What is a Cost-of-Living Raise?

Today’s American workers are struggling with the unprecedented high cost of living that even reasonable salary increases can’t offset. If you’re an employer, it’s likely that a large percentage of your workforce is battling record-high grocery bills, inflated credit card and student loan interest rates, and unsustainable rent increases.

For their part, companies are trying to manage the rising cost of doing business while still making a profit. All this generates widespread discussion about the merits—and feasibility—of giving employees cost-of-living raises.

In this guide, we’ll explore the impact of inflation on employee pay and offer some guidance for businesses considering implementing cost-of-living pay increases.

What Is the Cost of Living?

‘Cost of living’ describes the amount of money people need to maintain a particular standard of living while residing in a specific location. It includes their ability to cover basic expenses like housing, food, and transportation.

People living in major cities, where the cost of housing and food is greater, would have a higher cost of living than those residing in suburban or rural areas.

What is a Cost-of-Living Raise?

A cost-of-living raise is a practice companies implement to help keep their workers’ pay on par with inflation—the rise of prices related to living. It is also referred to as a cost-of-living adjustment (COLA) or cost-of-living increase.

The most common cost-of-living raise is the government’s yearly increase in Social Security benefits, but companies also apply them to employees’ yearly wages or salaries, benefits, and other compensation elements.

What’s the Difference between a Raise and a Cost-of-Living Increase?

It’s important to understand the difference between a raise and a cost-of-living increase; the two terms are not interchangeable.

• A raise refers to an increase in a worker’s salary or hourly wage that boosts their spending power. After receiving a raise, the employee can afford more goods and services or put more money into savings. Raises are typically based on merit, reflecting a worker’s performance or contribution to an organization.
• A cost-of-living increase is a rise in a worker’s salary or hourly wage aimed at ensuring their spending power is commensurate with inflation or other economic indicators. Cost-of-living increases are designed to ensure employees can afford the same goods and services over time. They’re not merit-based and don’t improve the worker’s overall purchasing power. As we touched on earlier, typical employment-related cost-of-living raises take into account where the employee lives.

What are Social Security Cost-of-Living Adjustments (COLAs)?

Millions of Americans depend on their Social Security payments to survive. Retired workers are the largest group of beneficiaries, but many children, spouses, and disabled people also receive these government benefits.

While Social Security benefits are initially calculated using an individual’s earnings record, if monthly payments remained static, they would quickly lose purchasing power. In 1975, the government instituted annual cost-of-living adjustments (COLAs) to prevent this.

The COLA for 2023 was 8.7%. So, if someone received $10,000 in Social Security benefits in 2022, their 2023 annual benefit totaled $10,870. For 2024, the COLA is 3.2%, so if a person received $10,000 in Social Security benefits in 2023, their 2024 annual benefit will be $10,320.

Some say these adjustments don’t adequately reflect increases in seniors’ living expenses. The Senior Citizens League forecasts the COLA for 2025 to increase by just 1.75%.

Understanding the Factors that Might Require Average Cost of Living Increases

Let’s take a closer look at some of the most common reasons employers implement cost-of-living increases and how they’re calculated.

You’re Asking the Employee to Relocate to a New City

The cost of living differs vastly in different areas of the country. Here are a few interesting facts:

• Hawaii tops U.S. states with the most expensive cost of living. The total average annual expenditure of $55,491 leaves its residents just $5,929 on average to spend per year.
• Mississippi has the lowest cost of living, with residents spending $32,336 annually—$23,155 less than Hawaii.

Living costs also vary between cities within a state. Living in downtown Manhattan, for example, will be far more expensive than living in Albany, New York. So, if you’re asking an employee to move to a more expensive city or neighborhood for their job, you should definitely offer them a cost-of-living raise.

How to Calculate a Cost-of-Living Increase Percentage for a Relocating Employee

It’s common for employers to use the Cost-of-Living Index to determine how much they should pay an employee who is relocating. This index compares living costs by region and/or city. To calculate an employee’s cost of living in a new location:

• Set the cost of living to 100 in the employee’s current city.
• Calculate the average price of similar items, like groceries, healthcare, and transportation, in both the employee’s current and new city.
• Work out the average percentage difference between the prices of all items.
• If the cost of living in the new location is 10% higher, the cost-of-living index equals 110.
• In this instance, a fair cost-of-living salary increase would be 10%.

Bear in mind that the cost of living in different locations can change over time, so be sure to stay current on the cost of living in various cities or regions.

Offset the Effects of Inflation

Inflation will gradually erode your employees’ purchasing power regardless of where they live and work. In the past few years, real wages—or how much their income is worth after accounting for inflation—haven’t kept up with escalating housing, food, transportation, and healthcare costs despite average wages rising.

