• Realtime
  • OT June July 2013
  • Mort Reinhart
  • Using Tax-Sheltered Annuity Accounts to Replace the Suspended Pension COLA


    While the suspension of cost-of-living adjustments for all current and future retirees in 2011 has had a draconian effect on those who have been retired for many years, new retirees might be able to ameliorate the impact by providing a personal "cost-of-living" adjustment for themselves by using their tax-sheltered accounts wisely in one of two ways. (There is an assumption here that many administrators have been taking advantage of the tax sheltered annuity accounts permitted by Sections 403(b) and 457 of the Internal Revenue Code while working, and that many, whose pensions are sufficient to meet their retirement needs, do not need the money in those accounts to supplement their basic pensions.)


    In the first of these ways, a retiree can track the national Consumer Price Index as reported each year in January and can withdraw an amount each year equivalent to the rise in the CPI to supplement her pension.  Using the example of a pension of $61,672 and assuming an inflation of 2% in her first year of retirement, our retiree can withdraw $1,233 (2% of $61,672).  Her second year pension would then be $62,905 ($61,672 plus $1,233 = $62,905), thereby negating the effect of inflation.  The following year, with inflation rising 1.5%, she can withdraw $943 (1.5% of $62,905) from her tax-shelter and add that to her $62,905, making her income the next year $63,848 ($62,905 plus $943 = $63,848).  Following this method each year in the future provides the retiree with a compounded personal "cost-of-living" adjustment and permits her to try to keep up with inflation.  


    The second way to try to keep up with inflation uses the same method, except that the adjustment is always based on the original pension.  In this scenario, the percentage of inflation adjustment each year uses the original $61,672 to calculate the dollar amount.  The first year with 2% inflation would be calculated in exactly the same manner as above (2% of $61,672), resulting in a pension of $62,905. In the second year, using the 1.5% inflation rate, the amount of the withdrawal would be $925 (1.5% of the original $61,672), making the next year’s pension $62,597.  The following year’s calculation would still use the original pension of $61,672 as the basis for the percentage of adjustment.  This method does not have the compounding effect of the first method, but is another way of providing some personal "cost-of-living" adjustment. 


    The Division of Pension and Benefits used a similar method with a slight twist (increasing the original pension each year by 60% of the previous year’s inflation) when the state was providing cost-of-living adjustments to retirees prior to Chapter 78.  There was also a feature in the initial cost-of-living payment law that existed before Chapter 78 that delayed the first cost-of-living adjustment for new retirees to the twenty-fifth month.  Between the delay and the limit of 60% of the inflation, retirees still had trouble keeping up with inflation. 


    Perhaps providing a "personal" cost-of-living has a bright side: it eliminates the delay and it provides 100% of inflation, unlike the suspended State program.  Sadly, for those who retired many years ago without considerable tax-sheltered amounts, however, there is no bright side to the suspension of the cost-of-living adjustment. For them, Chapter 78 was devastating.


    It should be noted that the longer the retiree lives, the larger the amount that will have to be withdrawn from the tax-shelter each year, which could reduce the balances in the tax-shelters considerably after many years.