Employees love raises. Regular raises can improve employee happiness and put them in a better financial position. And, raises can reduce your employee turnover.

You can give raises for merit or increasing job value. You might also give a cost of living raise.

Employee raise expectations and employer plans are out of sync.

Our free downloadable guide covers average pay raises, the cost-of-living adjustment, year-over-year inflation, and the disconnect between employer plans and employee raise expectations.

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What is a cost of living increase?

Inflation causes cost of living expenses to increase regularly. As the price of everyday items such as food, housing, gas, clothing, and utilities rises, your employees spend more. To remain in a consistent financial situation, employee wages must go up as living expenses go up.

A cost of living raise makes up for inflation. When the cost of living goes up by a certain percentage, you increase employee wages by the same percentage. For example, if the cost of living increases by 2% this year, you will increase employee wages by 2%.

With most raises, each employee gains a different amount, and some employees might not receive a raise at all. A cost of living adjustment is different. All employees receive an annual cost of living raise at the same time. Also, all employees receive the same percentage increase.

A 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 basic items increases, employees need more money to pay for things.

Regular raises also encourage employees to stay at your business. When the wages you pay keep up with living expenses, employees aren’t forced to look elsewhere for higher paying work. You might attract new employees by showcasing your COLA raises as an added job benefit.

Some employers are required to give cost of living raises. Government employees typically must receive cost of living adjustments. If your employees are part of a labor union, the union might negotiate a cost of living increase for the employees.

Private employers do not have to give cost of living raises. It is optional.

Cost of living raises shouldn’t be the only pay adjustments you give to employees. You might need to give other raises to keep up with competitors, industry standards, employee achievements, and increased experience.

How to determine cost of living increase

A cost of living salary increase is not arbitrary. The raise is based on standardized inflation numbers. You will likely use national or regional data to determine the increase.

Employers often base the COLA on the Consumer Price Index. The index measures the price change of certain items over time. The Consumer Price Index shows national trends, and there are also reports for several geographic areas.

You do not have to use the Consumer Price Index if you’re a private employer. You can use another cost-of-living index.

The Social Security Administration releases an annual cost of living adjustment to determine Social Security benefits. You might also base your COLA on this percentage.

There isn’t a typical cost of living increase. The raise percentage will vary by year because it is based on inflation.

If you plan to give regular cost of living adjustments, you might include your policy in your employee handbook. You might say how often you will give raises and how you determine the amount to give.

Cost of living adjustments normally only go one way—up. If the cost of living goes up, employee wages go up. But, if the cost of living goes down, employee wages don’t go down. Instead, you probably won’t give a cost of living raise that year.

Cost of living raise example

Let’s say the cost of living rose by 6% over the past year. You give annual salary cost of living adjustments, so you raise each employee’s wages by 6%.

So, if you have an employee who earns $45,000 per year, you would add 6% to their wages.

$45,000 x 0.06 = $2,700

$45,000 + $2,700 = $47,700

Due to the cost of living increase of 6%, this employee will now earn $47,700

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This article has been updated from its original publication date of July 31, 2017.