What Is a Cost of Living Adjustment (COLA) and How Does It Work?
- Payroll
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6 min. Read
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Last Updated: 02/22/2024
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Continued economic uncertainty in the U.S. may bring to light the topic of providing cost of living adjustments to employee pay. While not based on job performance or promotion, COLAs may help employees manage rising prices for basic staples. With inflation continuing to raise concerns in 2024, businesses may increasingly consider implementing cost of living adjustments. Read on to learn how a COLA works.
What Is a Cost of Living Adjustment (COLA)?
COLAs are increases in compensation intended to help employees maintain the value of their compensation against inflation. These increases are not viewed as merit increases resulting from good job performance but should be considered a way to help employees maintain their earning power.
What Is COLA Based On?
Since 1975, the Social Security Administration (SSA) has calculated annual cost of living adjustments to SSA benefits based on a price index such as the Bureau of Labor Statistics' Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). This index measures the rise in consumer prices for households where at least half of the income is from clerical or urban wage occupations and at least one of the household's earners has been employed for at least 37 weeks over the past 12 months. This represents about 29% of the U.S. population.
Why Is a Cost of Living Raise Important?
A cost of living raise is important because it's a compensation practice used to help keep employees' pay on par with rising prices for basic needs, such as housing, energy, and food. The government issues COLAs related to Social Security benefits, but employers may also apply these percentage increases to employees' yearly wages. Employers who want to keep pace in a competitive labor market may choose to apply an increase as part of their employee compensation plans.
When Is COLA Announced for 2024?
The SSA announced a 3.2% COLA increase for 2024 in October 2023. The increase began with December 2023 Social Security and Supplemental Security Income (SSI) benefits, payable in January 2024. The SSA also said that Social Security retirement benefits will increase by an average of more than $50 per month starting in January 2024.
What Is the COLA for 2024?
Each year, the SSA automatically applies a COLA to payments made to those receiving Social Security and SSI. For 2024, the COLA increase is 3.2%, calculated based on the rise in the CPI-W from the third quarter of 2022 through the third quarter of 2023.
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.
What Is Included in the Cost of Living Adjustment?
A COLA is often calculated based on an underlying metric, such as the Consumer Price Index (CPI) or the CPI-W. The indexes calculate price increases in living staples such as housing, food, and energy costs. State law or a union agreement may specify which index should be used to calculate a COLA increase. Employment agreements may also state the specific index that must be used to measure any cost of living raises.
How to Calculate a COLA Increase for Employees
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.
How Much Is a Social Security Cost of Living Raise on Average?
Over the years, COLAs have varied. In some years, prices have been largely stagnant, resulting in either no or minimal adjustment, as shown in the chart below. This year's 3.2% COLA is a much smaller percentage compared to the 2023 COLA of 8.7% but is in line with the 3.5% COLA average over the past few decades.
| COLAs Over the Past Decade | |
|---|---|
| Year Announced | COLA for the Following Year |
| 2023 | 3.2% |
| 2022 | 8.7% |
| 2021 | 5.9% |
| 2020 | 1.3% |
| 2019 | 1.6% |
| 2018 | 2.8% |
| 2017 | 2% |
| 2016 | 0.3% |
| 2015 | 0% |
| 2014 | 1.7% |
Historically, adjustments to the minimum wage were enacted to help lower-paid workers when the cost of living increases. Many states and localities have a higher minimum wage than the federal amount. And several have implemented annual increases based on increases in the cost of living.
Understand How Cost of Living Impacts Your Business
Competitive wages that align with cost of living adjustments should factor into your hiring, retention, and compensation strategies for 2024. If you plan to offer a cost of living raise this year, you can do so most efficiently by working with your payroll provider to implement the increase across the board.
COLA FAQs
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Do Employers Have To Give Cost of Living Adjustments?
Do Employers Have To Give Cost of Living Adjustments?
A cost of living increase is not mandated unless required by law or agreement. Additionally, it may not be needed every year. This may be the case during years when inflation remains flat, and the cost of living doesn't change, meaning that employees' pay value is not diminished.
Why would an employer give a COLA? There are several common reasons, including:
- Concern over employee retention when competing firms begin to offer higher pay rates.
- The need to persuade employees to move to a city or state with a higher cost of living.
- To alleviate the financial stress placed on employees during periods of inflation.
- Doing so is required by law or under the terms of an agreement.
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What Is Cost of Living?
What Is Cost of Living?
Cost of living refers to the amount of money needed to maintain a particular standard of living in a specific location, with the ability to cover basic expenses such as housing, food, and transportation. Areas of the country, such as major cities with higher food and housing costs, for example, would have a higher cost of living than suburban or rural areas.
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How Often Should Cost of Living Raises Be Given?
How Often Should Cost of Living Raises Be Given?
In instances where it's not mandated, COLA raises and how often they are given are at an employer's discretion. Cost of living raises may not be needed every year. For example, in years when inflation remains flat, employers may choose not to give a cost of living raise.
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When Are Cost of Living Raises Given?
When Are Cost of Living Raises Given?
In instances where employers have the option to give a cost of living raise, they can choose when to give them. Usually, a cost of living raise would be the same percentage increase for all employees, so it may make sense to implement the change at the beginning of a new year or following annual performance reviews. During these conversations, employees could also ask about a pay increase. But remember that cost of living adjustments aren't merit- or performance-based. However, your compensation plans should reflect market conditions and employees' ability to maintain earning power.
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Who Is Eligible for a COLA Increase?
Who Is Eligible for a COLA Increase?
All Social Security and SSI beneficiaries, including those receiving spousal benefits, automatically receive a cost of living adjustment increase. This equates to more than 71 million Americans. The increase began with benefits that Social Security beneficiaries received in January 2024. Increased SSI payments began with the December 29, 2023 payment.
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What Are Other Types of COLAs?
What Are Other Types of COLAs?
Most people think of cost of living adjustments as they relate to wage increases and salary, but they can also apply to benefits and other compensation packages.
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What Are Cost of Living Adjustments vs. Minimum Wage?
What Are Cost of Living Adjustments vs. Minimum Wage?
Minimum wage is the lowest mandated base pay a company can offer its covered nonexempt workers. The minimum wage is set by federal, state, and local governments (many states' minimum wage is higher than the federal minimum wage of $7.25 per hour, which has remained unchanged since 2009). State minimum wages are based on many factors; your state’s minimum wage laws may include provisions for cost of living increases. If you haven't already done so, learn about this year's minimum wage increases and other regulatory issues.
On the other hand, a cost of living adjustment is an increased percentage of pay set by the Social Security Administration to help beneficiaries and their families afford basic needs, such as housing, food, and transportation, based on current market conditions. With a few exceptions, there has been a cost of living adjustment nearly every year.
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