COLA: A recipe for improving your pension
Cost-of-living adjustments can help preserve your buying power throughout your retirement.
Just as you may receive a pay raise while working that helps offset increases in the cost of living, your future pension payments may increase from a cost-of-living adjustment, which we refer to by its acronym, COLA. These adjustments, when provided, help your pension keep pace with increases in the cost of living.
This isn’t a guaranteed benefit, so you may not receive COLA each year, and the amount may change from year to year. However, once you receive an adjustment, it will be added to each component of your pension for as long as you are to receive them. For the basic pension, it's for the life of the pension. Future COLAs will then be added to the new value of your basic pension.
Each year, BC's Municipal Pension Board of Trustees (board) carefully reviews several factors to decide whether to grant COLA and, if so, its value.
To understand how the COLA concept works, it helps to understand how your pension is funded.
Basic Account = Basic pension
Member and employer contributions and investment returns fund the basic account. You will receive your basic pension every month until you die. Depending on the pension option you choose, your named beneficiary may receive a pension benefit after your death.The basic account is fully funded and your basic pension is secure and guaranteed for life. The board knows this because it hires an independent actuary to conduct a valuation every three years to see if this account is fully funded. If an actuarial valuation indicates there is a funding shortfall, the board must raise contribution rates for both members and employers to ensure the account remains fully funded.
Inflation Adjustment Account = The source of COLASeparate from and unlike the basic account, the inflation adjustment account is not fully funded. However, like the basic account, member and employer contributions and investment returns also fund this account. While your basic pension is based on a formula, COLAs are non-guaranteed benefits, based on the funds available in the inflation adjustment account. If the board grants COLA in a particular year, funds from the inflation adjustment account are transferred to the basic account so that they can be applied to your basic pension, and bridge benefit and temporary annuity, if applicable.
A lid on the COLA cap keeps it sweet
Capping the amount of COLA provided helps to maintain the long-term sustainability of funds in the inflation adjustment account so they are not used up faster than they can be replaced. That’s why the plan rules and funding policy specify that:
- The cost of providing COLA cannot exceed the funds in the inflation adjustment account
- The amount of COLA cannot be higher than the increase in the Canadian consumer price index (CPI)
- The maximum COLA amount that can be granted cannot be greater than the COLA cap
In 2017-2019, the COLA is capped at 2.1 per cent. This means that if the increase in the CPI in a given year during this period is less than the cap of 2.1 per cent and the inflation adjustment account has sufficient funds, the board may grant COLA that is, at a maximum, equivalent to the increase in the CPI. If the increase in the CPI is greater than the cap of 2.1 per cent, the board can only grant a maximum COLA of 2.1 per cent.
Every three years, the plan’s independent actuary (a specialist in financial modelling, the laws of probability and risk management), will assess the cap for the next three years and recommend the board adjust it if needed.
Calculating COLA in this way ensures all COLAs remain sustainable over the long term.