Delivered on: Wednesday, October 28th, 2020
COLAs vs. Pay Raises:
Learn the stark difference and why it matters to federal employees and retirees
- PAY RAISES: when, why and how they are applied – and what effect this has on your initial federal pension,
- COLAs: when, why and how they are applied – and what effect this has on how your federal pension changes over time,
- Current projections for 2021’s anticipated Pay Raises and how newly announced COLAs will be implemented, and
- The main differences between how each are applied to CSRS and FERS – and the often significant financial impact on each.
Download Handouts: CLICK HERE
Register for our next 30-minute webinar: FedImpact.com/webinar
Find a comprehensive retirement workshop for your area: FedImpact.com/attend
Prefer to read instead? Below is a transcript from the video:
Welcome everyone to the FedImpact webinar today on cost-of-living adjustments versus pay raises. We’ve got an awful lot to cover so let’s go ahead and jump in. Let me first start by introducing myself. If you don’t know me, my name is Chris Kowalik of ProFeds. I am the founder here at ProFeds and the developer of the Federal Retirement Impact Workshop. We do a podcast and a slew of other things for federal employees, but I wanted to make sure that this topic on cost-of-living adjustments versus pay raises was really clear for everybody because there’s so much in the news.
Now, I’m going to stay really focused on presenting the material for you today but my awesome support team is standing by in the Q&A. So if you have questions, please don’t be bashful. Of course, I’ll likely cover a lot of what you all have questions on because we’re used to hearing questions from federal employees on this very topic, but don’t be bashful. If you’ve got a question, pop over to the Q&A.
Now, of course, we want to welcome everyone here today. For today’s topic, this was a pretty timely topic because cost-of-living adjustments have just been announced for next year, and of course, we’re waiting on the finalization of the pay raise for next year as well. So, we wanted to get this out to everyone so you knew what it was you were looking at. Now for our audience today, we have thousands of you registered for today’s session. I’m so delighted that you all are taking a keen interest in understanding how your money is going to work not only as an employee but also as a retiree. Now like I mentioned, the Q&A, our support team is standing by so if you have any questions, please pop over there and enter them.
There are handouts available. If you did not download them in the waiting room as you were waiting to enter today’s session, you will find them in the handout section right next to the Q&A tab. If you need to download those, of course, you’re welcome to do so. We’ll also send out an email following today’s session with a link directly to the handouts. Now, this session is being recorded. We want to make sure that you all have a chance to get the replay in the event that you get interrupted today or maybe for some reason or another, can’t listen to the entire session. That will come to you by email, and we’re really delighted to be able to send that to you as a registered participant. Now, stay all the way until the end of today’s session because we’ve pulled out five of the most common questions that we get for federal employees between cost-of-living adjustments and pay raises that we want to make sure that you hear about.
So let’s talk about our topic today, the cost-of-living adjustments and pay raises. We all want to make sure that our pay over time continues to go up. That’s true while you’re working as an employee, and certainly as a retiree as well. But today’s session is going to highlight the key differences and why it matters between these two distinctly different programs, or the way that our pay changes over time. We’re going to dig into the details of each one, and overarching I want you to know what it is that we’re going to cover.
The first is, who gets it? We’ll cover that for COLAs and for pay raises. What’s it based on? What’s the calculation based on? How much can you expect to get? When does it get applied? And, where do you have to live to be able to get it? And then here’s my favorite one that I hope you all pay very close attention to. Why does it affect you? Why does it matter? And, perhaps some aha moments that many of you hadn’t quite connected along the way.
All right, let’s start with our annual pay raises. Now, if you’re still working for the federal government, you know that we’re always keeping an eye on annual pay raises every year, and it feels great that your pay goes up, but I want to point out something really important as far as who gets it. The pay raise that you hear about each year, typically applied in January, only applies to increase the paycheck of current federal workers. It has no effect on retirement at all. Very, very important.
When we release the pay raise announcements, we get a flood of comments from retirees that, “That’s way mean more than last year,” or “That’s not enough,” whatever it might be. Whichever way the pendulum is swinging, but it doesn’t apply to retirees. In this case, it only applies to employees. And of course, the annual pay raises that we’re referring to are quite different from the pay grade increases or the step increases that you might be familiar with as well. Of course, we’ll take pay raises no matter how we can get them, but the one that we’re going to focus mostly on in this session today are the annual pay raises.
