What Is Cost Of Living Raise And How To Calculate It

A cost of living raise is increases in hourly rates or salaries designed to adjust employees’ earnings in line with inflation such as increased cost of services and goods. To calculate cost of living raise, employers can apply the percentage change in the CPI to the employee’s salary; for instance, if the CPI increases by 2%, an employee’s salary would also increase by 2% to match the rise in living costs.

By Brad Nakase, Attorney

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Table of Contents

1. What Is an Adjustment for Cost of Living?

2. What Is the 2024 COLA Increase Announced by the Social Security Administration?

3. How Do You Calculate a Cost of Living Adjustment?

4. What Does the Cost of Living Adjustment Cover?

5. Do Employers Need to Provide Adjustments for Cost of Living?

6. How to Determine an Adjustment for Cost of Living Employee Reimbursement

7. What Is a Normal Cost of Living Increase?

8. Recognize How Living Expenses Affect Your Company

What Is an Adjustment for Cost of Living?

An adjustment for the cost of living (COLA) refers to an increase in income that is meant to offset the rising prices of the goods and also services due to inflation. The main things to know about cost of living adjustments are:

COLAs are designed to preserve the purchasing power. The intent is to keep real incomes constant even as the prices rise over the time due to inflation.
Social Security benefits, government employee pensions, veterans’ pensions, and also private company pensions often have built-in cost of living adjustment to protect the retirement income. Things like food, housing, transportation, and also healthcare tend to rise in the costs over the span of time.
The size of the COLA is usually tied to a standard measure of inflation, commonly the Consumer Price Index (CPI). This tracks a basket of goods and services purchased by the households over time.
In times of high inflation, the COLA may not fully keep pace with the rising costs and, so there can still be some loss of purchasing power. But it aims to minimize the overall effect.
Not all income sources have automatic COLAs, in which case the inflation eats away at real earnings and purchasing ability over the span of time.

In short, the intent of a cost of living adjustment is to maintain the living standards and the real income value in the face of rising prices over a period of time. It aims to offset the consumer inflation.

Employers looking to discuss matters concerning cost of living adjustments should consult with an Employment or Labor Law attorney for employers. They can provide guidance on how to implement cost of living adjustments in compliance with labor laws, ensure that the adjustments meet legal standards, and advise on the contractual and policy aspects of employee compensation.

What Is the 2024 COLA Increase Announced by the Social Security Administration?

In 2024, the cost of living raise for Social Security and Supplemental Security Income (SSI) benefits will impact over 71 million Americans with a 3.2% increase. This cost of living raise will commence in January 2024 for more than 66 million Social Security beneficiaries, and for approximately 7.5 million SSI recipients, the cost of living raise will start on December 29, 2023. Note that some individuals might receive both Social Security and SSI benefits.

Additionally, the maximum earnings subject to Social Security tax will rise to $168,600 due to the cost of living raise. Workers who are younger than the “full” retirement age, which is detailed in the Full Retirement Age Chart, will see their earnings limit increase to $22,320 due to the cost of living raise. For earnings above this limit, $1 will be deducted from benefits for every $2 earned.

For those reaching their “full” retirement age in 2024, the earnings limit will increase to $59,520 due to the cost of living raise. Earnings above this will lead to a deduction of $1 from benefits for every $3 earned over this limit, until the month they reach full retirement age.

Workers who are at “full” retirement age or older for the whole year will not have an earnings limit, reflecting the adjustments made for the cost of living raise.

How Do You Calculate a Cost of Living Adjustment?

The basic steps to calculate a cost of living adjustment (COLA):

Choose an index to measure the inflation. The most common one is the Consumer Price Index (CPI) published by the Bureau of Labor Statistics.
Select a base year and value to compare against. For example, the CPI value in the January 2022.
Select a new year and find the CPI value for that same month. For example, January 2023.
Calculate the percentage change between the two CPI values:
(New CPI Value-Base CPI Value)/ Base CPI Value
Apply the percentage change to the baseline salary or the dollar amount to determine the adjusted amount.

For example, if the base salary was $50,000 in January 2022 when the CPI was 275, and the January 2023 CPI is 285:

(285 – 275) / 275 = 3.6%.
3. 6% of $50,000 is $1,800.

So the COLA would be $1,800, making the new adjusted salary $51,800.

This allows the salaries, pensions, and other payments to keep pace with the overall inflation in the economy. The process can use other price indexes as well, but the CPI is the most common.

What Does the Cost of Living Adjustment Cover?

A Consumer Price Index (CPI) or CPI-W are two examples of underlying metrics that are frequently used to generate a COLA. The indexes compute price increases for necessities of life like housing, food, and energy. An annual cost of living rise may be determined by reference to an index that is specified by state law or a union agreement. The precise index that must be used to gauge any increases in the cost of living may also be specified in employment agreements.

