A key feature of teacher pension plans is that they offer guaranteed income for life. But unless the purchasing power of that pension income keeps up with inflation, the guarantee doesn’t necessary provide ensured financial security. That is why many defined benefit pensions for teachers come with cost-of-living adjustments, or COLAs.
However, just because there are many plans with COLAs doesn’t mean there is widespread protection from inflation.
The average COLA provided by teacher pension plans this year has been 1.8%. This is effectively the same as the average cost-of-living adjustment offered to all public pension plan retirees.
The 1.8% figure is well below most measures of actual price inflation in 2022. That is because many COLA policies do not exactly match inflation. Instead COLA rules have maximum rates (e.g., increasing at the rate of inflation up to 2%) or they are linked to other factors (e.g., a 2% COLA, but only if the pension fund for base benefits has adequate resources).
There are some reasonable financial reasons for these rules. Some years retired teachers get COLAs that are actually larger than inflation. However, the net effect in 2021 and 2022 has been that public pension COLAs frequently are less than inflation.
Teacher pension COLAs vary in how much inflation protection they provide, and in who gets the benefit adjustments. In this article, we explain some of the different kinds of cost-of-living adjustments provided to retirees from public employee pension funds.
First, here is a list of teacher pension plans and classes of benefits and the COLAs they’ve provided in 2022.
Not all teacher pension COLAs are created equal. If you are trying to determine whether or not a COLA is adequate enough to maintain the spending power of your retirement benefits, you should consider the following elements of your plan’s COLA policy:
1. Compounding versus Non-Compounding Benefits
Retirement funds have two ways of adjusting underlying benefits when paying out teacher public pension COLAs.
Compounding Benefits: Retirement funds permanently adjust the base benefit and add any any future changes to benefits on top.
For example, someone with a $40,000 pension that gets a 2% COLA will have their base benefit increased to $40,800. The next year, if inflation means a 1.5% COLA, then the adjustment is calculated based on the new, higher number. So in this case, the benefit would increase to $41,412.
Non-Compounding Benefits: This means that all inflation adjustments are based on the original pension benefit value. Each year benefits increase, you get to keep the adjustment from the previous year. But, the percentage increase is based on your original pension.
For example, a former teacher with a $40,000 pension that got a 2% COLA would see $800 added on top for a total pension of $40,800. The next year, a 1.5% COLA would be calculated on the original $40,000 pension. $600 would then be added on top for a total pension of $41,200.
2. Three Types of Automatic Public Pension COLAs
There are generally three policy frameworks for those teachers who do have automatically granted COLAs that protect public worker pensions from inflation:
- Fixed-Rate COLAs: A pre-fixed specific percentage of benefit increase (or minimum dollar amount).
- COLAs Linked to Inflation: A percentage increase to benefits based on the national consumer price index (CPI), a local CPI, or the Social Security inflation rate. The actual amount is typically “up to” a maximum rate, such as 2% or 3%.
- COLAs Linked to Plan Performance: A percentage increase to benefits that is dependent on the funded ratio and/or investment performance of the underlying pension plan. The actual amount is also typically “up to” a maximum rate, but that maximum rate is determined by the specific provisions around plan performance. For example, the maximum COLA rate may be cut in half or suspended if the pension fund is under 80%.
Some state pension funds have inflation adjustments linked to both inflation and pension plan performance.
3. Ad Hoc Cost-of-Living Adjustments
There are a number of teacher pension plans that do not provide consistent inflation protection. Some of these states have no legal provisions to offer COLAs. Other states only payout COLAs if the legislature authorizes the benefit adjustment. Because COLAs are not legally required in these states, they are called “ad hoc” COLAs. These COLAS are also heavily dependent on local politics and legislative budgets.