Now the pay raises, what are they based on? Well, the levels by which the pay raises happen are not tied to a specific economic index. I think it’s important for everyone to understand that because it’s very subjective. This is oftentimes a very political decision and it comes under very heavy scrutiny by several groups. Whether it’s too high or too low, everybody’s got something to say about it. But a very political decision each year, certainly in an election year. Both sides of the aisle does it, and so we want to make sure that you understand that it’s not specific to a market index or an economic index as some of the other benefits that you have are tied to.
So next up, how much can you expect? Well, if you’ve been with the government for quite some time, you know that we can’t rely or have any guarantee on a pay raise. You’ve probably had your fair share of years where you got bupkis, and you also had a couple of years that you had pretty nice pay raises. It might not have felt all that nice because other things tend to eat away at that, but in the grand scheme of things they were pretty generous. Now for 2021, this would be the pay raise that’s announced in 2020 that will affect your 2021 pay. That’s technically not been finalized yet.
Normally we get a recommendation from the president in August of what that pay raise is likely going to be, or what he’s putting for. In this year, of course, everything has happened in a bizarre way in 2020. We actually received that notification very early in the year, in February, and it was an across the board 1% pay raise recommendation that President Trump put forward. Again, normally we don’t get it until closer to the end of the year or at least the end of the fiscal year close to that, but in this case we knew that President Trump was recommending the 1% pay raise as part of a bigger package that he submitted earlier this year. Now, Congress has remained silent on this issue mainly because they have other pressing matters to be dealing with right now. And assuming that they remain silent on this issue, it will simply go into effect at the 1% level.
If we look at the 10-year average for pay raises, something really important to keep in mind is that right now in 2020, we have a 1.14% average. If that 1% pay raise does take effect, the new tenure average will be 1.14%. But you’ll notice over the last 10 years, we’ve had quite a number of years where there were zeros in those columns, as well as some years that perhaps it looked a little bit more like the inflation levels. So, that’s how it works. I don’t know that expect is the right word to use, but at least when we’re thinking about over a long period of time what to be able to expect in a pay raise, this is a pretty good answer.
All right, so when does it get applied? Well, pay raises are typically applied in January of a given year. In the event that something gets in the way of a pay raise actually going through Congress and being ratified, most often there’s a retroactive pay that happens back to the beginning of the year. So the next question is, where must you live in order to get a pay raise? Well, any of the across the board pay raises that you hear announced will apply to everyone. It does not matter where you live. But oftentimes, there’s a locality pay adjustment as well and that would be specifically to one of the 53 locality pay areas designated within the United States. We’ve pinpointed them on the map. You already know if you’re in a locality pay area because you’re receiving that extra bump. Of course, everyone else is considered rest of the United States and you’ll go off of the rest of the United States schedule. Again, any place that we can get a pay raise we’ll take it, but I want you to understand what the key differences are.
All right, why does this affect you? Well, while you’re working, of course, we love to get extra money and it’s designed to help you, at least somewhat, keep pace with inflation and make certain that you’re able to satisfy the rising cost of your standard of living. I’m not going to call this a “cost of living” because I don’t want this to be confused with COLAs. But your standard of living and the day-to-day purchases that you make, we want to make sure that your pay at least doesn’t go backwards, but oftentimes it doesn’t feel like it quite keeps pace with inflation, which we’ll see a little bit later today.
As far as while you’re still working, you’ve got your eye on retirement and your current pay as an employee will affect your ultimate pension calculation. So all these pay raises that you’re getting, presumably at the end of your career are going to go into the pension calculation because they become part of your high-3 average salary. Now, I don’t have the time today to get into all of those details on what’s included in the high-3, but certainly any of your basic pay. That is your base pay, plus any locality pay that you are set to receive can positively affect your high-3, and so we want to keep our eye on that as we’re thinking about retirement.
The next main topic that we’re going to cover are cost-of-living adjustments. Cost-of-living adjustments (COLAs) are treated very differently than pay raises and it’s important to understand the distinct difference. As far as who gets a cost-of-living adjustment, these are annual inflation adjustments applied to a former federal employee and their pension, when they are retired. It will not affect employees in any way, just like pay raises affect retirees in no way. This is certainly important to understand when these announcements come out on either side, COLAs or pay raises, we want to make sure you’re paying attention to the right number so that you know how it affects you.
