What Is an Average Cost of Living Raise? Definition and How to Calculate
A cost of living raise is a practice that is implemented to help keep employees' pay on par with the rise of prices related to living (inflation). This practice is most significantly used by the government about Social Security but may also be applied by companies to employees' yearly wages.
In this article, we will explore what a cost of living raise is, how to calculate an average cost of living raise and provide an example of a cost of living raise in a real-life setting.
What is a cost of living raise?
A cost of living raise is an increase in income that correlates with the rise in the cost of living. A cost of living raise may also be referred to as a cost of living adjustment (COLA) or cost of living increase. This raise is most often applied in terms of benefits, salaries and wages and may be implemented by companies and the government.
The most common instance of cost of living adjustments is the increase of Social Security benefits applied by the government each year. For example, the Social Security Administration implemented a 2.8% benefit increase for the year 2019 to accommodate the rise in the cost of living. This meant that retirees saw an increase of 2.8% in their 2019 Social Security benefits.
Additionally, some organizations may incorporate an annual salary adjustment into the compensation plan to account for the yearly rise in the cost of living. However, many companies base their raises on merit and contribution rather than a rising cost of living. This is typically because most companies must only award raises to those workers who are productive and contribute to the overall profitability of the business to remain profitable.
Government organizations typically use COLA more often than other companies because the government often pays less than other organizations and has a less competitive environment. Additionally, employees who are part of a union may receive a cost of living raise on an annual basis. For example, employees of the U.S. Postal Service will automatically receive a raise annually based on the cost of living increase each year.
How to calculate an average cost of living raise
A cost of living raise is typically based on the increase (or decrease) of the standard cost of living each year. The cost of living may include an increase in the cost of housing, utilities, taxes, health care and food. When these necessities cost more, an individual's income must be increased to accommodate these prices.
How a cost of living raise is calculated varies from company to company, as there is not an official metric used to determine a standard salary increase related to the cost of living. Some businesses may use the denoted price of living increase as listed by the Consumer Price Index (CPI) for the previous year when calculating an appropriate cost of living raise for employees.
The CPI is determined by the Bureau of Labor Statistics and is based on changes in specific services and goods. Cost of living raises are typically only implemented when the cost of living rises and may not change when the cost of living decreases (deflation).
Related: Learn About Being an HR Generalist
Cost of living raises based on relocations
Another reason why employees may reason a cost of living salary increase is when they are transferred to a new city while working for the same company. For example, an employee who is transferred from Florida to New York City will probably receive a raise because the cost of living is higher in New York City compared to Florida. A city or state's cost of living index can also be used when considering whether a salary offer is suitable for a new job in another location.
Cost of living raises for retirement income
Individuals who receive monthly or annual retirement income may also receive an increase in funds as a result of a rise in the cost of living. This is because was the retirement income to stay the same, individuals would not be able to sustain their lifestyles on that income due to inflation. For this reason, some types of retirement incomes implement COLA to accommodate yearly increased costs of living. Common retirement incomes that incorporate a cost of living raise include Social Security, COLA-based pensions and COLA-indexed pensions.
Example of a cost of living raise
The following is an example of how a company may provide a cost of living raise to an employee:
In the past year, the cost of living increased by 2%. ABC Company provides an annual cost of living raise based on the increased cost of living prices each year. This means that each employee at ABC Company will receive a 2% raise to accommodate the rise in the cost of living over the last year.
So, if an employee at ABC Company currently earns $40,000 per year, they would receive a raise of 2%. You can calculate this by using the following formula:
Current employee salary x cost of living increase = Cost of living raise
For the abovementioned employee, the calculation would be as follows: 40,000 x 0.02 = 800
This means that the employee would receive an $800 raise and would now make $40,800 annually.
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