employees under FERS first hired before 2013 contribute 0.8% of pay to the CSRDF and 6.2% of wages to the Social Security trust fund for Old-Age, Survivors, and Disability Insurance (OASDI) up to the Social Security taxable wage base. In 2019, wages up to $132,900 are subject to the OASDI tax. Employees under FERS first hired (or rehired with less than five years of FERS service) in calendar year 2013 contribute 3.1% of pay to the CSRDF and 6.2% of taxable wages to the Social Security trust fund. FERS employees first hired (or rehired with less than five years of FERS service) after December 31, 2013, contribute 4.4% of pay to the CSRDF and 6.2% of taxable wages to the Social Security trust fund.

Whether a federal employee is enrolled in CSRS or FERS, his or her employing agency contributes money to the CSRDF. Agency contributions differ between CSRS and FERS. The Office of Personnel Management (OPM) estimates the cost of CSRS annuities to be equal to 36.6% of employee pay. This is the amount that would have to be contributed to the CSRDF each year to fully fund the benefits that employees earn under the CSRS. Under CSRS, employees and their employing agencies each contribute an amount equal to 7.0% of pay the CSRDF. Agency and employee contributions total 14.0% of pay. The Treasury makes an annual contribution to the CSRDF that covers most of the costs of the CSRS that are not covered by employee and agency contributions. On September 30, 2018, the Treasury made a payment $34.16 billion for CSRS to the CSRDF. However, the CSRS continues to have an unfunded liability, which is estimated to be $813.1 billion in FY2018.

Effective as of October 1, 2019, OPM estimates the cost of FERS at an amount equal to 16.8% of pay for employees first hired before 2013, 17.3% for employees first hired in 2013, and 17.5% for employees first hired after 2013. The employee contribution of 0.8% of pay under FERS for employees first hired before 2013 is equal to the difference between the CSRS contribution rate (7.0%) and the Social Security payroll tax rate (6.2%). Federal agencies are required to contribute to the CSRDF the full cost of the FERS benefits that employees earn each year, minus the employee contribution. Thus, federal agencies contribute an amount equal to 16.0% of payroll to the CSRDF for FERS employees hired before 2013 (16.8 - 0.8 = 16.0).

Under P.L. 112-96 , FERS employees first hired in 2013 contribute 3.1% of pay toward their FERS annuity. The cost for this category of FERS employees is equal to 14.2% of payroll (17.3 - 3.1 = 14.2). Under P.L. 113-67 , the normal cost of the basic annuity for FERS employees first hired after 2013 is 17.5%. These employees contribute 4.4%, while their employing agencies contribute 13.1% (17.5 - 4.4 = 13.1). (The additional amounts provided by the increased employee contributions [i.e., 4.4% vs. 3.1%] are applied toward reducing the CSRS unfunded liability until it is eliminated.)

Therefore, FERS benefits are fully funded by employer and employee contributions and interest earnings with the exception of FERS benefits for employees first hired (or rehired with less than five years of FERS service) after December 31, 2013. On behalf of these employees, the employee and agency contributions amount to more than the full cost of the FERS benefit until the point at which OPM determines that there is no longer a CSRS unfunded liability.

Operation of the Civil Service Retirement and Disability Fund

The CSRDF is a record of the budget authority available to pay retirement and disability benefits to federal employees. Each year, the trust fund is credited by the Treasury with contributions from current employees and their employing agencies, interest on the securities held by the fund, interest on previous service for which benefits have been accrued but for which budget authority has not yet been provided, and a transfer from the general revenues of the Treasury. Only a small part of the income to the fundâmainly contributions from employeesâis income to both the trust fund and to the government. The remainder of these transactions are intragovernmental transfers in which budget authority is transferred from federal agencies to the trust fund. Intragovernmental transfers have no effect on the size of the government's annual budget deficit or surplus.

