Annual Pay Raise vs. COLA: How Are They Different?

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By on July 28, 2020 in Pay & Benefits, Retirement with 0 Comments
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Only a few months ago in January, federal employees saw a pay raise of 3.1%. At the same time, federal retirees only saw an increase of 1.6% to their pensions. The difference comes from how those increases come about.

Cost of Living Adjustments (COLAs)

The increase federal retirees see in their annuity payments is called a COLA, or Cost of Living Adjustment. The increase is derived from a price index that is meant to mirror inflation. This index is called the CPI-W or Consumer Price Index for Urban Wage Earners and Clerical Workers. It is used as a measure of the average change over time in the prices paid by consumers for a wide variety of goods and services. Basically, as the price of everyday goods and services goes up, so does this index.

For example, last year this index rose by 1.6% which meant that federal retirees under CSRS and FERS received an increase (COLA) of 1.6%, but it isn’t always this simple every year. 

Federal retirees under the Civil Service Retirement System (CSRS) receive the full COLA. The COLA increase percentage is applied to their monthly benefit amount before any deductions, and is rounded down to the next whole dollar.

While CSRS pensions grow with the index exactly, pensions for federal retirees under the Federal Employees Retirement System (FERS) do not as inflation goes over 2%.

For example, if the index grows between 2-3%, FERS pensions will only grow 2%. And if the index grows by more than 3%, then FERS pensions will grow at 1% less than the index. For example, if the index grew 5% then FERS pensions would only grow 4%. 

The table below illustrates this formula for federal retirees under FERS:

If the CPI is:Then the COLA is:
<= 2%COLA = CPI increase
> 2% and <= 3%COLA = 2%
> 3%COLA = CPI – 1%

Because of how these COLAs are calculated, FERS pensions may not keep up with inflation over time. It will be important for retirees to make sure their investments (or other income) are able to make up the difference so that they can maintain their standard of living throughout retirement. 

To get the full COLA, regardless of whether or not he or she is under FERS or CSRS, a federal retiree must have been receiving his or her pensions for a full year. If not, the increase is prorated based on the number of months that the retiree was receiving benefits.

It is also important to note that for most FERS retirees, COLAs do not start until age 62.

Pay Raises for Current Federal Employees

The pay raise that active federal employees see comes about in a completely different way.

Any annual overall salary increase for federal employees is based in part on a comparison to wages in the private sector. Congress and the president both play a role in the final decision, and as you might imagine, this process can be very drawn out and political at times.

Oftentimes, the president makes a recommendation for an annual pay raise (or no raise) and Congress goes along with it. But sometimes in other years, Congress will take action to pass legislation that overrides the president’s recommended pay increase. This happened in 2019 for instance when Congress retroactively approved a pay increase for the federal workforce and overrode the pay freeze that had been recommended by the White House.

On the bright side, the 3.1% raise that we just saw in January of 2020 was much higher than we’ve seen in years. 

This table shows the last 10 years of pay raises.

20110%
20120%
20130%
20141%
20151%
20161.3%
20172.1%
20181.9%
20191.9%
20203.1%

And despite some years of no growth, federal pay (especially with all the other great benefits) seems to be still competitive enough to encourage people to seek out government jobs. 

We will have to wait and see what the government does regarding next year’s pay raise and what the future holds for the millions of federal employees and retirees around the country.

© 2020 Dallen Haws. All rights reserved. This article may not be reproduced without express written consent from Dallen Haws.

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About the Author

Dallen Haws is a Financial Advisor who is dedicated to helping federal employees live their best life and plan an incredible retirement. He hosts a podcast and YouTube channel all about federal benefits and retirement. You can learn more about him at PlanYourFederalBenefits.com.

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