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The Difference Between a COLA and a Pay Raise

And why you won’t get the full effect of either if you retire on Dec. 31, 2022.

I have been getting a lot of questions lately about choosing when to retire in order to maximize the impact of both the annual cost-of-living adjustment to retirement benefits and the yearly federal employee pay increase. It’s a tricky question to answer, but the place to start is by understanding how these two increases work.

January Pay Adjustment

The annual federal employee pay increases factor into your high-three average salary, one of the two primary factors for computing your retirement benefit. (The other is your length of service.) But keep in mind that if you choose your retirement date based on pay adjustments, you might never retire. Every day you continue to work, after all, your high-three increases.

Your high-three can have three, four, five or more pay changes that are each prorated based on how many days they were in effect before the next pay increase. Pay changes can be step increases, promotions or the January pay adjustment. If you were to retire on June 30, 2022, the pay adjustment that took effect for most feds on Jan. 2 would be in place for five months and 29 days out of the last three years. So your high-three would be higher than if you had retired on Dec. 31, 2021, and less than if you retire on Dec. 31, 2022. 

Last year, the January pay adjustment for most federal employees was a 2.2% increase to basic pay and a 0.5% boost to locality pay, both of which took effect on Jan. 2, 2022. This year, President Biden has proposed a civilian federal pay increase of 4.6%, the highest in 20 years. We probably won’t know whether Congress backs that figure until much later in the year. 

Cost-of-Living Adjustment

The COLAs that are granted for federal and military retirees, along with Social Security recipients, are provided so that over the life of your retirement, you can afford to buy groceries, put gas in your car, pay your rent or mortgage and cover other expenses of daily living. Although it can be argued that the COLA formula does not truly reflect the impact of inflation, especially for older retirees, it is certainly better than a level payment for life, which is what most private sector pensions provide. The recent spike in inflation is a reminder of the significance of this benefit. 

Retirees covered under the Civil Service Retirement System can receive a COLA at any age. Those under the Federal Employees Retirement System can’t get COLAs until age 62, with some exceptions. The COLA is applied to your gross monthly annuity.

A CSRS retiree eligible for the full 2021 COLA of 5.9% with a gross annuity of $5,000 a month would have received a new benefit of $5,295. The new rate would have been payable on Jan. 1, 2022 (covering December 2021).

Your first COLA may be prorated based on how many months you were on the annuity rolls before the COLA was granted. The initial COLA for FERS retirees who are not eligible to receive a COLA during their first year (or more) on the annuity rolls is the full COLA without proration. 

For those who are planning to retire on Dec. 31, 2022, and who will be eligible for a COLA, the first COLA will be granted on Dec. 1, 2023 and payable in the January 2024 annuity payment. It will be 11/12 of the COLA granted on Dec. 1, 2023. For those who retired on Dec. 31, 2021, and who are eligible for a COLA, the first COLA will be granted on Dec. 1, 2022 and payable in your January 2023 annuity payment. You will receive 11/12 of the COLA that will be granted on Dec. 1, 2022.

The CPI-W, which is used for computing the retirement COLA, is a specialized index that tracks retail prices as they affect urban hourly wage earners and clerical workers. The CPI-W places a slightly higher weight on food, apparel, transportation, and other goods and services. If the increase in the CPI-W is at least 0.1%, there will be a COLA. Generally, FERS COLAs are 1 percent less than the increase in the CPI-W. But if the CPI-W increase is between 2% and 3%, the FERS COLA will be 2%. If the CPI-W increase is 2% or less, the FERS COLA matches the increase.

As for the issue of choosing your retirement date based on the upcoming COLA and pay adjustment, I think the more important question is, “Can I afford to retire?” It’s important to consider all of the options available to maximize your retirement income. This might include rebalancing your investments, delaying Social Security to increase the monthly benefit, and delaying your retirement.