The CSRDF is similar to the Social Security trust fund in that, by law, 100% of its assets are invested in special-issue U.S. Treasury bonds or other bonds backed by the full faith and credit of the U.S. government. When the trust fund needs cash to pay retirement benefits, it redeems the bonds and the Treasury disburses an equivalent dollar value of payments to civil service annuitants. Because the bonds held by the trust fund are a claim on the U.S. Treasury, they ultimately are paid for by the taxpayers. According to the U.S. Office of Management and Budget (OMB), balances in the trust fund are

available for future benefit payments and other trust fund expenditures, but only in a bookkeeping sense. The holdings of the trust funds are not assets of the Government as a whole that can be drawn down in the future to fund benefits. Instead, they are claims on the Treasury. From a cash perspective, when trust fund holdings are redeemed to authorize the payment of benefits, the Department of the Treasury finances the expenditure in the same way as any other Federal expenditureâby using current receipts or by borrowing from the public. The existence of large trust fund balances, therefore, does not, by itself, increase the Government's ability to pay benefits. Put differently, these trust fund balances are assets of the program agencies and corresponding liabilities of the Treasury, netting to zero for the Government as a whole.

Civil Service Retirement Fund Financial Status

The CSRDF held a balance of $915.3 billion at the start of FY2019. (See Table 1 .) Obligations from the fund totaled $86.2 billion in FY2018, consisting mostly of annuity payments. Annuity payments totaled $85.6 billion in FY2018. Payments to the estates of decedents and refunds to separating employees accounted for another $421 million. The administrative expenses of the fund were $149 million, or about 0.17% of total obligations. In FY2018, an additional $2 million was transferred from the CSRDF to the Merit Systems Protection Board, which hears federal employee appeals (including federal retirement decisions).

Each year, the CSRDF receives cash contributions and intragovernmental transfers. Cash contributions from required employee contributions, other employee deposits, and the District of Columbia amounted to $4.5 billion in FY2018. The largest payments into the CSRDF were contributions from federal agencies ($27.4 billion in FY2018) and the Postal Service ($3.5 billion in FY2018) on behalf of their employees, interest payments ($25.6 billion), and a payment from the general fund of the Treasury to make up for the insufficient funding of benefits accrued under CSRS ($42.9 billion in FY2018). In FY2018, there was also a $38 million payment into the CSRDF due to offsets from the re-employment of annuitants. These payments are intragovernmental transfers. The CSRDF receives Treasury bonds as a record of available budget authority. It redeems bonds periodically as annuity payments come due.

Table 2 presents the annual income and expenditures of the CSRDF through FY2090, as estimated by OPM. Table 2 also shows the year-end balance of the trust fund and its estimated unfunded actuarial liability at the end of the year. The unfunded actuarial liability represents the difference between the present value of the fund's future benefit obligations and the present value of future credits to the fund plus the value of the securities it holds. The final two columns of the table show, respectively, the expenditures of the CSRDF relative to the government's total payroll expense for employee wages and salaries and CSRDF expenditures relative to the nation's annual gross domestic product (GDP).

The estimates presented in Table 2 show the income to the CSRDF rising over the projection period from $103.5 billion in FY2017 to $151.0 billion in FY2025 and to $759.9 billion in FY2090. The total expenses of the fund are projected to rise more slowly, increasing from $85.8 billion in FY2018 to $104.9 billion in FY2025 and t o $506.6 billion in FY2090. Consequently, the assets held by the CSRDF also are projected to increase steadily from $947.8 billion in FY2018 to about $1.2 trillion in FY2025 and to $10.6 trillion in FY2090. According to actuarial projections, the unfunded liability of the CSRDF peaked in FY2017, when it was $968.1 billion. From that point onward, the unfunded liability has and is projected to steadily decline until it is projected to be eliminated by FY2085.

In FY2018, expenditures from the CSRDF totaled $85.8 billion. The federal government's payroll expense for employees in FY2018 was approximately $213.0 billion (not presented in Table 2 ). Therefore, expenditures from the CSRDF were equal to about 40% of the amount paid as salaries and wages to federal employees. CSRDF expenditures are projected to decline relative to the government's wage and salary expenses, beginning around FY2025. By FY2090, the expenditures of the CSRDF are estimated to be equal to about 32% of the government's wage and salary payments to its employees. The decline in the ratio of CSRDF outlays to salary expense after FY2020 will occur mainly because future retirees will receive smaller pension benefits under FERS than they would have received under CSRS.

