Ep #34: COLA vs. Pay Increase

 You can spend. You can save. What is the right thing to do? Federal benefits, great savings plans too. You can save your own way, with help from Micah and Tammy. You can save your own way. Save your own way.

Micah Shilanski:  Welcome to Plan Your Federal Retirement podcast. I’m your cohost Micah Shilanski and with me, as usual, is the amazing Tammy Flanagan. Hey Tammy, how’s it going?

Tammy Flanagan:        Hey Micah, how are you doing? The amazing Micah Shilanski.

Micah Shilanski:  We are doing pretty good. We’re getting the last little joys of the summer and Fall out. We’re actually doing some camping right now with the family and, Tammy, that’s always a little funny. It’s that difference of summertime and Fall when it comes, because we were in the RV the other night and went to sleep and everything was fine. I woke up in the morning, I’m an early bird, I go to turn the faucet on and there’s no running water. I’m like, huh? That’s interesting. Did I not turn the water on? Did I not hook up last night? And sure enough, it had dropped down to 28, 27 degrees and our water lines outside had frozen. So nice little fun RV experience. Yes, winter’s coming to Alaska.

Tammy Flanagan:        Oh my goodness. Yes. Hard for me to imagine as I look out at a thunderstorm because it was so warm today that the clouds just erupted in rain.

Micah Shilanski:  There you go.

Tammy Flanagan:        It’s like the endless summer.

Micah Shilanski:  That’s awesome. One of the many beautiful parts about Florida.

Tammy Flanagan:        Well, we could use a little cool weather. Maybe not frozen pipes, but at least a few degrees cooler.

Micah Shilanski:  There you go. We talked about planning for the unexpected. Today’s podcast, we really wanted to jump into some additional misconception, I say additional because we talked about other misconceptions retirees have had in the past, but we really want to focus on some misconceptions people have when they’re planning their retirement. And Tammy, as you and I were pre-gaming this, a lot of this about the COLA and the high three and that illusion that says, “Well, great. If I get this COLA, once I retire I’ll get COLA, or if I wait along for an increase, all of a sudden my pension is going to be dramatically more.” When in reality, we’ve got to run the numbers, and it’s showing not as rosy as people think it’s going to be.

Tammy Flanagan:        Yeah, Micah, I agree. I get a lot of questions from people who wish they knew 12 months ago about a cost of living adjustment or employee pay raise, because now it’s kind of late to do much about it. If you’re going to plan your retirement for this year, it’s a little late to take advantage of this, what’s shaping up to be a pretty large cost of living adjustment. So I think today is going to be a really good way to explain and clarify, what is the difference between the retiree cost of living adjustment, the employee pay raise. Is there any sense made of trying to strategize around that? So I know you get them and I get a lot of questions around this topic. So I think this is going to be very helpful to people planning to retire in the near future.

Micah Shilanski:  You bet. Well, I love what you said there. Let’s bridge the gap a little bit between working and retired. Because the COLA operates, pay increases operate differently in retirement. So, Tammy, walk us through, for a current federal employee … Let’s say this year, no, we don’t know exactly what the pain increases are going to be. We’re going to use, there’s projections out there, so we’re just going to say 3%. Maybe there’s a 3% COLA that’s going to happen this year. If someone was an employee, Tammy, and they were just … not worried about retirement currently, what happens to their pay? And then let’s contrast that with a retiree.

Tammy Flanagan:        So, every January, at least most every January, there have been some years when there have not been a pay adjustment, but generally Congress will grant some type of a general pay adjustment or pay increase for federal civilian employees. And sometimes it mirrors what the military gets, sometimes it has nothing to do with what the military gets, but it does change the pay rate for GS employees under the general schedule. So this year it’s shaping up to be a fairly decent pay adjustment, maybe 2.7%, maybe with locality pay factored in most people get closer to 3%. And we really haven’t seen that high of a pay adjustment for a number of years. I know in 2020 it was 2.6, but other than that, nothing going back to 2009 even went above 2%. You were lucky to have received 1% or one and a half.

