Delivered on: Wednesday, October 18, 2023

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
• COMING SOON: Current projections for 2024’s anticipated pay raises and how newly announced COLAs will be implemented in retirement

Download Handouts: CLICK HERE

Register for our next short webinar: FedImpact.com/webinar

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For an introduction to a financial professional in our network: FedImpact.com/request-to-meet

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Transcript of this webinar:

Hello and welcome everybody to the FedImpact webinar on COLAs versus pay raises. Boy, this is an interesting time of the year because this, of course, is when all of the new numbers are starting to be announced for the following year, and there always seems to be a little bit of confusion between COLAs and Pay raises, who’s affected, when do they get it and what you need to know. I knew that this was going to be a very timely webinar to be able to deliver today. My name is Chris Kowalik. I’m the founder of ProFeds and I will be your presenter today. We’re always very happy to be able to bring these topics to feds, especially when there’s something as important as COLAs and pay raises are to all of you, and so we’re delighted to be able to do this today. Now, for today’s topic, again, this is a very timely topic to talk about just given the time of year that we are in, and we do have a wide variety of different types of employees on this call.

We even have retirees who are tuning in to better understand how their pay is affected as a retiree as well. As I mentioned, we do have our support team standing by to answer questions. If you would please submit those questions in the Q and A area right there in the webinar portal, they will reply back to you, and I will stay simply focused on delivering the content today. Now, handouts are available for download. You can do that right next to the Q and A area, or if you look to the bottom of your screen, you’ll also be able to get the link directly to the handouts for today’s session. Now, this session is being recorded. We will be sending the link to the replay to all of you who are previously registered for this session. If there’s something that happens that you’re not able to stay for the whole session or you just need another listen, you will have instant access to the replay.

No opt-in is required any longer with the revision of our website, and so we’re delighted to be able to bring that to you nice and easy and stay till the end, you might think that you’ve got this down between COLAs and pay raises, but we have an awful lot to share today. Let’s kind of jump in.

COLAs vs. Pay Raises

Cost-of-living adjustments and annual pay raises both affect someone’s pay. The question is who that someone is and how much their pay is going to be affected. For today’s session, we need to differentiate between COLAs and who gets those and pay raises and who gets those as well? Okay? You do not want to confuse the two, and you always want to know which one you should be looking at based on where you are in your career. Okay, so for today’s session, we’re going to be digging into the details of COLAs and pay raises.

For instance, who’s supposed to get it? What is it based on? How much can you expect for 2024? When does it get applied? Where do you have to live to get it and why does it affect you?

Annual Pay Raises

Okay, so let’s jump into annual pay raises. Let’s start with who gets it. Pay raises are annual pay increases applied to current federal employees’ paychecks while they are still working. In other words, pay raises do not affect retirees, okay? This is a January, typically a January pay raise, and you have to still be working in order to benefit from a pay raise. What’s it based on? Well, pay raises are pretty darn subjective. A lot of it depends on if it’s an election year, who’s in office, who’s trying to get into office, and that can be kind of a challenge for you as the end user of this paycheck to know who it is that is influencing the pay raise that you are expected to receive.

Pay raises are not based specifically on an economic index. It’s not based solely on inflation. Of course, whoever’s deciding on the pay raise can look to those factors to make a decision, but it is not set in stone. If X number of inflation, you get X number of pay raise, okay? That is not at all how pay raises work. Very, very subjective. Again, they’re often very political in nature and every year, pay raises have high scrutiny from a lot of different types of groups. They’re either too low or too high or not fair, and all of that is up for debate, but at the end of the day, whatever that pay raise is, that’s announced, of course, you want to see your pay go up and so that makes total sense.

All right, so next let’s talk about how much you can expect. We know that pay raises are not guaranteed each year. It’s, again, very subjective in nature. There were several years a little further back than this chart goes where there were no pay raises at all, and so you probably remember that if you’re employed by the federal government during that time. It’s not even that you’ll always get a little something, sometimes you’re not getting anything. Now for 2024, the pay raise is not final, but it is expected to be 5.2%. That includes locality pay, so there’s a 4.7% across the board pay raise that is for everyone. Then we’ve got another half a percent increase for locality pay areas. If you happen to be in an area where there’s no locality pay, then, of course, you’re not going to receive that extra half a percent.

