What Is a Cost-of-Living Raise, and How To Determine It
By Pierre Mouchette | Bits-n-Pieces
What is a cost-of-living increase?
Inflation causes the cost-of-living expenses to increase regularly. As the price of ordinary items such as food, housing, gas, clothing, and utilities rises, your employees spend more. To continue in a stable financial condition, employee salaries must go up as living costs increase.
A cost-of-living raise compensates for inflation. When the cost-of-living increases by a certain percentage, you increase employee wages by the same rate. For example, if the cost-of-living increases by 2% this year, you will increase employee wages by 2%.
Each employee gains a different amount with most raises, and some employees might not receive a raise. The cost-of-living adjustment is not the same. All employees receive the annual cost of living raise simultaneously. In addition, all employees receive the same percentage increase.
The cost-of-living raise is sometimes referred to as a COLA (cost of living adjustment).
Why should you give a cost-of-living raise?
The main reason to give a cost-of-living raise is to keep employee wages reasonable compared to living expenses. As the cost of essential items increases, employees need more money to pay for the same things.
Periodic raises encourage employees to stay at your business. When the salaries you pay keep up with living expenses, employees are not forced to look somewhere else for higher-paying work. You could attract new employees by showcasing your COLA raises as an added job benefit.
Some employers are required to give a cost-of-living raise. Government employees typically must receive the cost-of-living adjustment. If your employees are in a labor union, their union might negotiate a cost-of-living increase.
Private employers do not have to receive a cost-of-living raise. It is optional.
Cost of living raises should not be the only pay adjustments you give employees. You might need to provide other raises to keep up with competitors, industry standards, employee achievements, and increased experience.
How to determine a cost-of-living increase
A cost of living salary increase is not subjective. A raise is based on standardized inflation numbers. Employers often base the COLA on the Consumer Price Index. This index measures the price change of particular items over time. The Consumer Price Index indicates national trends, and there are also reports for several geographic areas.
You do not need to use the Consumer Price Index if you are a private employer. You can use another cost-of-living index. There is no typical cost of living increase. The raise percentage varies by year because it is based on inflation.
If you intend to make the regular cost of living adjustments, you might include your policy in your employee handbook. You might say how often you will provide raises and how you determine the amount to give.
Cost of living adjustments usually only go one way, up. If the cost of living goes up, workers' wages go up. However, if the cost of living goes down, employee wages do not decrease. Instead, you probably will not give a cost of living raise that year.
Cost of living raise example
Suppose the cost of living has increased by 1.5% over the past year. It would be best if you gave an annual salary cost of living adjustments, raising each employee’s wage by 1.5%.
So, if you have an employee who earns $35,000 per year, you would add 1.5% to their wages.
$35,000 x 0.015 = $525
$35,000 + $525 = $35,525