                           And then there was that three year pay freeze back in 2011 to 2013. So I think employees are pretty happy to see any type of pay adjustment outside of a promotion or a step increase. And especially for employees planning to retire, many of them have maxed out. They’re already the GS-11 step 10 or the GS-14 step 10. So they’re not getting promotions anymore, pay adjustments, so this is the only thing that causes their high three to go up. So the question I’ve been getting is, “What if I stay until after January?” How is that going to increase my retirement if I work until the end of January or to the end of March?

                           How long do I have to work to really make that new pay rate part of my high three?” And the simple answer is, you only have to work one day. Because if you work one day after it takes effect, you’ll have one day out of three years computed at that new pay rate. But will you really notice that in your retirement benefit? No, it probably wouldn’t even make a penny’s difference. So we did talk about this prior to this recording, Micah, and we came up with a little example of that. Did you want to walk through that with us and I’ll fill it in? Or do you want to do that?

Micah Shilanski:  Yeah, let’s go ahead and jump into that because one of the things, Tammy, and I know you like to do this as well. Sometimes we can get caught up in percentages. Hey, it’s a 3% increase, it’s XYZ increase, Let’s put it in dollars and let’s make the dollars relative to you and your goals. Because you’re going to see, you get in this kind of catch-catch can mentality that says, “Oh, if I wait for this pay raise, my high three will go up.” Or if I wait until next year, I’m going to get a step increase, my high three will go up. And the answer is, yes. And the answer is, does that positively affect your retirement income? Yes, it does. But to what end does it really affect it? What goal are we trying to achieve?

                           And so the best way to look at that, Tammy, you said is dollar amounts. So let’s take a basic example. Now I know people say, Tammy, you guys use other examples besides $100,000 for high three. No, this makes it really easy on Tammy and I versus telling you it’s $72,658 of your high three would make it slightly more complicated to follow. So just go with us in concept here. So if your high three is $100,000, and Tammy, let’s make it super easy. You have 30 years of service, it all counted towards eligibility and credibility towards retirement. And you retire when you’re 60 years young. Well, it’s pretty simple. Your pension is going to be for 30 years, that means it’s 30% of 100 grand. So 30,000 a year, or $2,500 a month would be your gross monthly benefit.

                           So now the question is, you got a 3% pay increase this year, and you worked an extra year in order to get the benefit of it, because keep in mind, Tammy, just as you said, if you just work one day into the new pay raise, it does add to your high three. But it’s only one day out of three years, which is a pretty small. So let’s say you worked an entire extra year with the pay raise and you got a 3% increase. So that would mean your pay would go up from a 100,000 to 103,000. But remember the high three is an average of your highest 36 consecutive months.

                           So that means your high three now, instead of 100,000 is only $101,000. But now you have 31 years of service. You worked an extra year. So your percentage goes up a little bit. Your high three goes up a little bit. Now you’re 61 years young. So now what is your pension? Rounding, your pension is $2,600 a month. Roughly for that extra year of work, and 3% pay raise, equates to an extra $100 a month for the rest of your life in retirement. Which, great that it went up, but is that what you’re really solving for?

Tammy Flanagan:        I know. The question I get a lot is, what is the maximum benefit? I want to stay until I’ve achieved the maximum retirement. And there is no such thing. I don’t know about you, Micah, but I’ve never heard of FERS having a limit or a maximum. So if you work 100 years, you can get 100% of your high three. So I like your idea, Micah, of solving for what it is we’re trying to accomplish. Set a goal, and then once you’ve achieved it, then the rest is gravy. If you work beyond that, that’s fine, but at least you’ve met your goal.

Micah Shilanski:  Absolutely. So if you have a goal of saying, look, I want to spend $4,000 a month, $5,000 a month, $10,000 a month. Whatever that monthly income is, and here’s a hint, if you work with Tammy and I, it’s what you’re currently spending. That’s what we’re going to look at for how much you want to have in retirement. What you’re spending now, how do you best replace that income? So how much is going to come in from your pension? How much comes in from your supplement? How much comes in from your social security? How much can you pull safely from your TSP account? All of those numbers added up, that’s what you need to be solving for. Don’t get caught up in the conversation of, “Oh, I got a 3% COLA. That means I need to work an extra year.” Maybe it does, maybe it doesn’t, but those two things are not related.