If we just look back over the last 10 years, you’ll see the employee pay raises over that period of time. You’ll maybe appreciate that since 2020, those pay raises have been more significant than they normally had been in the previous four or five years and much better than they were the previous years before what’s on this chart because that’s where we had a bunch of zeros right in a row. A 5.2% increase in pay, or even the 4.7% is quite a welcome change, I’m sure for many of you. If we look on average, that 10-year average is about 2.39%, just to give you an idea of what the trajectory has been overall of this time.

Now, next up, when do pay raises get applied? Pay raises are typically applied in January of a given year. If there’s any scuffle about whether a pay raise is going to be authorized and getting it finalized. For instance, if Congress is having a tough time making decisions and approving whatever has been recommended, then, of course, there may be a little bit of a late implementation of a pay raise, but typically it would be retroactive back to the beginning of the year. Even though they may be late on making a decision, most often it goes retroactive back to January.

All right, so where must you live to get it? Well, let’s talk about locality pay areas. On the left-hand side you’ll see a map where we’ve just pinpointed all of the different locality areas. We actually have four new locality pay areas that are about ready to be finalized. That is Fresno, California, Reno, Nevada, Spokane, Washington, and Rochester, New York. If you happen to be in one of those areas, you did not previously receive locality pay and now you will, okay? There have been plenty of other outlying cities that are relatively near a locality pay area that have now been included in those locality pay areas. Double check those locality pay areas for you to see if that means a pay change in the coming year.

The across the board pay raise that we talked about before this, in this case, the 4.7%, those are not tied to your specific location. That is what everyone will receive regardless of their location. Locality pay raises can, of course, increase the extra boost that you are getting to your pay based on where you live. Why does it affect you? Well, while working, of course, pay raises help to somewhat keep up with the cost of inflation, right? The rising cost to support the standard of living that you have. In other words, it’s helping to protect the purchasing power of your money. If your pay stayed the same but everything around you got more expensive, your purchasing power, of course, would not keep up. You wouldn’t be able to have enough money, it wouldn’t go far enough to maintain the standard of living that you have. Those pay raises help, but you have to appreciate that sometimes the pay raise doesn’t help enough to keep pace with inflation. Knowing that pay raises are not tied to a specific economic index, like inflation, might leave you holding the bag and although you got to pay raise, it didn’t actually help to get you further ahead.

Okay, so when it comes time to prepare for retirement, the higher your basic pay is, the higher your pension is going to be once you retire, right? Because typically, your final pay is what determines your high three average salary. We did a whole webinar on the high three and what goes into that calculation. I encourage you to go watch it if you’re not terribly familiar with the high three, but this idea that the more you make towards the end of your career when you’re at your highest earning level, is obviously going to help your pension. We don’t want to dismiss pay raises or the long-term effect that they can have on you, but certainly, there’s the short-term effect of what’s happening right now with respect to your standard of living. Then how does it influence what your ultimate pension is going to be maybe many years from now? Quite an effect that this can have on you both now and later.

Here’s a question that we typically get. If I retire on January 31st, in this case of 2024, does the new pay raise get factored into my retirement pension? Well, the answer is kind of. Okay? There will be one month of pay that you received in January 2024 that was at that higher level, and that will likely help to make your high three slightly higher. The reason it’s not making a bigger impact on your high three is because if you look at what the high three is, it’s your highest three years of consecutive earnings. January of 2024 in this example would only be one of 36 months included in the high three calculation.

Does it help? Yes. Does it help in an astronomical way? No. Okay, so please don’t delay retiring until January 31st just because you think that you’re going to miraculously get a much higher high three. If you want to wait until January for other reasons, if there’s something else super positive about waiting until that time, that’s certainly fine, but you are not going to have this super significant change to your high three just because you spent one month in a new pay level.

Cost-of-Living Adjustments

All right, let’s switch gears here and talk about those cost-of-living adjustments. Who gets it? Well, COLAs are the annual inflation adjustment applied to former federal employees either under the CSRS or FERS pensions while they are retired. COLAs do not affect employees at all. They affect retirees.

