Cost-of-living adjustment (COLA)
A cost-of-living adjustment (COLA) is a pay increase given to a group of employees to offset inflation, rather than for individual performance.
A COLA usually raises every covered rate by the same percentage or amount, while a merit increaseMerit increase. A merit increase is a lasting raise to an employee’s base pay, sized by individual performance and usually set during a review cycle.Click to open the term varies with each employee’s results. A COLA can be a fixed raise or follow a formula tied to the Consumer Price Index (CPI). The Bureau of Labor Statistics (BLS) names private sector collective bargaining agreements among the most frequent users of CPI escalation. Because a COLA changes the base rate itself, overtime payOvertime pay. Overtime pay is 1.5 times the regular rate, owed under the FLSA for each hour a non-exempt employee works over 40 in a workweek.Click to open the term for non-exempt employees rises with it from the date the increase applies.
How is a CPI-based COLA calculated?
A CPI-based COLA usually changes the base wage rate by the percent change in the CPI between a reference period and a later period. The agreement fixes the inputs: the index series (CPI-W, used mainly for blue-collar COLAs, or CPI-U, which covers over 90 percent of the U.S. population), the reference period, and how often the rate adjusts, most often annually. BLS calls seasonally adjusted data inappropriate for escalation. An agreement may add a cap on the increase or a floor that promises a minimum.
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Find the point change. Subtract the reference-period CPI from the later-period CPI in the series the agreement names (BLS’s example: 232.945 minus 229.815 is 3.130).
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Convert it to a percent. Divide the point change by the reference-period CPI and multiply by 100 (3.130 divided by 229.815, times 100, is 1.4%).
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Apply any limits. Hold the result to the cap or floor the agreement sets, if it sets one.
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Raise the base rate on the agreement’s date. Apply the percent to the base wage rate. A retroactive COLA also raises the regular rate for each past workweek it covers, so you owe a non-exempt employee 1.5 times the hourly increase for each overtime hour worked then.
General information, not legal or tax advice. Apply current federal and state rules with qualified guidance.