📉 Understanding the COLA Trap
Colonel Douglas J. Fowler, wrote a great research paper (link below), which delves into how the timing of a service member's retirement can lead to a phenomenon known as a "pay inversion." This occurs when a service member who retires later ends up receiving less in retirement pay over time compared to someone who retired earlier, despite having more time in service. The crux of the issue lies in how the first COLA is calculated for retirees.
Unlike annual COLAs, which are uniformly applied, the initial COLA is prorated based on the quarter in which a service member retires. This means that retiring in certain months can result in a smaller first COLA, which then compounds over time, leading to significant financial disparities.
The reason for this is simply due to the calculation used for the proration. It is based on a base quarter (Q3 of the year in which you retire) and the quarter prior to your retirement date. See an updated chart based on Colonel Fowler’s paper below assuming a 2025 retirement date.
So if you retire in March 1st 2025 your COLA that will be prorated on December 1st, 2025, and will be the difference in inflation between Q4 2024 and Q3 2025. However, if you retire on October 1st 2025 (or anytime in Q4), you will not receive any adjustment as you would be taking the inflation difference from the same quarter (Base Quarter is Q3 2025 and the quarter before your retirement date is Q3 2025).
↗️A Compounded Problem
Should you really care about this? This will really depend on the year of your retirement, the current inflationary environment, as well as a multitude of individual factors. Given that inflation has been higher in recent years it has definitely become more relevant. In his paper Colonel Fowler shows how the discrepancy can add up even for enlisted men/women at the E-8 level depending on the month they retire. In his example he has one E-8 retiring in June 2008 and one in July 2008 and the initial annual retirement pay discrepancy being $686 which compounds and adds up to more than $8,014 over the decade between 2009 and 2019. Therefore if you extrapolate off this it would not be a stretch that over a 30-40 year retirement the amount could be well in excess of $25k or nearly the price of a new car. All simply due to a 1-month difference in retirement date. The difference can be even greater for officers with higher base pay rates.
🗓️ Optimal Retirement Timing
To mitigate the risks associated with the COLA Trap, consider the following strategies:
• Retire at the end of a fiscal quarter: This timing ensures a more favorable calculation for your first COLA as you get the same bump as someone who retired at the beginning of the first quarter plus the additional retirement pay for longer service.
• Avoid retiring in Q3 & Q4: Historically COLAs for Q3 have been smaller than anticipated and Q4 retirees do not receive any COLA adjustment at all.
• Aim for a March retirement: Historically, Q1 retirees have received the most favorable initial COLAs with March being the best month due to it being at the end of the quarter resulting in the highest pay once length of service is factored in. Part of the reason for Q1 retirees receive the best initial COLAs is simply due to the longer length of time between the base year and the quarter prior their retirement. The greater time allows for larger discrepancies in inflation.
By strategically selecting your retirement date, you can maximize your retirement pay and avoid the pitfalls of the COLA Trap.
Link to the full paper: https://media.themilitarywallet.com/wp-content/uploads/2022/08/04110257/The_COLA_Trap-PSP-Fowler.pdf
*This post is for educational purposes only and should not be considered financial advice.