By now, Colorado PERA members are well aware that their Annual Increase (AI), or cost-of-living adjustment (COLA), has undergone some belt-tightening changes with the passage of Senate Bill 200 last year. What members and retirees may not know is that this action followed a broader trend for public pension plans throughout the U.S. In the past decade, pension funds in 18 states, including Colorado, have enacted reforms that changed COLA for existing retirees. Seven states have adjusted COLA for current employees and new hires, and another six have changed them for new hires only.
While there are many types and variations of Annual Increase and COLA (ad hoc, fixed, simple, compounding), essentially the adjustments to retirement benefits are meant to counterbalance inflation, which reduces the purchasing power of a fixed income. These adjustments are of additional importance to states such as Colorado, where a majority of public employees do not participate in Social Security. But unlike Social Security, defined benefit plans, including PERA, typically pre-fund COLA via employee and employer contributions over the course of employees’ careers.
The structure of pension plans varies widely, so it’s only natural that COLA do, too. PERA’s COLA is automatic, or predetermined by a set formula; and it’s compounded, meaning that annual benefit increases are calculated based on the original benefit plus any prior benefit increases. PERA’s annual COLA changes are influenced by the financial performance of the fund. For some PERA retirees, the COLA is based on factors such as the rate of inflation and the health of the Annual Increase Reserve for each membership division.
The COLA may also be affected by a person’s age, date of hire, or years of service and the length of time in retirement. If all of this seems complex, it is – because it varies for different PERA members. For a full explanation of how PERA’s COLA calculations work in practice, refer to the Annual Increase (AI) fact sheet.
The primary reason so many states have targeted COLA in their pension reform efforts is cost, along with the U.S. economy’s recent track record of historically low inflation. The NASRA research (on page 3) notes that a compounded automatic COLA of 1.5 percent will add 11 percent to the lifetime cost of a retirement benefit, and a 3 percent COLA adds 26 percent to that cost.
The changes to PERA’s pension fund were enacted by the State Legislature, as is often — though not always — the case with pension alterations around the country. One key component of the Colorado General Assembly’s efforts in 2018 was the addition of an automatic adjustment provision, which could enable COLA to decrease or increase depending on PERA’s progress toward reaching full funding within a closed 30-year time frame. The upshot for PERA members and retirees: The recent changes to the pension plan are not without pain and angst, but they’re part of a national trend toward protecting the long-term viability of public pension funds as well as stabilizing the funded status of the PERA plan which benefits all stakeholders.
ColaAcronym for cost-of-living adjustment; a type of annual adjustment meant to prevent a person from losing buying power due to inflation.ColaAcronym for cost-of-living adjustment; a type of annual adjustment meant to prevent a person from losing buying power due to inflation.Annual increaseAn adjustment to PERA retirees’ monthly benefit payments, paid in July each year. The Annual Increase amount is set in statute and can adjust up or down based on PERA’s funding progress. It is not tied to inflation.Defined benefitAlso known as a pension, this is a type of pooled retirement plan in which the plan promises to pay a lifetime benefit to the employee at retirement. The plan manages investments on behalf of members, and the retirement benefit is based on factors such as age at retirement, years of employment and salary history.Fixed incomeA type of investment that pays investors a fixed rate of interest over a set period of time. Bonds are a common type of fixed income investment.