What is the function of cost of living formulas in retirement plans?

Cost of living formulas play a crucial role in retirement plans by adjusting pension benefits after retirement. This adjustment is significant because, over time, inflation can erode the purchasing power of fixed retirement benefits. By applying a cost of living adjustment (COLA), retirement plans ensure that retirees' benefits keep pace with inflation, allowing them to maintain a consistent standard of living.

This adjustment method typically involves increases based on changes in a recognized cost of living index, such as the Consumer Price Index (CPI). By implementing these formulas, plans address the financial needs of retirees in light of economic changes, thereby making retirement benefits more sustainable over the long term.

In contrast to this, options related to calculating salary increases, determining lump-sum payouts, or assessing investment performance do not directly pertain to the core function of cost of living formulas in the context of retirement benefits. These areas focus on different aspects of compensation and plan management rather than the ongoing adjustment of pension benefits post-retirement.