Cost of living raise calculation: what a COLA really costs you

A cost of living raise calculation is simple. Multiply current pay by the inflation rate you choose, then add that amount to the pay rate. A $22 hourly worker with a 3 percent cost of living adjustment moves to $22.66. The harder part is the full employer cost once overtime and payroll taxes are added.

This guide is for owners setting next year’s pay budget. It covers the formula, which inflation number to pick, the loaded cost of a raise, and wage compression. It ends with a short note you can send your team. If your question is timing rather than math, read our guide on when to give a raise.

How the cost-of-living raise calculation works

The math takes two steps. First, multiply current pay by the percentage increase to get the dollar raise. Then add that salary increase to current pay to get the new salary or rate. The same formula works for an hourly rate or an annual salary.

Both examples use 3 percent. Use the same percentage for everyone if the goal is to maintain purchasing power across the team. A COLA is also separate from a merit raise, which rewards individual performance. I tell owners to show the two as separate lines in the raise letter, so a strong performer sees both.

A weekly raise is not an hourly raise

Check which one you mean before you promise either. A $2 raise per week adds 104ayearbeforetaxes(2 x 52). On an $880 weekly check, that is about 0.23 percent.

A $2 hourly raise is much larger. Over a 2,080-hour full-time year, it adds $4,160 to one worker’s current salary.

Which inflation number should you use?

Use CPI-U as your default, and consider CPI-W for hourly crews. Name the series in writing. As of the October 14, 2026 release, CPI-U rose 3.7 percent over the 12 months ending September 2026, and CPI-W rose 3.9 percent.

You can confirm both figures in the BLS consumer price index release. The SSA COLA is tied to the wage-earner index, but SSA sets it for benefits, so treat it as a reference point and nothing more. The Social Security COLA history shows 3.2 percent for 2024, 2.5 percent for 2025, 2.8 percent for 2026, and 3.6 percent for 2027.

How BLS suggests using CPI data for pay

BLS gives statistical guidance on using the consumer price index to adjust payments. It is not legal advice, but it keeps your method consistent from year to year.

• Name the exact series in writing, such as “CPI-U, not seasonally adjusted.”
• Use unadjusted data. BLS says unadjusted data are more appropriate for escalation purposes.
• Prefer national or regional indexes, since local indexes swing more.
• Consider an annual average. A December-to-December change is more volatile, while an average smooths out highs and lows.
• Don’t wait for revisions. CPI-U and CPI-W figures are final when BLS issues them.

Is a 3 percent raise actually a raise in 2026?

Not in real terms. With CPI-U at 3.7 percent, a 3 percent raise leaves pay roughly 0.7 percentage points behind prices. Against CPI-W at 3.9 percent, the difference is about 0.9 points. Employees still see more dollars, but their purchasing power slips.

That gap matters when you write the announcement. If your budget only allows 3 percent, say so plainly and don’t claim it keeps up with inflation. I’ve seen teams accept a smaller raise calmly when the owner showed the math, and push back when the letter oversold it.

What a cost-of-living raise costs the employer

Every added dollar of pay brings payroll taxes with it. Employer FICA adds 7.65 percent, so $1 of raise costs about $1.08 before state taxes and workers’ comp. For hourly staff, overtime hours carry the raise at 1.5 times, which pushes the total cost higher.

Overtime multiplies the raise

Generally, under federal law, non-exempt employees earn at least time and one-half their regular rate for hours over 40 in a workweek. Some states set stricter rules. So when the base rate goes up, the overtime rate goes up with it. At $22, overtime is $33 an hour, and at $22.66 it becomes $33.99. Review the overtime rules for small employers if your team often works past 40 hours.

Overtime also hides in the salary budget. In the accounts I’ve worked on, owners often budget the raise on 40 hours and forget the extra hours their crew logs in busy months. Pull actual hours from your time records before you set the number.

Taxes that rise with the raise, and taxes that don’t

Not every employer tax grows when pay grows. Our guide to federal and state payroll taxes covers each one in detail.