The final column of Table 2 shows federal outlays for civil service pensions as a percentage of GDP. Relative to the total economic resources of the economy, the expenditures of the CSRDF are expected to remain roughly steady for the next 10 years before declining substantially from FY2020 to FY2090. Federal expenditures for civil service retirement annuities were estimated to equal 0.48% of GDP in FY2012, down from a high of 0.55% in FY1991 (not presented in Table 2 ). Between FY2013 and FY2020, the annual expenditures of the CSRDF are projected to remain in the range of 0.47% to 0.41% of GDP. From that point on, outlays from the CSRDF will fall steadily to about 0.13% of GDP by FY2090.

CSRDF expenditures will fall relative to GDP mainly as a result of the decline in the proportion of civil service annuitants who are covered by CSRS and the increase in the number who are covered by FERS. The FERS basic annuity was designed to be smaller relative to high-three average pay than a CSRS annuity because FERS annuitants also receive benefits from Social Security and the Thrift Savings Plan. Because the transition from CSRS to FERS is mandated by law, the constant-dollar value of CSRDF outlays per annuitant will decline due to the different benefit formulas between CSRS and FERS. Consequently, outlays for civil service annuities are almost certain to decline relative to GDP, even if GDP grows more slowly than is assumed in the projections displayed in Table 2 .

The Civil Service Retirement and Disability Fund in the Federal Budget

In FY2019, the total receipts of the CSRDF are estimated to be approximately $104.4 billion, and obligations from the fund are estimated to be about $88.4 billion. Only a small part of the revenues to the fund ($4.9 billion) in this year were cash receipts. The remainder will consist of budget authority transferred from other federal agencies. The cash receipts of the fund come primarily from the contributions of federal employees toward their future retirement benefits. Other cash income to the fund comes from payments made by the District of Columbia on behalf of its employees covered by CSRS or FERS. Cash payments into the CSRDF are income to both the U.S. government and to the trust fund. These cash receipts reduce the government's budget deficit. Benefit payments to retirees and survivors are cash outlays of the federal government.

Most of the payments into the CSRDFâan estimated $124.8 billion in FY2018âare intragovernmental transfers. These transactions are income to the fund, but they are not income to the U.S. government. Intragovernmental transactions rarely involve cash. They do not affect the government's budget deficit or surplus because no money is received or spent by the government. Cash is rarely involved in intragovernmental transfers because individual government agencies, in general, have no cash to spend. What Congress appropriates to federal agencies each year is budget authority . Budget authority is legal permission for an agency to spend money from the accounts of the U.S. Treasury. The Treasury takes in money from the public by collecting taxes and by borrowing, and in most cases it is only the Treasury that disburses cash to the public.

It has been suggested from time to time that the CSRDF should be taken "off budget," as has already been done with the financing of Social Security benefits (but not Social Security administrative costs). Taking an account off budget means that its income and expenditures are not included in calculations of the government's annual budget surplus or deficit. Off-budget accounts are portrayed separately in the budget documents prepared by the Office of Management and Budget and the Congressional Budget Office (CBO). However, both OMB and CBO also publish unified budget accounts that include Social Security and other programs that are off budget. This is done because taking an account off budget does not end the activity or remove its effects from the U.S. economy. Whether Social Securityâor civil service retirementâis on-budget or off-budget, it still collects revenues from the public, pays benefits to the public, and affects the nation's financial markets by influencing the amount of private capital that is absorbed by government borrowing.

Taking the CSRDF off-budget would not affect the government's revenues or outlays in the unified budget accounts, but it would affect the size of the budget deficit or surplus as portrayed in any budget documents that excluded the CSRDF. For example, employee contributions to CSRS and FERS that are now counted as revenue to the Treasury would not be treated as revenue if they were paid to an off-budget CSRDF. The money that federal agencies now send to the trust fund in the form of intragovernmental transfers would instead be recorded as outlays, and would therefore increase the government's reported budget deficit or reduce the budget surplus in the year that the transfer occurs rather than in the future when benefits are paid. The outlays made by the fund to pay civil service annuitants would not appear at all in the federal budget. The net effect of these changes if the CSRDF had been off-budget in FY2018 would have been an increase of about $17.6 billion in the government's reported budget deficit, even though the amount of money collected from the public and the amount of money paid to civil service annuitants would have been no different than under current law.

