What is a cost-of-living adjustment (COLA) & how does it work? Due to the pressure of inflation the U.S Government providing cost of living adjustments to employee pay in order to help an Employee to manage rising prices for basic staples.
What are the benefits of providing cost-of-living adjustments?
Companies trying to decide whether to provide COLA must weigh the benefits and costs of doing so. The clear cost of offering these benefits is the financial outlay required. Providing cost-of-living adjustments means paying employees more and having less money to spend in other areas.
However, the following benefits of providing cost-of-living adjustments may offset this financial strain:
- Increased employee loyalty: Holding on to great employees can be challenging, but offering benefits like cost-of-living adjustments will inspire greater company loyalty in those employees and make them more likely to stick around.
- Better morale: Employers who offer cost-of-living adjustments show employees that they care about their concerns and livelihoods. This will boost morale around the company.
- Greater productivity: COLA alleviates some financial stress and strain for employees, making them better able to focus on their work. Output and productivity will also likely increase for workers who receive these pay increases.
All these benefits help contribute to the success of the company. Employers must decide for themselves whether the benefits of giving these pay increases are strong enough to outweigh the costs.
How Does a Cost of Living Adjustment Work?
A COLA is a standard across-the-board increase for a group of individuals. Employers often give out a cost of living raise where each employee receives the same percentage increase.
Typically, living costs in large cities such as New York or Los Angeles are higher than in smaller towns or rural communities. Employers with employees in several different cities or states may choose to adjust their cost of living raises based on location. This may help to meet more expensive housing, gas, or food costs affecting workers in certain areas.
In some cases, cost of living pay increases may be a requirement. Minimum wage laws, union agreements, executive contracts, and even retiree benefits such as employee pensions may contain provisions for annual COLAs. Some of these automatic adjustments may be programmed into a compensation system to guarantee they take effect as stipulated, while others may require additional oversight.
How is the cost-of-living adjustment calculated?
A COLA typically can be calculated as part of an annual compensation plan review. An employer should figure out which price index best aligns with their employees’ cost of living.
For example, if the chosen index rose 6% in the past year, employee compensation would be adjusted similarly. Employees with a $100,000 base salary might receive a 6% raise, or $6,000 for their COLA, before any performance-based increases. Likewise, an employee making $20 per hour might receive another $1.20 per hour, raising their pay rate to $21.20.