Okay, so very important that we understand the difference, and I think I know where some of the confusion with COLAs come in. Oftentimes, people think of a pay raise as an adjustment to your pay to support your cost of living, and so they think that’s a COLA when in fact it’s not. COLAs with respect to federal workers apply only to you once you are retired. I also know that on the military side, we often refer to COLAs as the special type of pay that you get based on where you live. Well, as a federal worker, we call that locality pay, which is different than a COLA. I understand where the confusion comes into play, but we’ve got to get the terminology right, so that when you’re seeing all these numbers come out in the media that you understand what you’re affected by and what you’re not.

Again, cost-of-living adjustments only apply to retirees, and of course, COLAs are also applied to social security benefits that someone might be receiving. That’s another application of COLAs, but as far as being a federal worker, it is simply applied to your CSRS or FERS pension. What’s it based on? Well, this is not subjective by any stretch. The Bureau of Labor Statistics sets a number called the CPI-W. It’s the consumer price index for wage earners, and it’s based on the rising cost of a slew of different things, a pretty broad scope of cost that they’re looking at, and I won’t get into the details of how the COLA is calculated, but looking at all of these things that an average person would be paying for, how have those changed year over year? Okay? Housing, food, groceries, medical care, travel, transportation. All of these pieces that you see on here are included in this index.

I have some good news and bad news for you. The good news is if you are a CSRS retiree, you are going to get whatever this number is that’s released, and this is essentially tracking inflation. When we think about inflation numbers, it is based on CPI-W is how much more expensive things are now than they were this time last year. That is what determines the CPI-W. When the CPI-W is high, so greater than 3%, then the CSRS retiree, again, is going to get that CPI-W. FERS retirees get that number minus 1% and 1% might not seem like a big deal, but it’s 1% for maybe three or four or 5%. That becomes a big chunk of the COLA that you’re not going to get because you’re a first retiree. Now, in the event we have a moderate CPI-W, somewhere between two and 3%, again, those CSRS retirees are going to get whatever that number is, but FERS retirees will get 2%, and then if we have a low CPI-W that is less than 2%, CSRS and FERS retirees get the exact same change to their pension for that following year.

Okay, so there is a definite scientific way that this number is being calculated. It is not based on who’s in office, any kind of political poll, any kind of pandering, any of that. This is simply based on the entire United States cost of living and that inflation number, which is what determines the CPI-W, which ultimately determines the cost-of-living adjustment that is applied to the pension.

How much can you expect? Well, we know that COLAs are not guaranteed. If we have years of deflation or no movement at all, then, of course, there will be a 0% CPI-W or 0% COLA. We saw that actually in 2016. You’ll see in the table on the right-hand side, both CSRS and FERS retirees got nothing added to their CSRS or FERS pensions. Now, for 2024, the 3.2% CPI-W was just announced. That translates for CSRS retirees to get 3.2% just like the CPI-W was announced, but FERS retirees get 2.2%, okay? Remember, you’re going to be a point behind when CPI is high. If we look back over the last 10 years, we’re going to see for CSRS retirees a 2.75% increase, and for that same period of time, the FERS retirees would’ve received an increase of 2.37% on average each year. It gives you an idea of the differences between the CSRS and FERS pensions and how they change over time.

When does it get applied? Here’s probably the most confusing part of COLAs and we just need to get this straight. Some important dates that we need to know. Typically, the COLA is announced in mid-October. It is applied to the December pension check to that accrual of the December pension, but that December pension isn’t paid until January, so it’s applied to December, but it’s payable in January. Now, CSRS retirees are going to receive cost of living adjustments to their pension regardless of their age, but FERS retirees will receive COLA’s beginning in the year in which they turn 62, okay? There is a small exception to that and that is our law enforcement officers, firefighters and air traffic controllers. They’re going to receive cost of living adjustments immediately, regardless of how old they are when they retire. Now, that very first COLA that you receive as a retiree may very well be prorated based on the number of months that you were retired in the prior year. We’re going to look, it’s kind of a weird year that they’re looking at. They say from December to November of the prior year.