One purpose of the federal budget is to show whether the government's revenues and outlays are in balance or out of balance. Therefore, taking any account off-budget distorts the picture of the government's fiscal condition. It is for this reason that financial analysts and economists focus almost exclusively on the unified budget totals when evaluating the effect of the federal budget on the nation's financial markets and the economy. If "outlays" were to include amounts not actually paid from the Treasury in the current year (as would be the case if the CSRDF were off-budget), then no revenue from the public would be needed in that year to pay for them. In years of budget deficits, some of the deficit would require borrowing from the public, and some of it would not. In years of modest budget surplus, there might appear to be a deficit because transfers to an off-budget account would be recorded as outlays, even though they do not involve payments from the Treasury to the public. For these reasons, taking the CSRDF off-budget might lead to greater confusion about the size of the real budget deficit or surplus, as has been the case with the off-budget status of Social Security.

Civil Service Retirement: Funding and AccountingÂ Issues

Accounting for Pension Costs Under CSRS and FERS

Actuaries use a concept called "normal cost" to estimate the amount of money that must be set aside each year from employer and employee contributions to pre-fund pension benefits. Normal cost is usually expressed as a percentage of payroll. There are two measures of normal cost: static and dynamic.

Static normal cost is the amount, expressed as a percentage of payroll, that must be set aside each year to fund pension benefits based on current employee pay with no future pay raises, no future COLAs for retirees, and a fixed rate of interest. Dynamic normal cost is the amount, expressed as a percentage of payroll, that must be set aside each year to fully fund pension benefits for workers who will continue to accrue new benefits, including the effects of employee pay raises, post-retirement COLAs, and changes in the rate of interest.

By law, the FERS basic retirement annuity and FERS supplement must be pre-funded according to its dynamic normal cost. Every year, OPM estimates the dynamic normal cost of FERS retirement annuities for employees entering the federal work force that year. For each group of new employees, OPM must estimate average job tenure, turnover, future salaries, age at retirement, rates of disability, death rates, the number of employees who will become annuitants, and how many will leave surviving dependents. OPM periodically re-estimates the dynamic normal cost of FERS to reflect anticipated changes in interest rates, inflation, and employee and retiree demographic characteristics.

OPM has estimated the current normal cost of the FERS to be 16.8% of payroll for employees first hired before 2013, 17.3% for employees first hired in 2013, and 17.5% for employees first hired after 2013. Federal agencies are required to contribute to the CSRDF the full cost of the FERS benefits that employees earn each year, minus the employee contribution. Thus, federal agencies contribute an amount equal to 16.0% of payroll to the CSRDF for FERS employees hired before 2013 (16.8 - 0.8 = 16.0). UnderÂ  P.L. 112-96 , FERS employees first hired in 2013 contribute 3.1% of pay toward their FERS annuity. The cost for this category of FERS employees is equal to 14.2% of payroll (17.3 - 3.1 = 14.2). Under P.L. 113-67 , the normal cost of the basic annuity for FERS employees first hired after 2013 is 17.5%. These employees contribute 4.4%, while their employing agencies contribute 13.1% (17.5 - 4.4 = 13.1). If the assumptions underlying these cost estimates prove to be accurate, FERS will be "fully funded." OPM has estimated the dynamic normal cost of CSRS, using the same economic assumptions used in FERS, at 29.3% of payroll. The financing of CSRS has at times been a topic of controversy, however, because it is not funded according to its dynamic normal cost. CSRS is funded through a combination of employee and agency contributions that together are equal to the static normal cost of CSRS, along with contributions from the general fund of the U.S. Treasury that make up some of the difference between the static normal cost of CSRS and its dynamic normal cost.