On a little bit of a side note, cost-of-living adjustments that are announced each year are also the increases that social security recipients would receive to the benefits that they’re getting from the social security program. So, what’s the cost-of-living adjustment based on? Well, each year, the Bureau of Labor Statistics releases a figure called the CPI-W. That index, that economic index looks at eight main areas within the US economy and determines how the cost of goods or services have changed from that same time last year. You can see the eight that we’ve listed here. Now, the Consumer Price Index for wage earners that you see here is different than some of the other CPIs that you might look at so make sure that if you’re going to do any digging, that you’re looking for the right index.
Off to the right hand side we’ve shown how it is that we determine the cost-of-living adjustment for retirees. In this case, we’re talking about federal retirees, not everyone else out in the US economy. So, federal workers who have retired from government service. When that CPI-W is relatively high, meaning it’s greater than 3%, CSRS retirees, you’ll see, they always get the CPI-W no matter what the number is. But FERS retirees ending up getting a different type of that number, typically a lower amount. So in the event that the CPI is high, like 3%, then the FERS retirees are going to get whatever that number is, minus 1%. Now, in the event that the CPI is more moderate, so somewhere between two and 3%, FERS retirees are going to get a flat 2%. And then anything with a low CPI, CSRD and FERS retirees will get the exact same change to their pension in that year.
But, that might not mean a whole lot to you until you see what the numbers actually look like. So, how much can you expect? Well, the cost-of-living adjustments are not guaranteed, just like pay raises aren’t guaranteed. For 2021, there has been a 1.3% CPI-W that’s been announced by the Bureau of Labor Statistics. It was just announced last week. Very important for retirees to be paying attention to this number. The 10-year averages that we’ve shown over on the right hand side, as of right now they’re at 1.52% and 1.34% respectively between the CSRS and the FERS categories. But once that new 1.3% goes into effect, those numbers actually go up a little bit at 1.65%, and 1.47% respectively.
Something important and what you might’ve seen in our most recent newsletter is that two lawmakers have proposed an emergency 3% override to the cost-of-living adjustment. They’re essentially saying, “Listen, don’t base what retirees are going to get an increase on based on the CPI-W. Let it be overwritten by Congress and signed by the president to be able to get the 3%.” Now, will that go through? Beats me. I’m not really sure, but it’s an interesting argument. Part of the argument is that the CPI-W doesn’t do enough to keep pace with inflation. You’ll see a little bit later that I would agree with that, at least for most of you on this call.
So when does the cost-of-living adjustment get applied? Well, it’s announced in mid-October of a given year, just like it was announced in 2020, and it will be applied in the following January. CSRS retirees will receive a cost-of-living adjustment in January regardless of their age, but FERS retirees don’t begin receiving cost-of-living adjustments until they reach the age of 62. Now, there are a couple of key exceptions. We have our special category employees. These would be our law enforcement officers, firefighters, and air traffic controllers. They’re going to receive a cost-of-living adjustment to their pension immediately, regardless of their age.
As far as cost-of-living adjustments, where must you live in order to get it? Well, I have good news and I have bad news. Where you live in retirement has no effect on your pension amount. That might be good, or that might be bad. It depends on where you live. The cost-of-living adjustments are applied uniformly regardless of your location. If you live in a really expensive area, your pension doesn’t go up for that purpose. And likewise, if you move to a really inexpensive area, your pension does not go down, which I’m sure you would find great news.
Cost-of-living adjustments, why does it even affect you? Well, cost-of-living adjustments are critical to I’ll say, somewhat retaining the purchasing power of your pension. We don’t want your pension to be flat over your entire retirement. That would be terrible for your purchasing power. Without a cost-of-living adjustment being applied to your pension, it would require you to more heavily lean on those other assets that you have, like your Thrift Savings Plan or 401(k)s, IRAs, any of those other types of accounts that you might have put away along your working years.
Now, don’t let this fool you. Even though you have cost-of-living adjustments being applied to your pension doesn’t mean you’re not going to still need some of those other accounts. You might even find that … Here in just a second, you’re going to see how inflation really affects the majority of you who are on this call today who are under the first program, and why you should pay special attention, because you might have to rely more heavily on some of those other assets, even with a cost-of-living adjustment. Now, one special note that I want to make and that is, that most of the remaining private sector pension programs, if you can find them out there, don’t have a cost-of-living adjustment at all. So I want to take a moment before we gripe about the cost-of-living adjustment and how it’s applied, I do want to acknowledge that I’m at least grateful that there is a cost-of-living adjustment out there for federal pensions.
