A cost-of-living adjustment (or COLA) is an increase in employees’ benefits or pay to make up for inflation. If workers’ income remains the same, their quality of life worsens as food and services become less affordable. Essentially, workers are getting paid less compared to the cost of living. Cost-of-living adjustment addresses economic changes.
How is the cost-of-living adjustment determined?
Each company that offers a cost-of-living adjustment can choose how to calculate the adjustment. For instance, businesses can consider the consumer price index, the inflation rate, or other indicators.
Since companies aren’t legally required to provide a cost-of-living adjustment, there’s no mandated way to calculate it. The amount they offer as a salary adjustment can change yearly, but it can also remain stable. These decisions are up to the employer.
Do companies have to offer cost-of-living adjustments?
Unless it’s required by law, each company can decide whether to offer this benefit and how much to change salaries for COLA.
In 2023, 80% of employers planned to provide base pay increases to cover inflation. Employers must offer a cost-of-living salary adjustment for every employee. It is not based on merit or performance.
Why is a cost of living adjustment important?
Companies must weigh the benefits and costs of COLA. Benefits include:
Increased employee loyalty: Offering benefits like cost-of-living adjustments can increase employee loyalty and retention rates.
Higher morale: Employers who offer cost-of-living adjustments show employees that they care about their welfare and standard of living. This can boost morale.
Greater productivity: COLA reduces financial stress that can distract employees from their work. Without needing to worry about finances as much, productivity can increase.
Cost of living adjustments
Cost of living adjustments include Social Security Administration (SSA), but companies can also offer employees COLA for:
- Pensions
- Across-the-board raises
- Relocation
Does everyone on Social Security receive the COLA increase?
If the federal government mandates a COLA is necessary based on the CPI-W (consumer price index), it applies to everyone who receives Social Security. COLA may not be given if the CPI-W does not increase.
What is a normal cost-of-living adjustment?
A cost of living adjustment is considered normal if it directly correlates to the consumer price index, which measures inflation. Employers generally use the CPI-U or a local CPI when calculating COLA. The Social Security Administration always uses the CPI-W.
How to calculate cost of living adjustments
The Social Security Administration has an official COLA method:
- Average the CPI-W across each month of the current year’s third quarter
- Average the CPI-W across each month of the previous year’s third quarter
- Calculate the difference in percentage between the two averages
- Round the result to the nearest one-tenth of one percent
Cost of living adjustment formula: (Current Q3 Average CPI-W – Previous Q3 Average CPI-W) / Previous Q3 Average CPI-W x 100 = COLA
After calculating COLA, Social Security benefit recipients can calculate their increase for the next year. For example, a retiree receives $2,000 per month in benefits, and the Social Security COLA for the upcoming year is 8.7%. That person’s new monthly payment adjusted for inflation would be:
$2,000 x 1.087 = $2,174
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