The Wyoming Retirement System (WRS) pension is an impressive retirement plan, offering guaranteed income to thousands of Wyoming employees across hundreds of employers.
Among its many features, a cost of living adjustment, or COLA, is available at varying amounts. This feature helps your benefit keep pace with inflation, but it reduces your payment initially. When does opting for COLA make sense, at what levels, and what is the financial impact? I’ll explore this in today’s post.
COLA Overview
WRS’s COLA feature is an annual guaranteed increase to your benefit each July following the second anniversary of starting your pension benefit. You can choose no COLA increase, or a 1%, 2%, or 3% COLA increase. The COLA option cannot be changed once you start your benefit. This adjustment is beneficial because over time inflation lowers the purchasing power of your money. An annual COLA increase helps your dollars “keep up.” The COLA increase continues to occur for a surviving beneficiary.
Example: Carl is in his second year of full WRS retirement. His monthly benefit is $4,058 per month and he elected a 2% COLA. In Year 3, his benefit will increase to $4,139; in Year 4 his benefit will increase to $4,221.
COLA increases are compounded, meaning in Year 4 Carl’s 2% increase was based on his Year 3 benefit. This compounding effect can have a significant impact on your benefit over a 25+ year retirement.
Exploring the COLA Options
There is a catch to the COLA increase. When opting for any COLA increase, your pension benefit starts lower compared to electing no COLA at all. My estimation shows that with each 1% raise in COLA, the initial benefit is reduced by about 9%.
Example: Ignoring the earlier example, if Carl starts his benefit without a COLA increase, the monthly amount is $5,000. Here is how Carl’s benefit is affected with the different COLA increases:
1% COLA increase: $4,523
2% COLA increase: $4,058
3% COLA increase: $3,607
As you can see, opting into a COLA option reduces your monthly pension benefit significantly. Between no COLA and 3% COLA, Carl’s benefit is reduced by a whopping $1,393 per month!
Why then, would anyone choose a COLA option? In short, to protect against the long-term consequences of rising inflation. Historically, inflation has been around 2.5% per year, but recent memory has shown us that inflation can rear its ugly head much more aggressively. In 2022, the inflation rate topped out at 9.1%.
While this is far higher than the top 3% COLA for the WRS pension, inflation can “eat away” at your pension benefit even more quickly without any inflation protection at all. A $5,000 pension benefit with no COLA won’t feel like much after modest inflation increases over 25 years.
COLA Breakeven Points: To COLA, or not to COLA?
By taking a closer look at the impact of COLA increases on your pension benefit, we can determine the point in the future where a COLA increase has “paid off.” In other words, there’s a point in the future where the value of the reduced benefit with COLA actually exceeds the value of the benefit without a COLA option.
COLA breakeven ages based on annual benefit
Example: Assume Carl retires from his teaching position and starts his benefit at age 65 with full eligibility. As you can see in the chart above, once Carl turns 77 his 1% COLA benefit would catch up to the value of his no COLA benefit. A year later the 2% COLA benefit has caught up to the 1% COLA benefit, and a year after that the 3% benefit has caught up to the 2% benefit. These would be Carl’s “breakeven” ages, meaning any years he lives beyond this he’ll continue to benefit from his elected COLA option compared to not having elected it.
These amounts compare the breakeven points on an annual basis, but it’s also worth considering the cumulative benefits and how those compare over time. By cumulative benefits I mean the sum total of all annual benefits.
COLA breakeven ages based on cumulative benefit
While the COLA options on an annual basis have caught up by age 77 to 79, the cumulative benefits don’t catch up at least until age 87.
Thus, part of the decision of “to COLA, or not to COLA” is a question of life span. Poor family health history or a previously diagnosed terminal illness could render COLA increases useless. And on the flipside, strong health and a very good family health history could make COLA increases valuable.
Also remember that this isn’t just a question of your own longevity, but that of your spouse as well, since opting for survivor benefit Option 2 or Option 3 will result in the benefit continuing to increase after your death for the life of your beneficiary, who may be younger than you, have a much stronger health history, or both!
Summary
Recent history has shown how inflation can impact our ability to afford goods and services. The Wyoming Retirement System’s COLA option is an attractive feature to protect against inflation over time. Be mindful though, of how the COLA option affects your initial benefit. Electing a COLA option will reduce the upfront benefit, which won’t be “earned back” until years down the road.
While no one has a crystal ball to know when they’ll die, personal health and family health history can help you estimate a reasonable COLA or no COLA option, while also considering the future income needs of your surviving beneficiary.
Important Note: These pension estimates are based on my own calculations, with several assumptions made. For the best estimate of your pension benefits and the impact of COLA increases, it’s best to reference your most recent WRS pension statement while utilizing the WRS pension calculators, linked here, or, call a WRS representative. They’re very helpful!