What are some of the typical cost of living adjustment (COLA) methods

[PMC]

What are some of the typical cost of living adjustment methods you have seen applied to retired employees benefits in a DB plan? Other than tieing the adjustment to the CPI are there other typical methods used and do you see them generally applied to individuals who have been trired for 5,10,15 years and are there varying amounts applied depending on how long the individual has been retired?

[AndyH]

The only clients I've ever had who have made the informed decision to do this (in the 1-2500 participant range) have been "institutional" non-profits.

The colas are generally unscheduled, periodic (once every 5-10 years). Typical increases might be (.8%-1%) x years elapsed since retirement. This tends to gradually make up for what is perceived is inadequate retirement benefits due to inadequate salary levels combined with inflation. It offers the client the opportunity to consider the increases in light of fund earnings and the associated contribution levels.

Some insurance company-administered plans have scheduled colas built into the benefits, usually tied to some index. I've seen many VNAs with this type of feature, but that's because they were established with the same insurer.

[Guest]

Our clients have used several approaches. A simplified method would be to grant some percent (ie: 3%) increase for each year that the individual has been retired or since the last COLA was granted. If COLA's have never been granted, this could result in significant increases for those who have been retired for many years.

It's also common to just give all retirees the same increase (ie:10%), or even the same dollar increase ($100).

A lot depends on the size of the group, the quality of the retired data, and most importantly the goals of the Employer or Union.

You may need to watch the 415 limits if your giving significant increases to retirees.

[david rigby]

As is apparent, many variations are possible.

I have also seen a scheduled COLA, tied to CPI, but with three limitations: minimum of x% per year, maximum of y% per year, and maximum of z% lifetime.

[Guest meggie]

The question has come to me, can a defined benefit plan provide ad hoc COLA to not only retirees who are currently receiving an annuity under the plan but also those who received a lump sum. I say why not?- does anyone feel differently?

[david rigby]

Is there a 1.401(a)(4) "benefits, rights, and features" issue?

Does the lump sum feature affect only HCEs?

Is there a possible violation of safe harbor status (such as, 401(l) permittted disparity)?

[richard]

Another approach I've seen (particularly in the 1980's) was where companies philosophically adopted a policy of ad hoc COLAs every 3-5 years desired to replace X% (such as 75%) of the cost of living increase since the last ad hoc COLA (or the employee's retirement date, if later). Then, we (or they) calculated the percentage increase that applied to the different cohorts of retirees, based on retirement year, that approximated the desired X%. The trade-off was the simplicity of the formula vs. matching the desired X%. Often, a fixed percent per year since the last ad hoc COLA (or the employee's retirement date, if later) came close enough.

[Guest meggie]

If ad hoc COLA (say 1% per yr since retirement, or since the last ad hoc increase, if applicable)is offered to all retirees including those who took lump sums, is it correct to say that the lump sum people automatically will receive the additional benefit as a lump sum since that was the original form of annuity elected? If they have to make a new election, then so would the retirees currently receiving an annuity also have the option to make a new election for the ad hoc piece?

[richard]

My instinct is that new elections would have to be offered, and that a QJSA would have to be one of the options. This is, after all, an additional benefit provided via plan amendment, and not part of the original accrued benefit. (My rationale is that when an employee elects a $10,000 lump sum instead of a $100 per month pension, he is not committing himself to an ultimate $11,000 lump sum instead of a $110 per month pension.)

I suspect that the large plans that have offered ad hoc COLAs provide it to the employee in the form of benefit already in effect, without giving the retiree any choice. If so, either they have done it wrong (but as a practical matter, the retirees wouldn't care, since they would normally elect the same form anyway), or my instinct is wrong (which is always a distinct possibility!).

[Guest]

Q & A 38 from the 2000 EA Gray Book discusses this somewhat. It does imply that you should offer the options and get new spousal consents if necessary. I remember that this was quit controversial when it was discussed at the meeting.

[Guest meggie]

Thank you all- and esp. for that site in the graybook.

[Guest Brian4]

Going back to meggie's April 2 posting. Benefit increases to former employees are subject to minimum coverage and nondiscrimination testing under Internal Revenue Code section 410(B) and 401(a)(4) regulations. Under the minimum participation requirements of 401(a)(26), employees whose benefits are under the small cash out limit can be excluded from these rules.

[Mike Preston]

I think Q&A 38 from the 2000 Gray Book provides a pretty good road map. If the individual receiving the additional benefit has an annuity starting date already on the books which is on or after the participant's normal retirement date, no further benefit election is mandatory, as long as the plan document so provides. If, however, the annuity starting date on the books is prior to the participant's normal retirement date the plan needs to get an election form signed with respect to the new benefits.

Note, however, that if an individual was at the pre-EGTRRA 415 limit when a lump sum was paid, then additional benefits may only be paid to this individual if they come back to work after the effective date of EGTRRA.