Why Are CSRS Revenues Less Than the Present Value of Benefits?

At the time that Congress established the CSRS in 1920, it set up a trust fund from which benefits would be paid. From the beginning, however, CSRS was funded on a "pay-as-you-go" basis. The trust fund was used to pay benefits to already-retired workers, rather than to pre-fund the pension benefits of current workers. Initially, only employees made regular payroll contributions to the fund. Regularly scheduled agency contributions were not mandated until the 1950s. For many years, there were so few federal retirees that the fund was able to meet its financial obligations to beneficiaries from employee contributions alone.

In 1956, Congress passed P.L. 84-854, which required federal agencies to make contributions to the Civil Service Retirement Trust Fund on behalf of their eligible employees. The contributions made by federal agencies were equal in amount to the money paid into the fund by their employees, and were made from appropriations that agencies received specifically for this purpose. Even with regular contributions from the employing agencies, however, the CSRS was still being funded on a pay-as-you-go basis. Contributions to the fund were sufficient to meet current benefit obligations but not to pre-fund the future retirement benefits of federal employees.

As the federal civil service pension system matured (that is, as the ratio of annuitants to workers began to rise), it became necessary to establish a formal system of accounting for the pension obligations that had been incurred by the federal government but for which funds had not yet been set aside. In response to this need, Congress enacted P.L. 91-93 in 1969. This law set the employee contribution to CSRS at 7.0% of pay and required an equal amount to be contributed from funds appropriated to federal agencies. This amount (equal to 14.0% of payroll) represented the total contribution required to pay the costs of pension liabilities accrued by federal employees, using "static" assumptions: no future pay increases, no COLAs, and a 5.0% annual rate of return on the securities in the Civil Service Retirement and Disability Fund. Agency and employee contributions under CSRS have remained at the same percentage of payroll since 1969.

P.L. 91-93 also requires three payments to be made annually from the general revenues of the U.S. Treasury into the CSRDF. These payments are

the amount necessary to amortize (pay off with interest) over a 30-year period any increase in pension liability that results from pay increases (but not retiree COLAs) or from bringing newly covered groups of workers into the CSRS; the amount of the employer's share of the cost of benefits attributable to military service; and interest, fixed at a rate of 5%, on the estimated amount of the previously accrued liabilities of the CSRS for which contributions have not yet been made to the fund.

Thus, while the static costs of the CSRS were shared equally between federal employees and their employing agencies, the Treasury was given responsibility for pension liabilities that are not part of the pension system's static normal costs. By including the 30-year amortized cost of pay raises in the annual transfer from the general fund, the Treasury assumed the additional pension expenses that result from pay raises. All costs of the CSRS that are not paid by employee and agency contributions or through the transfers to the CSRDF mandated by P.L. 91-93 ultimately will be paid from the general revenues of the Treasury. The costs of retiree COLAs, which also are not part of the static normal cost of the CSRS, are not included in the annual transfer from the Treasury to the CSRDF, and ultimately will be paid from the general fund of the Treasury.

Because the full costs of CSRS are not met by the combined total of employee contributions, agency contributions, interest earnings, and the supplemental payments from the Treasury, some future CSRS benefits will of necessity be paid from contributions that were made to the CSRDF on behalf of employees who are enrolled in FERS. This will create an unfunded liability for FERS, which will be paid off through a new series of 30-year amortization payments from the general fund of the Treasury to the CSRDF. As stated by OPM:

When the non-Postal CSRS account is depleted, projected to occur in 2022, the resulting transfers from the FERS account to the CSRS account create supplemental liabilities for the non-Postal FERS account. These supplement liabilities for non-Postal FERS must then be amortized by means of 30-year payments made by the Treasury.

Current law specifies that funds that were paid into the CSRDF on behalf of employees covered by FERS will be used to pay the unfunded liability of CSRS. FERS will then be reimbursed by a series of payments with interest from the general fund of the Treasury to the CSRDF.