High or unpredictable inflation that isn’t matched by wage increases can be especially hard to shoulder for poor people, who may be forced to cut back on essentials like food and heating just to get by.

How to Calculate Inflation-Related Cost-of-Living Increases

Inflation is typically expressed as the yearly change in the price of a basket of goods and services. In the U.S., there are two primary inflation gauges:

• One, the Consumer Price Index or C.P.I., measures the cost of items urban consumers purchase out of pocket, such as groceries, housing, transportation, education, and recreation.
• The Personal Consumption Expenditures index, or P.C.E., measures items people consume, including things they may not pay for directly, like health care, which insurance and government benefits often help to cover.

Annual C.P.I. is the most common yardstick companies use to measure inflation costs and determine cost-of-living raises.

Example of a Cost-of-Living Increase

Here’s a simple example of how an organization might give its employees an inflation-related cost-of-living raise:

• In the last year, the cost of living increased by 3%.
• The company policy is to award annual cost-of-living raises based on the average yearly cost-of-living price increase.
• This means that every worker at the company will receive a 3% raise to accommodate the rise in the cost of living over the last 12 months.

So, if an employee currently earns $35,000 per year, they will receive a raise of 3%. To calculate this, use this formula:

• Current employee salary x cost of living increase = Cost of living raise.
• For the employee in our example, the calculation would be 35,000 x 0.03 = 1,050.
• This means that the worker would receive a $1,050 raise and would now earn $36,050 annually.

Other Factors Influencing Cost-of-Living Raise Amounts

Beyond relocation and inflation, there are several other factors that typically influence a company’s decision to implement cost-of-living increases and their size. Let’s explore.

Business Economic Conditions

Inflation affects everything, including business owners. Small- and medium-sized businesses are generally hit the hardest:

• Small business owners are “very pessimistic” about their prospects this year.
• Nearly 25% of small business owners say inflation remains the most critical problem when it comes to operating, outstripping labor quality as the highest-ranking concern.
• The tally of small business owners expecting better business conditions over the next six months remains a “net negative 36%”.
• When business owners reporting lower profits were asked how operating costs are affecting operating income, 31% blamed weaker sales, 17% blamed the rise in the cost of materials, 16% cited lower prices, and 9% cited labor costs.

In this climate, workers who may have received generous cost-of-living raises during the last couple of years may not experience the same in 2024 amid economic uncertainty:

• Nearly half (49%) of business leaders say they won’t give cost-of-living adjustments to employees in 2024, and 26% say they either won’t or may not give any kind of raise at all.
• Of those giving cost-of-living raises, 48% will give 3% or less.

Salary Trends in Your Market and Industry

When calculating cost of living pay increases, employers should look carefully at the market rates for similar positions in their industry and area. Depending on the demand for people with specific skills in your industry, what’s considered a competitive salary and a reasonable cost-of-living increase can change dramatically.

Hiring in a competitive market can be challenging, and offering competitive pay and fair cost-of-living raises is an effective way to retain employees.

What if I Can’t Afford to Give My Employees a Cost-of-Living Increase?

If the raises you can afford to give your employees don’t match the rising cost of living due to inflation, or you can’t afford raises at all, you can supplement your workers’ pay with non-monetary employee benefits and perks like:

• Wellness incentives.
• Employee discounts.
• Travel benefits.
• The ability to work remotely or more shift scheduling flexibility.
• More personal time off.
• Financial wellness benefits and on-demand pay.

Effective leaders consider pay and benefits holistically and craft programs that help attract and retain talent while managing company costs.

Pair Cost-of-Living Wage Increases with Meaningful Financial Wellness Benefits

As we’ve explored, the cost of living consistently rises over time, negatively impacting your workers’ ability to provide for their families and save for their futures. So, don’t neglect the importance of regularly reviewing your employees’ salaries to ensure they’re still receiving a fair level of pay.

By ensuring your rate of pay keeps up with the cost of living, you’ll maintain high morale among your team and boost your retention rates. Even better, why not speak to Payactiv about ways to boost your employees’ ability to manage their finances, stretch every dollar, and ease financial stress between paydays?

Payactiv offers financial wellness products that empower more people to participate in the economy they helped create. Our Earned Wage Access services allow workers to bridge the gap between needing money and getting paid without incurring late and overdraft fees or taking out expensive payday loans. Now, those funds can go where they belong—in your workers’ pockets and back into our economy.

Are you ready to help your employees manage their daily finances, pay bills on time, save and budget, access free 1:1 financial coaching, and reach their financial goals? Let’s talk.

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