Tammy Flanagan:        That’s right. And I was just adding on, I thought, well, what if I stayed that extra year and earned another month of sick leave? Those leftover days adding up, well now I’ve added another $6 onto that benefit. So we can nickel and dime this thing to death, and some people like to do that, and there’s nothing wrong with trying to squeeze every last dollar. Six months longer, a year longer, everything is going to go up. If it’s not enough today, that’s good news that I can work longer and make it more comfortable in my retirement years. But if I’m already there, then I have to decide, is it time to go? Am I mentally prepared for this? It’s always not just about the money, but at least knowing that those financial pieces are in place, that’s such a relief and such a comfort to know that.

Micah Shilanski:  They are. Very, very much so. Now, the biggest benefit that you get when you choose to delay your retirement, in my opinion, it’s not the aspect that you got a 3% COLA. It’s not that your pension goes up 1%, the calculation goes up by 1% that you can use. It’s the fact that you get to put in another $26,000 into your TSP, or whatever your contribution is. It’s the benefit that you’re not drawing from your TSP because if you go from putting $26,000 a year into your TSP, to pulling $25,000 a year out of your TSP to live on, that’s a $50,000 difference between those. That’s a much larger benefit. So from the aspect of planning for retirement, sometimes you do need to delay your retirement to a certain age. Being it’s not just because the pension, the bigger effects are the other things that you’re doing, which have a huge effect on your retirement.

Tammy Flanagan:        Yes, I know. And I was just talking to a group of federal law enforcement officers last week. I went to my first live conference in over a year. It was a lot of fun, but they can retire at any age if they have 25 years of service. And many of them were really looking forward to doing that. And I thought to myself, you retire at 48 years old, or even 50 years old, that’s really only maybe the halfway point of your life. So can you really afford to retire that young? I know having 750,000 in your TSP is a lot of money, but when you have to make that last 30, 40, or even 50 years, that’s going to be quite a challenge, I would think.

Micah Shilanski:  Of the things that I love about retirement is, there’s two aspects to it. There’s the financial side and then there is the mental and emotional side. The financial side is what I love because it’s super easy. It’s just math. Do you have enough money to meet what you want to spend in retirement? And we can map that out all day long, but Tammy, to your point, if you retire at 48 or even at 57, are you mentally ready to be done? Now, maybe you’re mentally ready to be done as a federal employee, but does that mean you should stop working?

                           Maybe you need to transition to a second career. We’ve had a lot of clients stop working, especially I’d like to pick on my special provision folks. They retire at 48 and 52 years young. They think this is great for a year or two years, then their health starts to decline because they don’t have enough mental stimulus. And then we go get them a job somewhere else and their health, all of a sudden, does really, really well because they weren’t ready to be done. They weren’t ready for the rocking chair aspect of it.

Tammy Flanagan:        Right. And I think there is a transition, especially when you’re going from a high stress job as a federal law enforcement officer, to retire and just enjoy some of the freedom and the stresslessness of that life after retirement. But like you said, there’s other things we can do. We can become consultants, we can do background investigations, we can go into a whole different line of work. So I think retiring to something else for a while, especially at a younger age, makes perfect sense for many people.

Micah Shilanski:  Amen. Well, Tammy, let’s get a little bit back to the COLA question. So we talked about pay increases before you retire and what effect that’s going to have. But let’s say you retire in December. Let me rephrase that, once you retire, how does COLAs work in retirement?

Tammy Flanagan:        Right. So when Congress designed FERS, we’re going back to 1986, there was a whole part of Congress who didn’t want FERS to have any COLA. They wanted it to be a level payment for life, kind of like a corporate pension model. My father retired in 1980, he passed away in 1998, so for 18 years my dad got $975 a month in his Teamsters pension. And that was it. That was his retirement. So luckily, that side of Congress didn’t get their way. Senator, the late Senator Stevens from your state of Alaska, Micah, was the Father of FERS and he really fought hard to get a COLA included in the FERS basic benefit. And he did. So what ended up happening was, for most FERS employees, there is no cost of living adjustment until age 62. So for those employees who retire at 57, or even at age 60, it’s a level payment until you turn 62. Regardless of what inflation rates are, regardless of how high prices are going.