Accounting Issues Raised by the Way CSRS Benefits Are Financed

Actuarial estimates indicate that the unfunded liability of the CSRS does not pose a threat to the solvency of the Civil Service Retirement and Disability Fund. In its current annual report, OPM has stated that "total assets of the CSRDF ... including both CSRS and FERS are expected to continue to grow throughout the term of the projection under the existing statutory funding provisions." Nevertheless, the current method of funding the CSRS has in recent years been a source of debate for at least two reasons:

(1) Because employee and government contributions do not account for the full actuarial cost of CSRS pension obligations as they accrue each year, the CSRS continues to accumulate additional unfunded liabilities. Consequently, some of the pension costs that are incurred each year will not be reflected in the government's budget until those benefits are paid at some time in the future. Some budget experts argue that these costs should be accounted for in each agency's budget as they accrue, just as is done in the FERS.

(2) The supplemental payments to the trust fund that are required by the 1969 law come from the general revenues of the Treasury rather from the budgets of the various federal agencies where these costs are incurred. As a result, the amount of employee compensation for which agencies must account in their budgets each year understates the full costs of employment. Critics say that this contributes to an inefficient allocation of resources in the federal government by making labor costs appear lower than they really are.

If agencies were required to fully fund the current and future costs of the CSRS through increased contributions, they could do so from their current-law appropriations or they could be granted additional budget authority for this purpose. The two approaches would have different effects on the federal budget. For agencies to be held harmless for the increased contributions, they would have to receive additional appropriations to their salary and expense accounts. Because agencies would transfer the appropriated funds to the CSRDF, which would in turn use them to purchase Treasury bonds, no additional outlays would occur as a result of these appropriations, and they would not affect the federal budget deficit or surplus. The outlays would occur in the future when retired employees collect their CSRS annuities, just as under current law.

An alternative means of fully financing the normal cost of the CSRS would be to require agencies to increase their contributions to the CSRDF without receiving any additional appropriations to their salary and expense accounts. Pre-funding the full costs of the CSRS in this way would reduce the federal budget deficit, because the outlays of each agency would have to be cut by the amount of its additional transfers to the CSRDF. Outlays to CSRS annuitants would still occur in the future just as under current law. However, these future outlays would be offset by a reduction in current outlays so that the future payments to CSRS annuitants could be fully pre-funded. The reduction in resources available for current spending, however, would force federal agencies to cut spending elsewhere in their budgets.

Paying the full normal cost of CSRS through employee and agency contributions would prevent the system from accruing additional unfunded liabilities, but it would not reduce the previously accumulated liability of the CSRS. Under current law, this liability will be paid off eventually through a series of 30-year amortization payments from the general fund of the Treasury to the CSRDF. Some observers favor starting these amortization payments sooner. They note that private-sector employers are required by ERISA to begin paying down accumulated liabilities when they occur. Others advocate paying down the liability now as a way to forestall proposals calling for reduced pension benefits or increased employee contributions in the future.

Proposals to pre-fund CSRS in the same manner as required under FERS have grappled with the question of whether additional budget authority should be granted to federal agencies, or whether agencies should make higher contributions from their current budget authority. Many policymakers believe that greater pre-funding of CSRS retirement annuities would lead to improved accounting of personnel costs among federal agencies. However, CSRS has been closed to new enrollment since 1984, and the percentage of federal employees enrolled in CSRS is declining rapidly as these workers retire. At the beginning of FY2018, about 4% of federal employees, including Postal employees, were enrolled in CSRS. With the proportion of federal employees enrolled in CSRS declining each year, the budgetary treatment of government contributions toward their retirement annuities is becoming a less pressing issue.

Some observers have suggested that investing the CSRDF entirely in U.S. Treasury bonds does not represent true "pre-funding" of CSRS and FERS annuities because these bonds are merely a claim held by the government against its own future revenues. They suggest that at least part of the trust fund's assets should be invested in private-sector stocks and bonds where they could earn a higher rate of return than is available from U.S. Treasury securities (albeit at greater risk). In addition to issues of investment risk, however, this proposal would raise questions about how purchases of private-sector assets would be scored under current budget rules, and also whether it would be appropriate for federal trust funds to own the stocks and bonds of private-sector companies.