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What Is a Cost-of-Living Adjustment (COLA)?
A cost-of-living adjustment, or COLA, is an increase in wages, salaries, or benefits to counteract inflation. Inflation is measured using the Consumer Price Index (CPI). It is usually based on an objective measure that estimates how much additional money a typical person or household needs to maintain their standard of living over time.
Why Compensation Needs to Be Adjusted for Cost of Living
Cost-of-living adjustments compensate people for living in areas of higher inflation or when recipients have a fixed income. They are part of a good retention program and are a common bargaining point in union negotiations.
COLA and Relocations
Employees who transfer to a new location may experience increased living expenses. For example, an employee who moves from a small town in Tennessee to New York City should be considered for a hefty cost-of-living adjustment. The adjustment offsets the higher cost of living and preserves the employee’s disposable income.
Cost-of-living adjustments are typically used by public pensions and the Social Security Administration to keep up with inflation for retirees on a fixed income.
However, your employees are not on a fixed income. It is important to offer reasonable salaries and wages that keep up as the prices of goods and services increase, so employees aren’t forced to look elsewhere. Consider highlighting your COLA adjustment as an added job benefit that is part of your retention strategy.
Two of the most important elements addressed during collective bargaining are wages and benefits. Cost-of-living adjustments are typically built into collective bargaining agreements (CBA).
For example, in 2019, Service Employees International Union (SEIU) Local 503, ratified their CBA to provide workers a 2.5% cost of living adjustment each year for four years.
How to Decide When to Give a COLA
Giving a COLA may be required—for instance, in adhering to a union contract. But in other circumstances, it is optional, and your company has to decide if it is appropriate, and if so, how much it should be. Here are a few considerations in making that decision.
- The CPI may decrease. (This is rare, but has happened.) In those instances, an adjustment need not be made.
- Your business may not be financially stable enough to afford a COLA, or afford a COLA that matches that year’s CPI.
- You may have a compensation structure that accounts for cost-of-living increases in a different way.
How to Calculate a Cost-of-Living Adjustment
Cost-of-living adjustments can vary, as there is no official cost-of-living metric. Many employers use the (CPI) to set COLAs. Others follow the SSA recommendation, but keep in mind that this method is geared towards seniors.
CPI, as defined by the Department of Labor, is the measure of the average change over time in the prices paid by urban consumers for consumer goods and services. It is published monthly by the Bureau of Labor Statistics.
To calculate the cost-of-living adjustment for your organization, consider housing, food, healthcare, transportation, and energy. These are the universally recognized core components of any cost-of-living estimate, and represent expenses that typically apply to everyone.
Step 1: Determine Your Source
Determine if your organization will use national or regional data to determine the increase. Private employers are not required to use the CPI; you may use another index.
Step 2: Determine Your Policy
Determine if your organization will provide regular cost-of-living adjustments. If so, you will need to create a policy and/or include it in your employee handbook.
Step 3: Calculate and Communicate the Adjustment
Make your calculation (see example below) and communicate it to your organization.
When communicating decisions about COLA adjustments or the lack of one, explain the reason to employees in person and privately. Be ready to answer questions.
Example of a cost-of-living calculation
Say the cost of living rose by 1.5% over the past year, and your organization decided to match that by providing a cost-of-living adjustment/raise to each employee of 1.5%.
If you have an employee who earns $45,000 annually, this 1.5% COLA will increase their salary by $675.00, to $45,675.00 annually.
|Salary||% COLA Adjustment||Total Annual Increase||New Annual Salary|
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