PODCAST EPISODE 130:
Why High COLAs are Not a Good Thing

If you’ve heard about the high COLA that’s anticipated for next year and you’re wondering what it might mean to more than two million federal retirees out there, you are not alone. Stay tuned to learn why high COLAs are not a good thing.

Hi, Chris Kowalik of ProFeds here. And welcome to the FedImpact Podcast, where we offer candid insights on your federal retirement. So you guys know this show is all about helping you get super clear on what you want retirement to look like and taking action to make it happen.

So you’ve likely heard of the anticipated high cost-of-living adjustment that’s in store for 2023. Right now, as of the recording of this podcast, it is an astonishing 8.9% COLA for CSRS retirees and a 7.9% COLA for FERS retirees. The highest since 1981. Oh boy.

So on the surface, this looks to be like a win for retirees, but I can assure you, it’s not. Not by any measure whatsoever. Today’s episode is going to explain why.

Many of you who are listening are still actively employed with the government. And so remember that your pay changes by pay raises that are determined by Congress and the president each year. But for retirees, they don’t get pay raises. They rely solely on cost-of-living adjustments.

And they’re hoping they get one each and every year to keep their pensions rising over time. That’s what they all are hoping for. But without really understanding how COLAs work and how they’re calculated, you can’t really appreciate the effect over a long period of time.

But regardless of which boat you’re in, whether you’re an employee with pay raises or a retiree with cost-of-living adjustments, it’s really important to understand the concept of COLAs and why we should hold our applause when these huge COLAs are announced.

So today’s session, we’re going to talk about how these COLAs are calculated, when they’re announced each year, and when they go into effect, there’s a little bit of a delayed effect; why high COLAs aren’t considered good when you actually know what that means, and the real consequences of high COLAs and the spiral effect that it can have on your retirement assets.

Of course, any resources that I mention, they will be in the show notes. So if you happen to be listening to this podcast right from our website, you already have access to those show notes. But if you happen to be listening on iTunes or Spotify or any of these other networks, we’ll be able to show you exactly how to get access to all of those show notes as well.

So let’s start with a little bit of background. When you eventually retire from federal service, you are going to receive a monthly pension that will continue for the duration of your lifetime. Most of you know that. If that was a big surprise to you, we’ve got a lot of catching up to do.

But that pension itself will increase over time based on cost-of-living adjustments. So as they’re announced each year, they take effect, and that’s going to increase the amount of your monthly check.

How COLAs are calculated

Let’s talk about how COLAs are calculated. We first have to start with a specific number, it is called the Consumer Price Index. And we’re going to be very specific that we’re looking for the CPI-W. There’s a number of different indexes out there, but the one we’re going to be looking at that directly affects the pensions that federal retirees receive is the CPI-W.

So this is calculated each year by the Bureau of Labor Statistics. What they’re going to do is they’re going to look at the general price of normal consumer goods, they call it a ‘basket of goods.’ So food, gas, housing. Right? All those normal things. And they’re going to compare that to the same time last year.

They’re going to look at the difference in, well, what did it cost you last year at the same time and what does it cost you this year at that same moment in time in the year? So some years, that has gone up; some years, it’s gone down, or perhaps no change at all.

So the change that we’re looking for, this is a percentage, and it’s most traditionally referred to as inflation. And so there are a lot of different markers of inflation, but there are several markers outside of these consumer goods that we’re talking about that go into those different forms of inflation.

When we think of increases to pensions, we’re like, “Yay! That sounds great.” But if it’s only because everything around you got more expensive, then that’s not so great. Right? We’re not cheering quite as loud because we’re like, “Yeah, thanks. Thanks for letting my pension keep up so I can fill up my car with gas.”

Is CPI-W the same as COLA?

So a question we get a lot of is, “Is the CPI-W (this number that’s released by the Bureau of Labor Statistics), is that the same as cost-of-living adjustments? Okay. So that’s a very valid question and one that I think warrants us having a conversation about here.

So the short answer is no, mostly because the government likes to make this hard on everybody. They can’t just have a straight answer to something, which is something that we really try to distill down on this show to make things simple for everybody to really understand so that you can apply it to your situation.

So the reason that we can’t just say COLA and CPI-W are the same is because CSRS and FERS retirees are treated differently. The older system, CSRS, will receive the cost-of-living adjustment, which is the CPI-W. No matter what that number is, CSRS retirees get that percentage of a change to their pension each year. And again, changes every year, but whatever that CPI-W is, CSRS retirees get it.

