The first time I heard the term “pension COLA,” I had no idea what it meant. My mind immediately started racing, and I thought, ok, either that’s a typo about a city in Florida, or that is a type of soda pop I don’t want to try. Thanks to Google, I was able to learn a little on the topic. Saving face so I could appear slightly more pension-savvy than I actually was in front of my payroll peers.
Whether or not you’re familiar with a pension COLA, if you keep up with the news in any capacity, it is likely that you’ve heard changes are coming down the pike in 2019 for contributions to retirement plans.
Before learning what changes are in order, we first need to clarify the definition of a pension. Then, after determining what the upcoming changes mean for employers and employees, you can decide if a pension COLA is right for you.
On the fringes
Fringe benefits are a hot topic, where hiring and employee retention are concerned. Employers offer fringe benefits to attract quality candidates, and in turn, entice quality employees to stay.
Retirement plans fall under the fringe benefits umbrella. Meaning it’s mutually beneficial for both the employee and the employer to participate in a company retirement plan. There are different types of retirement plans, and the pension falls into the category of a defined benefit plan (DB), in which the employee receives a set level of retirement income, barring any catastrophic changes to the entity.
Employees tend to favor this kind of plan because they feel more secure knowing there’s a fixed benefit amount they’ll receive. Likewise, employers often favor this kind of plan because they can contribute more to the plan than they can contribute to defined contribution plans (DC).
Increased contributions translate to increased deductions, and of course, everyone and the dog enjoys a good tax deduction wherever available.
Generation upon generation
One of the important realizations emerging as healthcare and life expectancy improve is that not all generations are equally equipped to retire properly. In other words, some generations are just better prepared for retirement.
To start, Baby Boomers, the oldest generation of workers, and those who are either retired or quickly approaching retirement age, are at a point where if they are not currently financially set for retirement, it’s really too late.
Generation X (people born between 1965-1980) only projects about a 61% income replacement rate at retirement. The Millennials (people born approximately between 1981-2000), however, took to retirement concepts in time to get a solid foothold. Their income replacement rate upon retirement is approximately 75%.
Long story short, it is evident that each generation seems to become increasingly more receptive (at an earlier age) to acknowledging the benefits of retirement planning. Each new generation also seems to take it a step further, acting upon the knowledge they obtain.
As the generations place more and more importance on retirement planning, it is imperative that the retirement offerings remain solid enough to continue to sustain the interest and faith of the generations to come.
The writing on the wall
So what do these income replacement rates at retirement mean for pension plans and other retirement accounts? They mean that in many cases, increasing the allowable contribution amounts could greatly benefit those nearing retirement. This helps them achieve a higher income replacement rate when they’re finally able to bid adieu to the working world forever.
So, guess what? Sometimes when we call, the government answers! The IRS recently announced changes to dollar limits on both contributions and benefits for qualified retirement plans.
A quick review of the changes will show a trend for either of a $500-$5,000 increase, depending on the item to be adjusted. While not earth-shattering, anything is better than nothing. The American Payroll Association provides a complete list of the changes for 2019.
In the meantime, the chart below will give you an idea of some key changes on dollar limits for qualified retirement plans.
Pop a top
While the pension plan is a great thing, there is another side to consider. It is not uncommon to see pension plan shrinkage, which can naturally occur over time due to inflation.
So, how can you combat this? Prescription: Take a nice big sip of a pension COLA. Wondering how to get your hands on one?
Well, you’ve got to start with an over-funded pension plan. A pension plan becomes over-funded due to a boom in the stock market. Clearly, over-funded pension plans are a good thing. Who’d want to have less money when you could have more money?! They’re an indication of a healthy plan that will have enough money to pay employee’s benefits in their retirement.
When your pension plan’s assets exceed the benefits to be paid (also called obligations), it may be time to consider researching whether or not your plan should be considered for a cost of living adjustment (pension COLA).
A pension COLA could help offset the negative effects of pension shrinkage because it could give your company a way to use the excess funds to pay additional benefits.
Some companies automatically adjust for cost of living increases. Others give a “13th check” at the end of the year. Basically, an additional payment atop the regular 12 monthly payments beneficiaries receive. Either way, you can determine the current funding level of your pension plan by reviewing your pension plan funding notice.
The moral of the story is that retirement planning is essential. It’s fair to want to feel confident that our hopes for our retirement futures are taken seriously.
Seeing measures put in place to not only increase allowances for certain contributions and benefits for qualified retirement plans but also to allow qualified plans to utilize a pension COLA, shows future retirees that someone hears our concerns.
Now, enough talking about COLA. This topic has me thinking a nice cocktail is in order. Cheers!