A Cost of Living Adjustment (COLA) is an occasional increase in the amount of a retiree’s or beneficiary’s pension payment in order to account for inflation. COLAs have been much discussed recently, in part because it has been so long since many retirees have received one. This post will explain what a COLA is, why it matters, and what states are doing to provide COLAs for retirees.
A defined benefit pension plan provides a set benefit amount at retirement according to a formula. That formula usually factors in years of service, final average salary, and a benefit multiplier. This determines the pension benefit that a retiree will receive throughout their retirement. For convenience’s sake, let’s say a retiree receives a $24,000 annual pension, or a monthly amount of $2,000. This benefit is guaranteed for the rest of the retiree’s life. However, without a COLA, the value of that pension benefit will erode over time. Why? Because of inflation.
The price of almost everything is constantly going up. According to the U.S. Bureau of Labor Statistics, the average inflation rate in the United States has hovered around 2 percent for the past decade. This means that if you bought something for $100 this year, the same item would cost $102 the next year. However, inflation does not increase at the same rate for all expenses. For example, the rate of inflation for health care is consistently higher than the general inflation rate (about 70 percent higher).
Returning to the example of our retiree with a $2,000 monthly pension, that retiree’s pension will stay the same year after year, even as the cost of monthly expenses goes up each year. Over time, this retiree will be able to buy less and less with their monthly pension because the cost of food, health care, and other items will have increased since their retirement. This is why many pension plans offer COLAs, to reduce the deteriorating effects of inflation on pension benefits. Social Security makes annual cost of living adjustments. In 2018, Social Security recipients will receive a 2 percent COLA. As we’ve discussed before, about a quarter of state and local public employees do not participate in Social Security.
COLAs are managed differently by different pension plans. Some plans include automatic COLAs; others require that plans meet certain funding requirements before a COLA can be awarded. Following the Great Recession, public pension plans in many states ended or suspended COLAs. However, now that pension plans are recovering from the financial crisis and funding levels are improving, several states are currently considering proposals to either offer one-time COLAs or restore regular COLAs.
In New Hampshire, House Bill 1756 would offer a one-time allowance of $500 to certain retirees, as well as a 1.5 percent COLA. In Oklahoma, retirees are working with members of the legislature to introduce a COLA bill. Retirees in Oklahoma have not received a COLA in ten years. In Kentucky, Senate Bill 92 would permit certain municipal pension plans to offer cost of living adjustments in line with Social Security adjustments.
Teachers, firefighters, nurses, sanitation workers, and other public employees earn modest, but dignified retirements after years of service to their communities. Without at least an occasional COLA, those retirements become less secure over time as the value of their pension benefits erode. States are taking action this year on COLAs in order to address this real need from their retired public servants.