But FERS retirees are a little different. They don’t receive COLA, they receive diet COLA. We’ll talk about that concept and how it relates to FERS retirees. But it’s also important to realize that for FERS retirees, you will not receive a cost-of-living adjustment to your pension until you reach the age of 62.

If you retire at 57 (let’s say that’s your minimum retirement age), you’re going to go five years without any change to your pension. That’s something that you have to wrestle with when you’re thinking about when to retire. Know that your pension will stay flatlined all the way until 62. And then at that point, you don’t even receive the full COLA. You receive the diet COLA.

So let’s talk about this diet nonsense here. So in good government fashion, there are different thresholds to grant this CPI-W, this COLA amount. So in the event that we have a low CPI-W number, meaning low inflation, then CSRS and FERS retirees get the exact same change to their pension that following year.

So if it’s under 2% inflation or, again, CPI-W, then CSRS and FERS retirees get the exact same amount of a change to their pension that following year. If we have kind of a moderate number, 2% to 3%, then remember, CSRS retirees always get whatever the CPI-W is. And then FERS, in this scenario, will get 2%. So if the CPI-W is 2.5, CSRS get 2.5, FERS would get 2%.

Now, in the event that we have a really high cost-of-living adjustment (or CPI-W), so 3% or higher, CSRS always get the CPI-W, get that percentage, whatever that is. And then FERS get that number minus 1%. And 1% might not seem like a big deal, except it’s 1% from 3%. And so that’s a third of the increase that you won’t get if you’re a FERS retiree.

If by no other reason than the fact that that’s the way the law was written for handling this for FERS retirees. Not a whole lot more rhyme or reason than that.

So the challenge is, when we’re looking at nearly 9% CPI-W (that’s the anticipated COLA for next year for CSRS), FERS are going to be further and further behind the more years we’re in these high-inflation times because they’re automatically going to get 1% knocked off the top.

So it’s important to realize the effect of this diet COLA. At first, it might not seem like a big deal, but the more and more years that go by where FERS retirees get less and less and less of that increase, that’s a snowball effect that we need to be paying attention to.

We kind of have a sense of how the COLA or the CPI-W is calculated and how it plays out for FERS retirees, but let’s back up and talk about when it’s announced and when it goes into effect.

When COLAs are announced and go into effect

For purposes of the CSRS and FERS pension (and frankly, for social security benefits as well), the CPI-W is calculated at the end of the fiscal year, so the end of the third quarter of the calendar year each year. So end of September, early October.

That announcement is made in October of a given year. And it will go into effect in January of the next year. Okay. So it’s announced in October, it goes into effect in January.

These changes, these COLAs are set to happen automatically based on the Bureau of Labor Statistics’ CPI-W figure that they release in October. I share this with you that it’s automatic because I want you to have an appreciation for the difference that pay raises operate on.

Pay raises are very political. It depends who’s in the White House. It depends who’s in both houses of Congress. And it’s a fight for pay raises, right? I’m not going to go into the details of all of that. That’s for another show. But it’s important to realize that cost-of-living adjustments are based solely on the number released by the Bureau of Labor Statistics. It doesn’t go through Congress. It doesn’t go to the White House. It is simply happening.

Pay raises, totally different story. We actually did an entire show on the difference between cost-of-living adjustments and pay raises to really help employees (and frankly, retirees) to understand the stark difference between these two things and why you don’t ever want to confuse them.

Let’s talk about this unprecedented inflation level that we find ourself in. We feel it at the pump, right? It is painful to fill up a car with gas. And so it’s something that’s staring right in the face of everybody, not just Feds, of course, but everybody across the board.

With these high-inflation times, of course, we’re going to be looking at cost-of-living adjustments to level that out for retirees. So when we hear these cheers of the talks of big COLAs for CSRS and FERS retirees, you’re never going to hear me cheering. I don’t want to see high COLAs because that means we have high inflation.

Here’s a concept that I hope everyone can appreciate a little bit. When you retire from federal service and your pension is calculated at that moment in time, you don’t get ahead of the game, ever, by cost-of-living adjustments because all it’s doing is keeping up with inflation. You’re not better off. You’re just keeping up with that inflation.

These COLAs are widely regarded as a good thing, and you hear all these people cheering. And I love the idea that you have more money in your retirement check, but who cares if you get an extra $50 in your check if it took you $100 to fill up your gas tank? Right? I mean, we have to have some perspective here of what we’re looking at.