In this case, December of 2022 to November of 2023, how many months of that year were you set to receive a pension check? You’re going to get that prorated amount, okay? We need to understand when this really kicks in and when it doesn’t and not make a rash decision on when you plan to retire based solely on when COLAs are announced and applied.

All right, so here’s a question just to give you a sense of how this works. The question is, if I retire December 31st, of 2023, do I get the COLA in January of 2024? Again, the answer is no. You’ll only be getting a prorated portion of the 2024 COLA based on how many months of the prior year, again, December of 2022 to November of 2023, that you were receiving a pension. Well, because you didn’t retire until December of 2023, you had zero years or zero months during that December 2022 to November 2023 timeline. You are going to get 0% of the COLA in that first year. You’re going to have to wait until January of 2025 to receive the cost-of-living adjustment. Okay? Hopefully, that clears up that very common confusion that we hear from feds.

Let’s talk about COLAs and where you must live to get them. Where you live in retirement has no effect on your pension amount at all. At all, okay? COLAs, these cost-of-living adjustments are applied uniformly regardless of your location. Now, that’s not to say that your pension isn’t affected by where you live, but it was where you lived while you are earning your highest three years of earnings, which is really influencing your pension amount. For instance, if you were in an area that had a super high COLA during your highest three years of earnings, your pension is going to be based on that high three, and so that will determine your starting pension.

Remember, COLAs get applied after your pension has already been calculated, and so whatever that starting point is for your pension, COLAs happen after that. If you decide to move from Houston, one of the highest locality pay areas in the country, to a small little town that has nothing to do with government service and no locality pay anything like that, that’s okay. It doesn’t affect your pension whatsoever. However, the opposite is true too. That’s the bad news. If you are in an area where you lived while you were accruing your high three that had no locality pay, and so your pensions based on that lower pay amount, without that boost of the locality pay, then your pension is not going to be reflecting the higher cost of living for that area. Again, that locality pay. If you decide to move from that area to an area that is more expensive, I’ll use Houston as an example, again, at that point, your pension check doesn’t go up for that purpose.

It will go up based on this CPI-W that’s announced every year, but it is applied uniformly regardless of where you live at the time that you are receiving it. Okay? Again, this kind of goes back to that confusion of what COLA means, and we want to differentiate that from the locality pay that’s used to support your standard of living while you are working and not confuse that with the cost-of-living adjustment that is applied to a retiree’s pension.

Why does it affect you? Well, COLAs are pretty critical to somewhat retain the purchasing power of your pension money. Without COLA, and I would argue even with COLA, you have to rely more heavily on other assets like the thrift savings plan. If you want to maintain the standard of living that you have right now, you know that you’re going to have a pension that is lower than the check that you received today as a worker, if you don’t have enough to pay the bills and live the lifestyle that you want, you’re going to have to rely on other accounts like the TSP, maybe 401Ks, IRAs that you have out there, whatever the retirement products are that you have.

If your pension does not keep up with the pace of inflation, you’re going to need more and more and more money from accounts like TSP to supplement the pension that you have so that you can purchase the goods and services that you wanted. The problem is that if that’s all traditional money in the TSP, that’s all going to be taxable to you. Not only did you take more money from an account to begin drawing down on that account and using it, but you’re also increasing your tax bill. We have to be super careful about knowing how COLAs affect the pension and specifically for FERS retirees. What happens when your pension doesn’t keep pace with inflation? What causes this domino effect of needing to take other assets from accounts like the TSP?

Okay, now I do want to point out it’s not all doom and gloom when we look at COLAs as they’re applied to federal pensions. For one, I’m grateful even for the diet COLA that FERS retirees get where they’re not getting the full CPI-W. The reason is that most of the remaining private sector pensions, if you can find one, don’t have a COLA at all. If you have a pension that is $10,000 a year, let’s say, just to make things simple, it will remain $10,000 a year for the rest of your life out in the private sector. You don’t have that problem as a federal retiree. For that, I’m very grateful that at least there’s a COLA in place even though it’s maybe not a perfect testament to the inflation that you’re experiencing.

Recap

Let’s recap. I want to show you what happens if you are a retiree, or you are still working and how the COLAs and pay raises will affect you.

