The costs of proposals to add or restore cost-of-living adjustments for public retirees

In the aftermath of the Great Recession and alarming growth in unfunded pension liabilities, many states reduced or eliminated cost-of-living adjustments for public employee pensions to manage the stability of pension funds. However, with inflation in 2021-2023 hitting levels that had not been seen in the United States in decades, some governments have considered reversing these changes and reinstating cost-of-living adjustments for public pension benefits. Since many state and local public pension systems have yet to recover from the 2007-2009 economic and stock market downturn, it is still too early for most public pension plans to consider adding more financial obligations that could generate runaway costs and debt again.

Cost-of-living adjustments (COLA) are designed to counteract the effects of inflation on retirement income and are generally seen as an optional add-on to a core pension benefit. Between 2010 and 2013, 17 states reduced, suspended, or eliminated cost-of-living adjustments for current public workers and retirees in an effort to address the growing solvency issues of their pension plans. According to an analysis by the Center for Retirement Research at Boston College, eliminating a 2% compounded COLA reduces pension liabilities by 15-17%, making this an attractive option for policymakers facing billions in unexpected pension costs.

Today, with the impact of inflation at the forefront of retirees’ minds, there are growing calls for state and local lawmakers to introduce or restore cost-of-living adjustments for many of these public employee pensions. 

In Washington state, there are frequent proposals to address the loss of purchasing power for the oldest retirees. These proposals aim to institute a COLA for retirees of Plan 1 of the Public Employee Retirement System and the Teacher Retirement System, two plans that have never had a COLA. Washington did have a provision called “gain sharing” in place until 2011, which granted retirees an increase to their annual retirement benefits, but the state was forced to shut that program down after the massive losses of 2009. As the state has only granted one-time increases to benefits over the past few years, Plan 1 retirees are calling for a recurring COLA. Responding to this pressure, lawmakers passed legislation that mandates the State Select Committee on Pension Policy recommend a course of action for implementing a permanent COLA for these retirees.

Similarly, in 2011, the Rhode Island General Assembly enacted the Rhode Island Retirement Security Act of 2011 (RIRSA). The law suspended COLAs for all state employees until the public pension plans’ funding level for all groups, calculated in the aggregate, would exceed 80 percent. Now, 12 years later, despite not reaching the 80 percent funding goal, state legislators are considering a bill that would re-establish a 2.5% compounded annual COLA for retired state and municipal workers and public school teachers.

A decade ago, New Jersey, facing severe pension underfunding, also eliminated its COLA for retired public workers. However, the recent legislative session saw similar pressure from retirees and beneficiaries to reconsider the cost-saving measures of the past. Legislation proposed in the current session, Bill S260, would reinstate an automatic COLA for members of the state’s retirement systems. An automatic COLA is different from an ad hoc COLA, which requires a governing body to actively approve a post-retirement benefit increase. An automatic COLA occurs without additional actions and is usually predetermined by a set of rates or formulas.

There are both advantages and disadvantages to restoring COLAs for retirees and beneficiaries. On the one hand, they can protect against inflation, which is eroding the purchasing power of retirees’ pension benefits due to rising prices. Over the past year, the Consumer Price Index for all urban consumers increased by 6 percent, which can create real budget challenges for some retirees on fixed incomes. 

On the other hand, implementing cost-of-living adjustments can pose a significant and unpredictable financial burden for state and local governments and taxpayers, only adding to the ongoing funding challenges of many public pension plans.

In New Jersey, for instance, public pension funds currently have a funded ratio of just 33.2%, meaning the state only has about one-third of the assets needed to pay for the retirement commitments already made to public workers. If the automatic COLA for plan members were to be reinstated, the state’s contribution would need to rise from $7 billion to an estimated $9 billion annually, and New Jersey’s local governments would need to contribute an additional $1.6 billion per year.

The pressure from retired workers to implement or restore cost-of-living adjustments will continue to be a thorny issue for policymakers, and this pressure becomes all more prevalent if inflation remains high. Nevertheless, policymakers must also carefully consider the long-term costs of COLAs—or any benefit increases—before committing current and future taxpayers to that arrangement. Realistically, most states must first address the underfunding of their retirement plans before adding costly inflation-protection benefits.