The cost of living adjustment covers the following:

Housing Expenses: Rent or mortgage payments, property taxes, and utility costs.
Food and Groceries: Everyday food items, dining out, and general grocery costs.
Healthcare: Medical insurance premiums, out-of-pocket expenses, and prescription costs.
Transportation: Costs associated with commuting, vehicle maintenance, and public transit.
Education: Tuition fees, school supplies, and educational resources.
Clothing and Apparel: Regular clothing purchases and necessary apparel items.
Recreation and Entertainment: Expenses for leisure activities, hobbies, and entertainment.
Miscellaneous Needs: Other everyday expenses, including personal care and household items.

Do Employers Need to Provide Adjustments for Cost of Living?

Unless specified in a union agreement, benefit plan document, or employment contract, or mandated by law or agreement (e.g., yearly minimum wage hikes), a cost-of-living rise is not necessary. Offering employees cost-of-living increases may not be necessary every year. There are years when both inflation and the cost of living stay constant, maintaining the value of an employee’s compensation.

Why might an employer provide a COLA? There are numerous typical causes, such as:

Concern about keeping employees on board when rival companies start paying more.
The requirement to convince staff members to move to a state or city with a greater cost of living.
To lessen the financial strain that employees experience when there is inflation.
According to an agreement or the law, something must be done.

How to Determine an Adjustment for Cost of Living Employee Reimbursement

Usually, a yearly review of the compensation plan includes the computation of a COLA. The pricing index that most closely matches the cost of living for their employees should be chosen by the company. An equivalent adjustment would be made to employee salaries or hourly rates if the selected index had increased by 6% during the previous year.

Research Local Cost of Living: Investigate the cost of living in the employee’s location. This includes housing, food, transportation, healthcare, and other essentials.
Compare with Base Location: Compare these costs to those in the organization’s base location or the employee’s original location if different.
Use Cost of Living Indexes: Utilize reliable cost of living indexes to quantify the differences in expenses between the two locations.
Assess Employee’s Needs: Consider the specific circumstances of the employee, such as family size, housing needs, and any special requirements.
Determine the Adjustment Rate: Based on the research and comparisons, decide on a percentage or fixed amount that would adequately cover the cost of living differences.
Regular Updates: Regularly update the reimbursement to reflect changes in the cost of living and any changes in the employee’s circumstances.
Clear Policy and Communication: Establish a clear policy for how the adjustment is calculated and communicate this effectively to the employee.
Legal and Tax Implications: Consider any legal or tax implications of the reimbursement, both for the employee and the company.
Feedback and Adjustment: Be open to feedback from the employee and be prepared to adjust the reimbursement if it proves insufficient or excessive.
Document and Review: Document the methodology used for calculation and periodically review the policy to ensure it remains fair and relevant.

Before receiving any performance-based raises, an employee with a $100,000 base pay, for instance, may get a six percent raise, or $6,000 for their COLA. Similarly, a worker earning $20 per hour might get paid an additional $1.20 per hour, for a total pay rate of $21.20.

What Is a Normal Cost of Living Increase?

A normal cost of living increase typically refers to a raise in pay that is intended to offset the rising inflation and costs so that a person can maintain their standard of living. Some key things to note about normal cost of living increases:

They are usually around 1-3 % per year. This is a rough average of inflation rates in the developed economies. The actual percentage may vary alot depending on the current inflation level.
Cost of living increases are very common with the salaries, Social Security benefits, pensions, and also many other payment streams intended to maintain purchasing power over the long periods.
The goal is to prevent a decline in what people can buy with their money due to the inflation shrinking the value of a dollar over the span of time. It allows many people to tread the water, not gain or lose standard of living.
The actual inflation rate varies, so the cost of living increases may end up overshooting or lagging behind the inflation in a given year, though the increases are intended to approximate the inflation over time.
Benefits that lack a COLA or the companies that don’t provide raises to match the inflation lead to stealth pay cuts over the years as the buying power declines.

So in essence, a normal cost of living increase is seen as 1% to 3% total pay boost annually, keeping pace with the gradual inflation of prices over the years. The intent is to preserve the standard of living based on a certain level of real wages or spending ability.

Recognize How Living Expenses Affect Your Company

Offering competitive pay aids in luring and keeping talent. Employers run the danger of losing human capital when they fall behind and don’t pay enough to support staff members in making ends meet. In order to attract the top candidates in each local employment market, it’s critical to comprehend how living expenses vary among regions. The most effective way to execute a cost-of-living rise that you intend to offer in the following year is to collaborate with your payroll provider to apply the increase uniformly.

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