We have to understand how inflation compares to cost-of-living adjustments, and I wanted to look at a little bit larger of a swath of time. Instead of just the 10 years, I wanted to go back 20 years and give everyone a little bit of perspective. Over the last 20 years, inflation within the United States has been 2.133%. The CSRS cost-of-living adjustments have actually beat inflation, which was a shocking number to me at 2.162%. But FERS, which are the vast majority of you on this webinar today have trailed inflation, and it becomes a bigger and bigger problem the longer that you go. You’re at 1.785% over the last 20 years. But let’s put some numbers to this, because we tend to maybe not quite grasp the effect of inflation or other numbers like this until we start putting some numbers to it.
Off to the right hand side, I wanted to do a really simple calculation. I’ve shown a pension of $10,000 a year. Now, the vast majority of you are going to have a pension much greater than this. Some many times fold, you’re going to have a pension. It’s not uncommon for us to see pensions 30, 40, 50, 60, 70,000, depending on the level of pay and how many years of service that you’ve had. I wanted to see, if we had somebody retire 20 years ago, so that was 2000, which is shocking to me that the year 2000 was 20 years ago. It seems like yesterday. But over a 20-year period, what’s the real effect of the cost-of-living adjustment and the inflation, had it been applied specifically to that federal pension?
If in the year 2000 we were to have a pension of $10,000 per year, and we applied the simple inflation figure to it that the US has actually experienced, it would’ve grown to $15,251 per year. Now, had you been a CSRS retiree and we applied that cost-of-living adjustment, you’d have a few extra bucks at $15,339 per year. But I want to stay acutely focused on the FERS retirees, or all the FERS who are on this webinar today that will eventually be retirees so that you understand how this works. If your pension was $10,000 a year, beginning in the year 2000, and we applied that 1.75% cost-of-living adjustment, your pension would’ve only grown to $14,245. Now, like I mentioned a few moments ago, I am grateful that there is a cost-of-living adjustment on it because most pensions don’t have that at all and so we want to give kudos to that.
And you might say, “Hey listen, I’m only about a $1,000 behind my CSRS counterpart. What’s the big deal?” The big deal is that the longer this goes, the worse it gets. And keep in mind, it’s only a $1,000 difference because we only started with a $10,000 pension. If you have a pension that’s 20, 30, 40, $50,000 or more, we’re going to exponentially see this problem evolve. So very, very important that we understand the effect of inflation not only on your pension, but everything else. I cannot describe to you how important it is that you plan for inflation. It is the carbon monoxide of retirement planning that so many people fall ill too, if you will, because we hadn’t quite adjusted for the effect of inflation.
All right, I wanted to cover like I promised, I wanted to cover the top five questions that we get about cost-of-living adjustments and pay raises from our workshop attendees. I consulted with our speakers and I wanted to make sure that I was really clear on the types of questions that we’re still getting in our retirement workshops to be able to cover them today with you. The first question is if I retire in January of 2021, does the new pay raise get factored into my retirement? I’ll answer that by starting to say, kind of.
That one month of pay, presumably you retire at the end of January in 2021, that one month of higher pay will be included in your pension calculation because it will become part of your high-3 average salary. Presumably your highest three years are there at the end. But, it doesn’t have some magical effect like it affecting all of your high-3. it’s just going to impact one of the 36 months that are included in that calculation. I like where your head’s at, but you’re not going to get a full year’s worth of credit for that pay raise year, if you only work in January.
Next question. If I retire December 31st of 2020, do I get the COLA in January of 2021? The flat out answer is no. And it doesn’t matter if you’re CSRS, FERS, special provision employees. You will not get a cost-of-living adjustment in January if you retire at the end of December. The reason is, is they’re going to look backwards to the prior year and say, “How many of those months were you receiving a federal pension?” You’ll get a prorated amount from the January pay raise. So in this case, you look back into 2020 and you were retired zero months out of the year. You had not received a pension at all in 2020 and so you will get that percentage of the cost-of-living adjustment, which is nothing. Now, in the event that you retire in the middle of a given year, you’ll receive a prorated version of the cost-of-living adjustment in that following January and from that point forward, you’ll receive the entire amount.
