This article was written by Federal Navigators and was originally posted on FedSmith.com.
The CSRS Voluntary Contribution Program has been available to CSRS or CSRS Offset employees for many years. VCP can be a very useful option for the CSRS employee to significantly increase their retirement savings by allowing them to contribute up to 10% of their lifetime federal earnings to this account.
Know Your Options
It is my experience that most CSRS employees are unaware of the VCP and how it can benefit them even though the program has been in existence since they joined the government. It is simply not advertised and is generally unknown to the extent that it is almost a secret.
The VCP was created to allow CSRS and CSRS offset participants to supplement their annuity at retirement by contributing after-tax dollars up to 10% of their basic salary. If you study the details of the program, you will note that contributions can be made retroactively back to the date of hire.
You must be an active employee to contribute to the VCP, retirees are not eligible. Also if you owe a deposit or redeposit, you are required to pay off the deposit before being able to contribute to the VC account. Again, the contributions can only be made with after-tax contributions so an eligible employee must have additional money set aside to contribute to the plan. These funds can come from your personal savings and investments of from inherited monies. The interest earned on the deposit is tax-deferred as long as it remains in the account.
The VCP also offers a lot of flexibility. You can contribute to your VCP a little at a time, or with one big check. Deposits are made in increments of $25. The CSRS participant may withdraw their contributions anytime either before or after retirement.
As we stated before, there would be no tax on the contributions because of the after-tax nature of the account. However, the interest is not tax-free and would need to be transferred to a Traditional IRA to avoid taxation. There may also be a potential 10% penalty tax on the gain if you are under the age of 59 ½.
CSRS Voluntary Contribution Program Annuity Option
At retirement, voluntary contributions, with interest, may be used in several ways. One choice is to purchase an additional annuity. This annuity will be in addition to the regular CSRS annuity which is unaffected by the VCP annuity. The 2 annuities are mutually exclusive.
When you “annuitize” your VCP you are trading the entire balance for a fixed stream of income over your lifetime. The rules regarding this annuity have some similarities and significant differences to your CSRS Annuity.
Similarities to CSRS Annuity
- The VCP Annuity is for life, like the regular CSRS Annuity.
- You may also elect a survivor option for a spouse just like the CSRS annuity.
The Differences from the CSRS Regular Annuity
- There is NO COLA
- The internal calculation of the VCP Annuity income payout is different:
Calculation for the CSRS Voluntary Contribution Program annuity income option:
Each $100 deposited in the account will provide an annuity payment of $7 a year for life at age 55 and increasing at 20 cents per year for each year the Annuitant is over 55 at the starting point of the income. Thus, if you retire at age 60, each $100 will buy $8 a year of the VCP life annuity: at age 62, $8.40 a year, and so forth.
- Another difference from the CSRS Annuity is that although a spouse can be a survivor annuitant, any person, related or unrelated to the VCP contributor can be as well. This can be the same person designated on your regular CSRS annuity or a different person entirely. If you elect a survivor benefit, your annuity will be reduced and your survivor will be paid half of the annuity for their life. The calculation of the original annuity amount depends on differences in ages between the annuitant and the survivor. For example, if your survivor annuitant is your 20 year old daughter, the reduction in the annuity pay-out will significantly be reduced because of her young age.
The Voluntary Contribution Election Form #RI 38-124 is needed to begin your VCP annuity.
Roth Conversion Opportunity
The second and the best option (In my opinion)
A very unique option/opportunity exists for CSRS employees to enhance their retirement savings with the use of the VCP. As we have already explained the participation rules state that eligible employees may contribute up to 10% of their “lifetime” earnings. This can be done retroactively any time before they retire.
According to IRS notification 2008-30 the after-tax portion of the VCP can then be rolled into a Roth IRA. This is true even if the employee’s salary level would normally make them ineligible to contribute to a Roth IRA.
It is important to understand the significance of what I have explained. This is a way for CSRS employees to transfer up to 10% of their career earnings (or as much as they possibly can up to that 10%) and deposit it into a Roth IRA that can be potentially tax free forever. Wow!
Any income generated from your Roth will be tax-free for the remainder of your retired life. The Roth IRA is also income tax free to your beneficiaries upon your death. It is important to understand that the general Roth IRA rules must be followed. I will discuss these rules later in this chapter.
Roth Conversion Example:
- Jim is 60 and is a CSRS employee nearing retirement. Over the course of his career he has earned $2,000,000.
- Jim was able to save $200,000 and he now has that in a savings account at his local bank. Jim could (before he retires) open a VCP account and deposit the entire $200,000 (10% of his lifetime earnings) into the account.
- The account would immediately begin to earn interest tax-deferred (currently 1.625%). Jim could then wait until retirement and begin his VCP annuity.
- Since Jim is 60 and has deposited $200,000 into the account his life annuity would be $200,000/ 100 = 2000. If you recall for every $100 invested in the VCP will purchase $8 a year of the VCP annuity at age 60. So 2000 times the factor $8.00 would equate to a lifetime income of $16,000 (2000 x $8.00) annually.
- Jim could elect a survivor if he wishes that would lower this income amount depending on the age of his survivor.
- If Jim decides the Annuity Option is not a good alternative for him, his second option is to establish a Roth IRA and transfer the entire balance into the new account.
- This is permitted even though Jim would typically not be able to deposit money into a Roth IRA because of the Roth contribution limits and eligibility rules.
- Once the funds are in the Roth IRA, Jim can then invest the money as he desires. When Jim decides to make withdrawals from his Roth IRA the income he withdraws will remain tax-free as long as Jim follows the Roth IRA regulations. Plus any remainder will transfer tax-free to his beneficiaries.
Roth IRA Basics
With a Roth IRA, you pay taxes before the money is contributed into the account. Because the taxes are paid in advance, no taxes are paid on withdrawal from the account. This is different from a traditional IRA that allows you to defer taxes now and pay taxes on withdrawal from the account.
With a traditional IRA you will typically get a deduction from your taxable income when you contribute funds, with a Roth IRA you do not. Where the Roth can be greatly beneficial is when the money is allowed to grow for many years before it is withdrawn tax-free. Just like Traditional IRA’s the Roth has restrictions to access the funds.
The money should remain in the account for 5 years and until you reach 59 ½. If these rules are followed you can withdraw the principal and earnings tax-free. If these rules are not followed and withdrawals are made before 5 years, a 10% penalty applies and income tax must be paid on the earnings. Please refer to IRS Pub 590 Individuals Retirement Arrangements for more specific details if needed.
A Final Word on Roth IRA’s
I believe the Roth IRA is a wonderful opportunity to enjoy tax-free income/withdrawals to supplement your CSRS annuity during retirement. This is particularly important if you believe tax-rates are likely to increase in the future – like I do.
So let me summarize the potential benefits of CSRS or CSRS offset employees participating in the VCP:
- Up to 10% of your career “lifetime” earnings can be contributed into the plan retroactively before retirement.
- The VCP can be used to create additional guaranteed income with the CSRS voluntary contribution program Annuity option at retirement.
- Flexibility to withdraw the funds (if funds are needed) prior to or after retirement.
- Ability to transfer the after-tax contributions to fund a Roth IRA
- The current yield is 1.625% (2013) which is attractive given the current low interest rate environment.
Employees who wish to make contributions into the VCP should obtain form SF 2804 “Application to Make Voluntary Contributions” available through the Office of Personnel Management (OPM) and submit it to your agency’s human resources department. Payments are made directly to OPM and are not payroll deductions.
Please note that this article is meant to be a summary/highlight of the CSRS Voluntary Contribution Program. For more details please refer to your personnel department.
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