What happens if you separate at the end of October of 2023? Do you get the 2024 pay raise? The answer is no. You’re not going to be an employee during that time, and so you naturally will not receive that pay raise. Do you get the COLA? The answer is yes. You will start to get 1/12th of the COLA starting in your January pension check. The reason being is that November would’ve been the first pension month that you had, and remember, we’re looking at December of the prior year to November of the current year where the COLA is announced to determine how many months of that year you were receiving a pension check. In this case, you would’ve only received the November pension check, and that will mean that you get 1/12th of the COLA starting in January.

Now for those employees who retire in November or December of this year, they will receive neither one. You won’t get the pay raise, and you won’t get any cost-of-living adjustment for the 2024 COLA. You’re going to need to wait until 2025 to begin receiving any of that cost-of-living adjustment. Now, for anyone who separates at the end of January 2024, do you get the pay raise? Well, the answer is yes, but remember, it’s only going to count for one of the 36 months of the high three average. It’s not going to make a super significant difference in your ultimate high three that is used to calculate your pension. Do you get the 2024 COLA? Gosh, the answer’s no. For the same reasons that we talked about for November and December. You simply were not retired in time to be able to get that COLA for 2024, but you’ll be in line to get it for 2025, at least a portion of that COLA.

Now, February of 2024, same kind of concept as January. Yes, you will get the pay raise and it’ll count for two of the 36 months of your high three average. Again, all of this is assuming that your highest pay is here at the end of your career, but it is important to recognize you will not receive the 2024 COLA either. Okay? Hopefully, we’re kind of zooming in on these five months right around the end of the year to answer those questions of those pending retirees that you’re employed right now, but you’re about ready to step into retirement and how all of this affects you.

Wrap Up & Next Steps

Now, let’s do some wrap up and next steps. Quick wrap up. Pay raises and COLAs are paid in very, very different ways and neither one of them are guaranteed. Okay? We should appreciate that this is all calculated based on a number of different factors. Some of them are very objective, some are very subjective. Knowing which ones you are entitled to, super, super important. You should not base your decision to retire solely on a pay raise that is expected or a COLA that is expected. Please look at the bigger picture, making certain that you are actually in good shape to retire before you make that decision. Here’s one of our training mantras that we really focus on in our workshops, webinars, podcasts, whatever it is. That is when you know your numbers, your financial decisions become obvious. If you don’t understand what your pension is going to be and what retirement is, how that’s lined up for you based on all the assets that you have, it makes it very difficult to make great financial decisions to know that it’s time to retire.

Please do not look at pay raises and COLAs in a bubble. Look at those in context to the bigger picture that you have so that you’ve got great numbers to make decisions from.

All right, so our job here at ProFeds is to help federal employees retire with confidence. The very best way that we can do that is to get you into one of our workshops. The workshops that we do are in-person training sessions. They are full day. There is no cost for you to attend. During that session, we cover all of the federal benefits topics and the decisions that you’re going to need to be making. The best part about the workshop is that after the workshop, you have an opportunity for some one-on-one help if you need some clarity to get your numbers right and understand how your federal benefits affect your bigger retirement plan. We want to help you be the hero in your own retirement story.

You have what it takes to be able to get the retirement that you want, but it doesn’t come to you by accident. You have to wake up and make it happen. We’re here to help in that process. You can see all the details of the Fed Impact workshop by going to fedimpact.com/attend. You’ll see all the locations and dates available for registration right now.

All right, so our handouts and replays for today’s session, again, you can download them if you’re still here on the webinar. Otherwise, if you’re not in a place where you can download them easily, we will certainly email them to you along with a link to the replay.

Now, our next webinar topic, this is always a fun time of year because so much is changing for next year, we’re going to be focusing on optimizing your TSP for 2024. That webinar will happen on November 17th at one o’clock central. You can sign up for that webinar just like you did for this one at fedimpact.com/webinar.

All right, I want to thank you all for joining us. We’re really delighted to be able to bring these updates to you and keep you focused on the things that are most important for you to be able to live the retirement that you want. Again, you can find a workshop at fedimpact.com/attend, and to attend that next webinar on TSP for 2024, you can go to fedimpact.com/webinar. All right, thank you all so much. We’ll see you next month.