Next question. I thought locality pay was factored into my retirement. Why don’t I see it on my retirement stub? This is a great question and a source of frustration, I think for a lot of retirees, because you’re getting some conflicting messages. So, locality pay is factored into your initial pension calculation because it’s part of your salary. Your base pay plus locality pay is called your basic pay, and that is included in your high-3 average, which is a number used in the calculation of your pension. However, once your pension is calculated, there’s no more locality pay that’s factored in. Like I mentioned a few minutes ago, no matter where you live in the United States or even abroad, it does not matter. It does not change the pension amount that you receive. But of course, wherever you live in your highest three years of earnings does matter, because that’s what’s used to calculate your initial pension.
All right, next very frequently asked question. If I move once I retire, does my retirement pay change? I’ve covered this a couple of times today, because I want to make certain that everyone watching today’s session realizes that when you move when you’re already retired, it does not affect your pay at all. That again can be good news or bad news, depends on where you’re moving from and where you’re moving to, but it does not affect the pension calculation.
Last question, and then we’ve got a couple of good wrap ups here. Once retired, does the cost of my other benefits like FEHB, FEGLI and long-term care go up by the cost-of-living adjustment percentage? The answer is no. Most of those benefits that you just mentioned, FEHB, long-term care, FEGLI, all of those increase by a number much higher than the cost-of-living adjustment. For instance, something that was just announced here recently is that the FEHB premiums for 2021 are going up by an average of 5%. Well, wait a minute, I just told you the pay raise is expected to be 1% and the cost-of-living adjustments is expected to be 1.3%. But your FEHB premium is going up by 5%. So, it’s not in tandem. It doesn’t go up in line with pay raises or cost-of-living adjustments. Each of these benefits operate on their own payment schedule. FEGLI is a different deal. FEGLI, it depends on how old you are, what kind of FEGLI coverage you have, but it is not in line and it’s certainly not capped at the increase based on the cost-of-living adjustment.
We’re done with our questions today. I know several of you have probably asked questions about the handouts and the replay. The handouts again, are available for download right in the webinar platform. If you happen to be watching this on a replay, of course, the handouts will be included. We’ll also email you the handouts for anyone who was registered for today’s session so that you have that, along with the link to the replay for all of our registered participants.
Now, it goes without saying that the topic we cover today is a small little sliver of the bigger retirement picture. You’ve got to get the rest of the story of how the rest of your benefits are going to change as you approach that retirement window, and then well into retirement. I strongly encourage you to attend one of our workshops. We have both virtual and live options available. Of course, we’re virtual through the end of the year, and some of our locations are beginning to open up live. There is no cost to attend any of our workshops, and we’re going to cover all of the big benefits and the decisions that you’re going to need to be making with respect to those benefits as you approach that retirement window.
For those of you who are listening to this webinar today who have already been to one of our workshops, maybe it’s been a couple of years since you’ve gone through. I would encourage you to go back through. Hop on one of our virtual sessions and get a little bit of a refresher because I guarantee, your ears will hear something different and your stomach will probably react differently to certain items as they’ve changed over the years. So again, whether you’ve attended in the past or you’re new to our workshops, I would encourage you to go check them out at fedimpact.com/attend, and you’ll be able to find a workshop for your area.
All right, last up. Our next webinar topic I’m excited about because it’s very timely as we approach the FEHB Open Season for this year. Now, the FEHB Open Season is a time, of course, for you to go in and make any plan changes, that type of thing, nice and easy. But, I want to take a different spin on the FEHB Open Season and what to do, or sometimes what not to do if we’re keeping an eye on retirement. So when we think about adjustments that we might make to our FEHB coverage, things like should you switch from your FEHB plan over to your spouse’s plan out in the private sector?
Maybe they have cheaper coverage, maybe they have free coverage as a teacher, whatever that might look like. How does that ultimately affect you when you step into retirement, as far as the choices that you have for keeping FEHB? We have a long list of those items that we want to make sure to bring to everyone’s attention. It’s Managing the 2020 FEHB Open Season by keeping an eye on retirement. That next date is November 13th. We’ll do this at one o’clock Central Time, just like we’ve done today’s session, and you can sign up at fedimpact.com/webinar.
All right, we’ve made it to the end of today’s webinar. I thank you for your time and attention, and I hope that this began to spark some energy for you on paying attention to the bigger decisions, the bigger factors that influence not only your pay right now as an employee, but also as a retiree. We look forward to seeing you at one of our workshops soon. Again, to find a workshop, go to fedimpact.com/attend, and to register for our next informative webinar, go to fedimpact.com/webinar, all right? From all of us here at ProFeds, thanks so much for us and we’ll catch you next time!