                           So that’s one thing. Now our law enforcement officers and other special groups, they do get immediate COLAs even if they retire as early as 48 or 50. But for the general FERS population it’s 62. And then on top of that, if the rate of inflation goes above 2%, then the FERS retirement benefits get a diet COLA. So if it’s between two and 3%, like it’s been in some of the past years, it would be a 2% COLA. It’s just flat 2%. If the rate of inflation goes above 3%, 3% or greater, then it’s 1% less. Which looks like what’s going to happen for the 2021 COLA. It looks like we might be seeing as high as a five or 6% cost of living adjustment for retirees this year. But for FERS annuitants, it’s going to be 1% less than that. So if it’s 5%, FERS get four.

                           Now the way it works in the first year that you retire, let’s say somebody says, “Hey, I’m getting out of here August 31st or September 30th.” I’m retired before that COLA kicks in, which is going to take effect on December 1st, but not for a whole year. So if I retire at the end of September, I’m only retired October and November, or two twelfths of the rating period, which means I would only get two-twelfths of the diet COLA. So for someone to get the full cost of living adjustment for 2021, you would have had to have been retired as of December of 2020. So this isn’t something you can really plan for, this isn’t something you can plan ahead to receive, it just happens. We can’t really predict inflation with too much accuracy. But for those people who are already retired a full year, or even a portion of this year, they will get to see some of that cost of living adjustment in their January retirement check.

Micah Shilanski:  Right. The big takeaway here, it’s not what you think is going to be. It’s not going to be that full 5% or 4%, whatever that adjustment is. It’s going to be reduced. So the big thing that we need to be thinking about, I take this from a planning standpoint, Tammy. I don’t know if you got any pushback on it saying, great, it’s going to be what it’s going to be. We can’t control what inflation is. Nor can we control what Congress is going to do. And some people ask the questions, “Well, what if they change the law? They’re always talking about changing this and getting us to the full COLA.” They’re always talking about it, they’re kind of never doing it, and I’m not going to plan on proposed law changes. We’re going to plan on a current law we have. And that just means your pension over time is not going to keep up with inflation. Okay, great. Now we know how that works. That means we’ve got to turn to other areas and say, “How do we outpace inflation? What do we do in order to bridge that gap?”

Tammy Flanagan:        That’s right. Yeah, we have to remember that only about 3%, maybe, of federal proposals actually become law. Because there is a proposal right now to equalize the COLA for FERS. Don’t get your hopes up. Like you said, Micah, it is very, very slim chance of that passing. And we have to remember, social security benefits. If you’re old enough for social security, and receiving it, that will get a more generous COLA. Comparable to what the rise in the consumer price index is. So the other thing we have some control over is how much of our savings we’re going to spend. And I think that’s what you’re alluding to is, how do we make that last long enough to make up for any loss of buying power down the road in the future?

Micah Shilanski:  You know, Tammy, and probably what makes sense, as we’re talking about this, let’s focus on the … What do you think of this? Let’s focus on the COLA and whatnot today, then maybe next time we start jumping into social security. Because you’re right, the way social security does COLA is different than the way your TSP can do pay increases is different and your IRAs, et cetera. All of these have different things. So what do you think we turn this into a little mini series about COLAs and retirement?

Tammy Flanagan:        Yeah, I think that would be great. Because you really do have these three sources of income in retirement, they all act and react a little bit differently to prices and to the different aspects of each benefit. So yeah, I think social security would be worth spending some time, just dissecting that and talking about how that’s going to play out in your future. It’s one of those lifetime payments, which is wonderful, and it does get a COLA. But there are some things to know about it.

Micah Shilanski:  I love it. Tammy, I know one of the things that comes up frequently, I think people confuse this a little bit with social security. And again, we’ll jump into that one on the next episode. But people will say, “Well, I’m retiring at 57. I know I don’t get COLA until I’m 62, but then I’ll get caught up, right?”

