Straight talk on retirement and pensions
July 24, 2018
Cost-of-living adjustments: your favourite type of COLA
As a member of BC’s College Pension Plan, you will enjoy a monthly pension for life once you retire – regardless of how long you live.
Each year, prices for goods and services usually rise. The culprit is price inflation, and it’s of concern to all retirees on fixed income.
Inflation is measured by monitoring how the prices for goods and services increase over a stated period of time. It’s caused by factors too numerous to examine here. The Bank of Canada aims to control inflation in Canada, and it generally does so by adjusting interest rates. Currently, it views a steady, low rate of inflation as a good thing, so it targets an inflation rate of about two per cent per year to keep the Canadian economy humming along.
Why does the Bank of Canada encourage inflation?
It’s because deflation – the opposite of inflation – is harder to control and results in a stagnant economy. When deflation occurs, people defer purchases, believing products or services will become cheaper if they wait. This puts downward pressure on prices. Deflation may be good for shoppers, but it’s bad for businesses and workers because demand for goods and services slows down. In short, deflation hurts economic growth.
Here’s the real kicker about inflation though: when costs go up, your paycheque and pension don’t automatically go up too. Pay increases for working plan members are negotiated with their employers and may not keep up with the cost of living.
So, what happens when you retire? How does the plan help mitigate the effect of inflation on your pension?
Fortunately, the College Pension Board of Trustees usually grants annual cost-of-living adjustments (COLAs) to your pension. While not guaranteed, COLAs help maintain the purchasing power of your pension by increasing your monthly pension amount. Here’s the sweet part: Once a COLA is granted, it becomes part of your basic pension the following January.
How COLAs are determined
The board wants to ensure COLAs are sustainable over the long term. So, each year the trustees examine factors to decide whether to grant a COLA.
The decision is based on three factors:
- The annual change in the 12-month average Canadian consumer price index (CPI) from November to October
- The funds available in the plan’s inflation adjustment account (IAA)
- The COLA cap
The COLA cap is the maximum COLA that may be granted in any year. It is expressed as a percentage. For example, for 2017–2019, the COLA cap was set at 2.07 per cent. This means that for those years, a COLA of up to 2.07 per cent may be granted, subject to changes in the CPI for the previous year and the decision of the board to grant a COLA or not.
Capping the annual COLA helps maintain the long-term sustainability of funds in the IAA by making sure they aren’t used up too quickly. This helps ensure inflation protection remains available for future generations of plan members.
The total cost to the plan of providing members with COLAs can’t exceed the funds available in the plan’s IAA, and the value of the COLA granted by the board can’t exceed the lesser of the COLA cap or increase in the Canadian CPI.
The bar graph below illustrates how COLAs maintain the value of a hypothetical $15,000 annual pension, using a sample 20-year period from 1998 to 2018. The COLAs applied in this illustration are based on actual changes in the Canadian CPI for this time period.
Without COLAs, cost of living for this hypothetical member would rise but the purchasing power of this pension would fall – it would be eroded by inflation. Imagine if there were no COLAs during retirement to help offset increases in the cost of living. Your pension would buy fewer and fewer goods and services each year. This is a troubling reality for many retirees without well-managed workplace pension plans.
The plan’s COLA history is posted on this website. It shows the plan has consistently granted COLAs for many years, with one exception: in 2009, there was no inflation –there was deflation – so there was no COLA granted in 2010. This history represents a phenomenal record of inflation protection for plan members. Few pension plans in Canada can boast such robust protection.
How COLAs are funded
Watch for a future post to learn more about the IAA and how it’s used to fund COLAs.