Damn those compounding COLAs!
I am always highly suspicious of statements like this from the Bloomington Pantagraph:
COLA compounding effectively means the state’s pension tab roughly doubles every 20 years.
Doubles compared to what? I’m guessing compared to no cost-of-living adjustment, but that’s not a viable policy option. Just two weeks ago, only one other representative voted for Speaker Michael Madigan’s proposal to eliminate the COLA.
Of course, compounding is not the only way to calculate a COLA. There’s also simple. Under a simple scheme, a COLA is calculated on the original amount of the pension. If that’s $10,000 and it’s a 3 percent simple COLA, then each and every year, there is a $300 adjustment to the pension. A compounding COLA looks at the present amount of the pension. In the first year, that’s 3 percent of $10,000 — so $300. In the second year, that’s 3 percent of $10,300 — so $309. After 30 years, a “simple COLA” pension will be 22 percent less than a “compound COLA” pension.
Still, compounding is the best way to calculate a COLA. Remember, the intent of a COLA is to protect a pension from inflation. Just as inflation compounds, so should a COLA to ensure a pension has the same purchasing power over a person’s retirement.
And inflation isn’t the only thing to compound. So do the returns on the investments made by retirement systems. Whatever the rate of return, it is a return on the present value of the investment — not the original value. There’s no reason, then, that the assets of a pension fund shouldn’t be able to keep up with inflation (at the very least!) and accommodate a compounding COLA.
Rather than freak out over compounding COLAs, our energy would be better put to solving the real pension problems in Illinois — a reasonable and realistic plan to pay down our $96 billion in pension debt and a way to guarantee the General Assembly doesn’t shirk its responsibility to pay into pensions as it’s done in the past. That’s what got Illinois into this mess — not compounding COLAs.