Return of the COLA?

Annie Erling Gofus - Jan 04 2023
Published in: Mobility
| Updated Apr 27 2023
Cost of living allowances (COLA) can play a role in recruiting and retaining talent.

Inflation has been skyrocketing in the United States lately, reaching alarming rates. Consumers have been taken aback by the current inflation rate given its sharp contrast to the low levels experienced over the past decade. For many, financial restrictions have obligated them to reduce consumption in order to provide for the basic necessities of life.

The cost of living has been climbing to unprecedented heights in recent years, but fortunately, it appears that the rate of inflation is finally starting to decelerate. Thanks to decreasing gas prices, one of the most influential factors in rising inflation costs, the rate of inflation recently witnessed a considerable drop.

Despite all signs pointing to a drop in inflation, Americans continue to endure escalating fees for medical care, rent, and dining out. The cost of housing has been the primary cause for the monthly increase, overshadowing any reductions to energy-related indexes.

Many factors must be considered when including the cost of living allowances in a relocation package. These factors can include the distance of the move, the number of family members, and whether the transferee will need assistance selling their existing house.

The cost of living is a vital aspect to consider when moving to a new area. The term “cost of living” is used to describe the amount of money necessary to support a certain lifestyle. This includes basic expenses for items such as housing, transportation, food, clothing, and other household products.

Online cost-of-living calculators can help determine how much a salary will buy in another city. CNN's calculator shows that if a worker is currently earning $75,000 a year in Cleveland, Ohio, they will need to make more than $198,000 annually to maintain the same cost of living in Manhattan. But if someone is moving from Cleveland to Los Angeles, they would need to make $115,000 annually to cover the 178% increase in living expenses.

With inflation and the cost of living on the rise, many companies are asking themselves, “Do we need to bring back the COLA?”

What Is COLA?

Cost of living allowances or adjustments (COLA) are used when a company moves an employee to a location with a higher cost of living and provides financial assistance to make up the difference.

To ease the pain of increased daily expenses, some employers offer a cost-of-living stipend as part of their relocation packages. Cost-affecting factors such as housing, utility bills, and taxation are considered. Sometimes, a COLA is a one-time payment given to help ease the transition into a more expensive location. Other times, a COLA is paid out in regular installments to help cover increased costs.

To keep up with inflation, compensation-related contracts, real estate contracts, and government benefits used COLAs during the 1970s. The Social Security Administration (SSA) uses the U.S. Bureau of Labor Statistics' (BLS) Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) to compute COLAs. COLA is calculated by determining the percentage increase in CPI-W from one year to the next. The SSA website is frequently updated with this information.

If you're thinking about giving your employees a COLA, location cost differential (LCD), or anything similar, first consider the following factors.

How to Calculate Cost-of-Living Adjustments

In order to pay any allowance, there must first be a standard to compare against. To come up with the standard, you will look at how much housing, goods, and services cost, as well as individual or family size. While there are companies that are dedicated to running these calculation services for other businesses, some corporations may develop their own system internally over time.

The cost-of-living adjustments can be calculated in a few different ways.

Cost of Living Index

Employers can use a cost of living index to help set compensation for employees relocating to new locations. The cost of living index shares approximately how much it would cost the average person to afford basic needs like food, shelter, transportation, etc., in different regions.

While the U.S. government doesn't release an official cost of living index, a few organizations track the cost of living in various regions.

Social Security Administration's COLA

Each year, retirees receiving Social Security benefits see their payments increase thanks to COLAs. The change is dependent on the rate of inflation, which indicates how fast prices are rising in the economy.

For example, if a retiree receives $20,000 annually and the inflation rate is 3%, the value of their money gradually decreases as prices for goods start to increase. Though a 2% or 3% inflation rate may not appear to be drastic, over the course of five to 10 years, it can result in a significant reduction of income when accounting for inflation.

In order to keep up with the increased prices from inflation, COLAs are put into place so that benefits also increase annually. This is all based on the measurement from the Consumer Price Index (CPI).

Consumer Price Index

The CPI is a measure of rising prices in an economy and is simply the average price of a basket of common goods and services. CPI covers the prices of necessary living expenses such as housing, transportation, food and water, and education. While CPI isn't a perfect measure since it doesn't account for investments or more expensive items such as property, it does provide an idea of inflation rates for smaller, day-to-day purchases.

How COLA Is Paid

The final determination, if a payment is to be made, is how the payment will be paid. Will you provide a one-time allowance? Will you review the data every six months and offer stipends accordingly? If you choose to pay monthly, will you calculate the change once and then spread your payments out over the course of one year, two years, or more?

U.S. domestic COLAs are typically calculated only once, after which they are either paid as a lump sum or over a period of time. Depending on the size of the COLA, companies may want to keep the employee in the new location for a more extended period so they have time to adjust.

On the other hand, it is suggested that those receiving international COLAs recalculate their benefits more often because of varying currency rates, inflation rates, and other uncontrollable elements. Companies will often offer the COLA until the completion of a predetermined assignment. If an employee is assigned to work in another country indefinitely, their company may eventually want them to transition to living there permanently (localizing) and stop receiving the COLA after a set period of time.

How COLA Impacts Relocation Packages

Cost-of-living adjustments can be an important part of any global mobility program and can help ensure employees feel secure when relocating. With the rise of inflation and interest rates, employees will be carefully weighing their options when considering relocations.

It's impossible to know when inflation will stop as prices can decelerate at varying paces. After the initial increase in gas prices in early 2022, we are now seeing a gradual decrease. As gas prices continue to decrease, the cost of transportation for goods is also becoming cheaper - resulting in more competitive prices at your local store. Economic analysts anticipate inflation to persist for the majority of 2023 and prices to return back to pre-inflation rates by 2024.

A well-rounded relocation package is a key ingredient in recruiting and retaining high-quality candidates, as it allows your company to compete in the global job market. Easing the relocation process for both current and prospective employees can greatly improve the overall employee experience.

Establishing a COLA policy for your relocation packages can be a constantly evolving processing, considering the ever-changing economic climate. Because of this, it's important to review your policies regularly and make sure you're taking into account the ever-changing cost of living in different regions across the world.