Do All Pensions Increase With Inflation?

A pension provides a monthly income in retirement. For retirees on a fixed income, a concern is inflation, which reduces purchasing power over time. Whether pension payments will adjust to keep up with the rising cost of living depends entirely on the specific rules governing an individual’s pension plan.

Understanding Cost of Living Adjustments

A Cost-of-Living Adjustment (COLA) is a periodic increase to a retiree’s monthly benefit intended to offset the loss of purchasing power from inflation. Not all pension plans offer COLAs, and for those that do, the structure can vary. The terms of a COLA are established by the plan’s official documents or by law.

A COLA calculation is tied to an economic indicator that measures inflation, such as the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). Pension plans with COLAs compare the CPI-W from one period to the next to determine the percentage increase for the following year. This often involves using the average from the third quarter.

Pension plans may feature either automatic or ad hoc COLAs. An automatic COLA is a guaranteed, annual feature of the plan, though the increase is often capped at a certain percentage, like 2% or 3%. This means the adjustment may not match a higher inflation rate.

In contrast, an ad hoc COLA is a one-time, discretionary increase granted by the plan sponsor. These are not guaranteed and occur irregularly, depending on the pension fund’s financial health.

Inflation Adjustments in Public Sector Pensions

Pensions for government employees are more likely to include automatic COLAs than private sector plans, as these adjustments are often established by law. For example, the Federal Employees Retirement System (FERS) and the Civil Service Retirement System (CSRS) both have provisions for annual COLAs.

There are differences in eligibility between these federal plans. Under CSRS, COLAs are applied to all annuities, but for most FERS retirees, adjustments do not begin until age 62. This age requirement is waived for disability retirees, survivor annuitants, and certain special provision employees.

For eligible FERS retirees, the COLA calculation is tiered based on the inflation rate. If the CPI increase is 2% or less, the COLA matches the CPI. If the CPI increase is between 2% and 3%, the COLA is 2%. If the CPI increase is more than 3%, the adjustment is 1% less than the CPI increase. This structure means the adjustment for FERS retirees does not fully match the inflation rate during periods of high inflation.

State and local government pension plans for employees like teachers and police officers also feature automatic COLAs. The formulas are dictated by law and can include caps, such as a 3% maximum annual increase. Some plans feature a “COLA bank,” where inflation above the annual cap is credited to a retiree’s account. This credit can be used to supplement COLAs in future years when inflation is below the cap.

Inflation Adjustments in Private Sector Pensions

The Employee Retirement Income Security Act of 1974 (ERISA) sets minimum standards for most private industry retirement plans. However, ERISA does not mandate that private pension plans provide a COLA. As a result, automatic, guaranteed COLAs are a rare feature in corporate pension plans.

The decision not to offer automatic COLAs is a financial one for the sponsoring company. Guaranteeing annual increases for all retirees represents an unpredictable long-term liability. Funding this promise requires higher employer contributions, which impacts profitability. For these reasons, most private companies do not include this feature in their pension plans.

When private pension plans provide an increase, it is nearly always an ad hoc adjustment. A company might grant a one-time percentage increase after a profitable year or during high inflation. This action is voluntary and at the company’s discretion, meaning retirees have no contractual right to these increases.

How to Find Your Pension’s Policy

To understand your pension’s rules on inflation adjustments, consult the Summary Plan Description (SPD). Your plan administrator is required to provide you with a copy of the SPD free of charge. This document outlines the plan’s provisions and will state whether it includes a COLA.

When reviewing your SPD, search for terms to locate the relevant section. Look for:

• Cost-of-Living Adjustment
• COLA
• Inflation adjustment
• Post-retirement increase

This section will describe if and how your benefit may be increased. It will specify whether adjustments are automatic or ad hoc and detail the formula, inflation index, and any caps.

If you cannot find your SPD or have trouble interpreting it, contact the plan administrator directly. The administrator’s contact information will be listed in the SPD or other plan communications. You can request a new copy of the SPD or ask directly about the plan’s COLA policy.