Tammy Flanagan:        Yes, right. Wrong,

Micah Shilanski:  Wrong. That’s right, there’s no catch up with this. When you’re eligible for COLA you’ll get it in January of the next year, once you’re eligible for that increase. But there’s no catching up for that. You’re just going to get COLA when it comes in. Now, Tammy, how does it work for special provisions folks? So they can retire, of course, differently. FERS is not until 62, so if a special provisions retires at 48, does that mean they have to wait … what’s that? 14 years before they would get a cost of living increase?

Tammy Flanagan:        No, they’ll get cost of living adjustments immediately, on their FERS basic benefit. However, nobody, not even FERS special provision, gets COLA on the first supplement. So that one piece of their FERS benefit, which is the lifetime piece of it, that will immediately start getting diet COLAs once they’re living out their retirement. But that extra piece, the bridge payment that takes the place of social security until they turn 62, the FERS supplement, that’s a level payment. Whether you’re getting it for five years after you retire, whether you’re getting it for 10 years, 12 years after retirement. It stays the same, it doesn’t change.

Micah Shilanski:  And this is a really important planning point in what we call the retirement income timeline. We like to draw it with our clients, the next 10 years of their retirement income, and where it’s going to come from and how it changes in retirement. Because what’s unique as a federal employee is your pension benefits are so different than almost any other company out there that still provides pension benefits. Tammy, to your point, you’re getting a pension income, if you will. One check that comes in, but it has two components. One component, which is the first supplement, is fixed. It isn’t going to increase. But then you have the other component, if you’re law enforcement, which could be increased. Excuse me, special provisions. Which could be increasing over that period of time. This is the power of understanding how your benefits work. Because if you were planning on everything going up the day you retire, you could be running into a cashflow problem five, 10 years into retirement.

Tammy Flanagan:        Yeah. It’s almost like you’re losing money every year that you’re retired because not only do you not get any COLA on the supplement, but even your FERS retirement benefit’s getting a diet COLA. So consider the fact that it’s possible that every year you live out your retirement, you’re losing buying power, possibly every single year, if we enter a period of high inflation. So we have to account for that somehow. And I know that’s kind of a difficult thing to plan for, but it’s definitely important to consider. Especially knowing that some of us are going to live out retirement years longer than we even worked.

Micah Shilanski:  The other thing to really think about, inside of this Tammy, and this can spark a whole fun political debate, which I’m not trying to do. But the aspect of what retirees, how COLA is based for retirees in my opinion, is not really inflation for retirees. That’s not your real cost of living increase. So even if you’ve got a full COLA, which we know you don’t, it still wouldn’t keep up with your cost of living increases that you have over time. So I’m not ragging on the pension, I think you have a phenomenal pension, it’s a great base layer for saving for retirement income. But it’s not going to be enough. You got to be looking at other things in order to maximize your retirement, just to outpace inflation.

Tammy Flanagan:        Right. And I think as employees, many times we’re used to getting either a promotion or a step increase, along with that January pay adjustment. But in retirement, you’re lucky to get a January pay adjustment in the form of a COLA. So this is why we always use that phrase, fixed. I’m living on a fixed income. Which is not too far from the truth, even though we can do some things to help pad it and give it a little bit more buying power, lasting power. So those are some of the things that we need to think about as we plan this transition in our life.

Micah Shilanski:  And Tammy, not to make this too demoralizing. That’s not the intent. We want to be empowering with good information. Let’s say you went into retirement, let’s take our gross example we were given before of $2,500 a month. Just makes my math easy. And let’s say you got, inflation was 3%, and so you got a 2% cost of living increase. You get the full 2%. How much is that? That’s $50. So you got a $50 increase per month in your pension. Okay, wonderful. How much did your health insurance go up last year?