So more dollars doesn’t mean you’re getting ahead. And for FERS retirees, it doesn’t even mean that you’re keeping up. Everything around you is getting more expensive but your pension’s not quite there. It’s not quite keeping up because for CSRS retirees, you’re always keeping up because your pension is going to increase by the inflation figure, by CPI-W.

FERS retirees, you’re going to be, “keeping up” as long as the CPI-W, that COLA number is under 2%. But FERS retirees are falling behind, further and further behind anytime that CPI-W number is high, anything above 2%. And by falling behind, I mean you fall behind inflation or that buying power of your money.

Now, of course, we have to look at everything in perspective, right? This is still better than a private-sector pension out there that typically have no cost-of-living adjustments at all. So I’m grateful that we at least have that, and I’ll cheer from that perspective.

But when it comes to the average federal employee turned retiree, to hear them cheer about high COLAs makes me shake my head a little bit because we’re measuring the wrong thing. Everything around you is getting more expensive and we’re hoping that the pension keeps up.

The real consequence of high COLAs

So here’s the real consequence of these high COLAs and high inflation. Those two things go hand in hand. If we see several years of high inflation, you might need to augment your pay with more money, from where? Probably the Thrift Savings Plan. That’s the go-to for federal employees. It’s your big pot of money. Hopefully, it’s big. Right?

And you’re like, “Well, my pay is not really keeping up. I’m falling further behind. Things around me are getting more expensive.” And we’re not talking about trips and fancy stuff. We’re talking about food and gas and housing. Right? And so you turn to the Thrift Savings Plan to be able to supplement or augment that pay.

But here’s the spiral effect, inflation’s high, so you say, “I need more money out of the TSP.” But you take the money out of the TSP. And presumably, it’s taxable (or the majority of it would be taxable from the traditional side of TSP). So then you’re like, “Oh gosh, I have to pay more taxes.”

And so what happens when taxes go up? The spiral deepens. And eventually, you just can’t catch your breath. Okay. And that’s why we get so worried about these high COLAs and high inflation, because we don’t actually solve the problem that we’re setting out to solve. We end up creating a bigger problem when we begin taking more money out of accounts like the Thrift Savings Plan.

Before you know it, because you have to account for taxes and then everything around you is more expensive, this spiral just gets faster and faster and you just can’t get out of it. And that’s where we start to see the rapid decline of assets like the Thrift Savings Plan that give us pause when we’re thinking about the long-term effect of your money running out.

And believe me, we see this too often for federal employees that don’t have a plan in place to be able to manage these types of things. They cheer for a high COLA when, in reality, it’s actually the very scenario that hurts them the most.

I hope today’s short topic has given you a little bit of perspective on the cost-of-living adjustment and what it really means for federal retirees so that as you hear the water cooler chatter and everything you see on the news about these big increases to your pension if you’re already retired, or the prospect of your pension if you’re still working, that you have a little bit of perspective to filter some of that information through before you start cheering.

Wrap-up

Of course, we do retirement workshops all over the country to help federal employees prepare for retirement and have a little perspective of their own when it comes to protecting yourself from things like inflation and high taxes.

if you have not already been to one of our workshops or you just need a refresher (or you want access to the show notes from today’s episode that includes the transcript), you can go back and re-listen to the audio on this and links to all the resources that we mentioned like the podcast on COLAs versus pay raises, and see what training we might have available in your area.

Please text the word “PODCAST” to 224-444-6144 and we’ll make sure that you get access to all of those things. Okay. Again, text the word “PODCAST” to 224-444-6144 and we’ll send that right away.

Just as a recap for today, CSRS and FERS retirees are treated very, very differently when it comes to COLAs. CSRS retirees get it right away, and it always matches inflation. And FERS retirees don’t get it until they turn 62, and it either matches inflation or is lower than inflation, it never beats it. On either side, CSRS or FERS, you’re never going to get ahead of inflation.

Always remember, think twice before being excited for a high cost-of-living adjustment. It is usually indicative of other things not going right with the economy.

So that’s it for today. I hope that our talk about CPI-W and COLAs and inflation has been helpful to you as you think through all the various aspects of planning to retire. I also hope that you’ll stay tuned to the FedImpact Podcast to get straight answers and candid insights on your federal retirement. And of course, if you haven’t already, I hope that you’ll subscribe so that you’re sure not to miss an episode.