What Is the Impact of Cost-of-Living Adjustments on Present Values?
Applying a cost-of-living adjustment (COLA) typical of federal and state government plans represents a valuable growth component that increases the value some 20 percent to 40 percent. For example, an Army officer retiring in 1965 at 42 years of age with a $20,000 annual pension would have an annual pension of $64,868 today based on average annual increases of 4 percent. Keep in mind that COLA comes in several flavors. The most popular are compounding and noncompounding. With the compounding COLA used in civil service and Social Security, the percentage increase is applied to the previous year’s benefit. Noncompounding COLAs, which are more typical in state plans, always base the increase on the initial entitlement. The younger the retiree, the greater the effect of COLA on the present value.