Tammy Flanagan:        I know. So there’s, yeah, health insurance, groceries, gasoline, you name it. And you may be living the lifestyle that certain expenses are going up more than others. In fact, you might be doing things differently than you did when you first retired. So all that plays into it. I guess the good thing is that, as federal employees, many of us are used to living within our means. So if the means don’t expand as quickly or as much as we hope they would, we can still make that work. We just have to be prepared for it. And it’s not a bad thing to be, because to have these three sources of income, how lucky are federal employees to have a pension, social security, and a substantial savings account that we’ve all been encouraged to take advantage of. So to me … Oh yes, lifetime health insurance. How about that?

Micah Shilanski:  Lifetime health insurance that the government pays the significant portion of your premium for the rest of your life. And again, I like to say, I look at this with my green glasses on. I am very envious of your health insurance, because I get to see your great benefits, then I get to go to the public sector and buy it. There’s a huge difference between these policies. So you have a phenomenal set of benefits. So yes, this is a downside. There’s things we could improve in COLA. But understand how your benefits work so you can plan for your retirement.

Tammy Flanagan:        Right, yep. And for the most part, I think most … If we do proper planning, we can live out a quite comfortable life after retirement. But taking into account these things certainly does pay off at the end, if we understand how it works.

Micah Shilanski:  Well, Tammy, let’s jump into action items because what we know is, this is all about action items for our listeners. Things that not only, hopefully it’s great, fun, entertaining information for you as well. But things that you can implement this week, this month in your retirement planning. So what do you think the first action item for our listeners should be?

Tammy Flanagan:        For me, it’s all about just understanding what we’re entitled to. So take a step back, look at your paycheck every two weeks, look at what you’re living on that comes from your employer every other week. After you have all the deductions for taxes and insurance and retirement withholdings, that’s what you’re living on. How is that going to change? And then where is that going to come from? So estimate your FERS benefit, not just the gross amount, but the amount after any reductions and after any withholdings. Then do the same thing for social security, if you’re old enough to claim that benefit, and start considering those different withdrawal options from your retirement savings. And see where you stand. See if it means, maybe I do need to work a few more years, not just a few more months. Maybe I’m in good shape and maybe I can leave sooner than later. So, take your temperature of those benefits and where you are at the moment.

Micah Shilanski:  I love it. The second thing that I want to add to that, it will look very similar to what you said, Tammy, is I want to say, figure out what the dollar amount you need is to spend a month and when you want to retire. Because we can get caught up in this catch-catch can game about saying, “Oh, well, if I wait this year I’ll get that 3% pay increase. Oh, but next year I’m going to get a step increase. Oh, I might get a promotion because I’m acting right now and I’m probably going to get moved to that position. Oh wait, now I’m going to be 62, I should wait until then.”

                           And if we play that game, you should never retire. Because the longer you work, the more you’re going to have. So we really need to step back and say, “Great, what are my goals? What’s my bucket list? What are the things I want to do this year? What are the things I want to do in retirement? How much is that going to cost me a month to save for and to do?” And then how do we fill that? And then once you make that eligibility, perfect. That’s the time that it makes sense for you to be able to financially retire. Now the second question, of course, is mentally. Are you mentally ready? But that’s how we answer that financial piece.

Tammy Flanagan:        Yep. Yeah, I agree, Micah. I think sometimes it’s all about the finance and other times it’s more about the emotional side of it. Or the mental side of really making that transition. That can be a scary proposition for a lot of people. So maybe we’re just using the excuse about the financial part, that we can’t afford it yet. So I think it can be both, and almost have equal weight to that mental transition, as well as the financial.

Micah Shilanski:  I love it. All right, last action item for you guys. If you’ve made it this far, that means you love the podcast. I mean, come on. You’ve put up with Tammy and I for this long. So jump in iTunes, share this with a friend, share this with a coworker. Because this podcast is growing because of you and you federal employees sharing this information. Tammy and I were talking about it on our pregame, we’re getting more and more feedback, which we absolutely love. Now, if you have a question or there’s a topic that we haven’t covered on this podcast that you want to hear about, shoot us an email. The email address is podcast@ planyourfederalretirement.com. Shoot us a line, we would love to hear from you. Even if it’s a, “Thanks, you guys are doing great.” Or if you have some constructive criticism, we’d love to hear that too, because we’re always looking to improve it. And until next time, happy planning.