It is the time of the year when federal retirees, and those who are soon to be federal retirees, are focusing on the cost-of-living adjustment (COLA) for the coming year. The COLA for next year will be announced in October. The inflation figures for July-September of this year will tell us how much the COLA will be starting in January.
At the moment, one estimate of the COLA for 2022 is an increase of 6.2%. If this projection becomes reality, it is about five times the 1.3% COLA increase in January 2021. It would also be the largest COLA in thirty-nine years.
2022 COLA Calculations
If you are a new federal retiree or have just not paid attention to how the system works, a COLA attached to your federal pension is a significant benefit. The yearly COLA adjustment helps a person who is retired maintain their standard of living by getting a yearly boost in pension payments based on the rate of inflation.
There is a difference in the COLA calculations for those under FERS and for those under CSRS. The FERS pension COLA is based on an inflation gauge (the CPI-W). Essentially, this means that if the CPI-W shows that prices are higher, then FERS and CSRS pensions will also go up.
Social Security and CSRS pensions receive COLAs based on the rate of inflation as calculated by the CPI-W. The COLA for FERS pensions is not as generous.
If the inflation rate is less than 2% in a year, the FERS pension will get the full amount of the COLA. If inflation rises between 2% and 3%, the FERS COLA will be 2%. If inflation is up more than 2%, the FERS COLA is the inflation amount minus 1%.
In other words, when the measure of inflation is up more than 2%, a FERS pension increase will fall behind. For a person who may be retired for many years, this difference is likely to be substantial over time.
So, when inflation is above 3% using the CPI-W index, FERS pensions will lag 1% behind this inflation rate every year in which this occurs.
CSRS vs FERS
The Civil Service Retirement System (CSRS) is an older retirement system for federal employees. The Civil Service Retirement Act, which became effective on August 1, 1920, established this retirement plan.
The Federal Employees Retirement System (FERS) became effective on January 1, 1987.
This is what the Office of Personnel Management said about the CSRS system when FERS was being introduced in 1987:
(CSRS) is a very good retirement system. But, it was designed many years ago for a workforce that usually made a career out of working for the Federal Government. CSRS provides excellent benefits to employees who retire from the Federal workforce after many years of service.
In general, CSRS will be better if you know for sure that you will retire from the Federal Government after a long career—20 or 30 years. But what if you’re not sure what the future holds? Maybe you’re not planning to spend your entire career with the Federal Government, or you may want to retire early before you have 30 years of service. In either case, FERS may be the retirement plan you want.FERS Transfer Handbook: A Guide to Making Your Decision
CSRS was phased out starting in 1987. There are very few current federal employees who are still working under the CSRS system—less than 100,000. Of the more than 2.1 million federal retirees (including the Postal Service), 61.8 percent are drawing benefits under CSRS.
Why Do CSRS Employees Receive a Better COLA?
As explained above, federal employees who retire under CSRS receive a larger COLA (in some years) than FERS employees receive. This enables CSRS retirees to keep up with inflation better than FERS—at least with regard to their pension payments.
CSRS employees do not receive Social Security as part of their retirement plan. Some CSRS employees do receive Social Security based on employment other than having worked for Uncle Sam but it is not an integral part of the CSRS plan.
The FERS system was designed to make it easier to leave federal service and to take a job with another organization. CSRS was designed to provide a retirement plan after a long career of working for the federal government. The federal retirement system was described as a system with “golden handcuffs.” It was designed on the assumption that a federal employee would remain a federal employee until dying or retiring.
When CSRS was implemented in 1920, many Americans spent their entire careers working for one employer (or on their own farm). Companies used to have retirement plans similar to CSRS (often without a COLA) and CSRS followed a similar system.
The FERS system was based on different assumptions and a different model. FERS employees receive Social Security and the full Social Security COLA every year. So, while they do not receive the full COLA for their pension or annuity, they do receive the full COLA for Social Security.
FERS employees also have access to invest for their future retirement through the Thrift Savings Plan (TSP) for their entire career with the federal government. The federal government provides an extra matching amount that goes into the TSP to provide a greater income stream during retirement. The TSP gives employees a chance to invest money for future retirement income as they see fit and also receive a tax break. The money is invested by the Federal Retirement Thrift Investment Board into funds selected by the employee.
Employees who invest in the TSP often have a substantial amount of money as a result of having invested wisely in the TSP. There is not a guaranteed rate of return on TSP investments. Investing in stock index funds and leaving it over a period of years has always provided a good rate of return for investors. Unlike contributions to a federal annuity, federal employees investing in the TSP control this money and how it is invested. Each individual impacts how much the rate of return will be upon retiring based on their selection of funds receiving their investment dollars.
If a federal employee leaves federal service before retiring, the Social Security benefit and their TSP investments stay with that person.
The extra COLA amount for CSRS employees is the result of Congress having decided the benefit of the TSP investments, including a matching amount provided by the federal government for an employee who invests in the TSP, and the additional income provided during retirement by the Social Security system justified a lower COLA than the one provided for CSRS employees.