• Employer FICA: 6.2 percent Social Security plus 1.45 percent Medicare, or 7.65 percent. A full-time worker at $22 earns well under the 2026 Social Security wage base of $184,500, so the full rate applies to the raise.
• FUTA: 6.0 percent on the first $7,000 per employee, or 0.6 percent after the up to 5.4 percent credit. Once an employee passes $7,000 for the year, extra pay adds no FUTA.
• SUTA: each state sets its own rate and wage base. Employees at this pay level are often past the state base already, but check your state unemployment tax rates to be sure.
• Workers’ comp: the premium generally equals payroll divided by 100, times your class code rate, times your experience modifier. Higher pay grows insured payroll, so the premium grows too. Here is how workers’ comp premiums are calculated.

Illustrative budget model: 10 employees at $22 an hour

This illustrative model uses ten hourly employees at $22 an hour who average 45 hours a week. A 3 percent COLA lifts each weekly check from $1,045.00 to $1,076.35. Over a year, the raise costs about $17,549 once employer FICA is added.

This team’s current annual payroll is $543,400, so the loaded raise adds about 3.23 percent of current payroll, not 3 percent. Before you lock in the number, run these checks:

• Calculate a monthly figure. Here, that is about $1,462 a month of added cost.
• Add your own workers’ comp estimate. It sits outside the model because rates vary by class code and state.
• If overtime drives most of the extra cost, look at ways to manage overtime costs before you trim the raise.
• Fold the final figure into your plan using our small business payroll guide.

How to avoid wage compression when the minimum wage rises

Wage compression happens when entry pay creeps up to the pay of more experienced staff. California’s minimum rose from $16.50 to $16.90 on January 1, 2026, a 40-cent jump of about 2.4 percent. Avoid it by restoring the old pay gap for staff near the new minimum.

Take an illustrative California example. A shift lead paid $17.00 sat 50 cents above the old floor, but after January 1 that gap shrank to 10 cents. A raise to $17.40, about 2.35 percent, restores the 50-cent gap.

1. List every employee paid within $1 of the new minimum wage.
2. Write down the dollar gap each person had before the increase.
3. Decide whether you will restore the dollar gap or the percentage gap.
4. Run the new rates through the loaded cost math above, then budget them with your COLA.

How to announce a COLA to your team

Keep the note short and specific. Name the percentage, the inflation data behind it, the new rate, and the first paycheck that shows it. Send the note before that paycheck goes out so the new number is no surprise.

It also helps to point people to a quick explainer on reading a pay stub. That way they know how to read the new rate on their stub.

Short COLA announcement template

Use a plain subject line, such as “Your cost-of-living raise for [year].” Then fill in the brackets below.

Hi [Name],

Starting with the paycheck dated [date], your pay rate goes from [22.00]to[22.66] an hour. This is a [3] percent cost-of-living adjustment. We based it on [CPI-U, which rose 3.7 percent in the 12 months to September 2026]. Your overtime rate also rises from [33.00]to[33.99]. This raise is separate from your performance review.

Questions? Reply to this note or stop by anytime.

[Your name]

How FRIDAY fits into a COLA rollout

FRIDAY handles the payroll side once you have picked the numbers. It runs payroll with automated tax filing and direct deposit, and it tracks employee time. That time record gives you actual hours to check against your overtime budget before the next raise cycle.

Employees also get a self-service portal. Payroll on the Startup plan runs $59 a month plus $12 per user. You can test it with a 14-day free trial, with no setup or cancellation fees.

FAQs

What does a 3% COLA cost including payroll taxes?

Plan on about $1.08 for every $1 of raise once employer FICA of 7.65 percent is added. In an illustrative team of ten $22-an-hour workers averaging 45 hours, a 3 percent COLA costs about $17,549 a year. State unemployment tax and workers’ comp can add more on top.

Which inflation number should I use for a COLA?

CPI-U is a sound default because it covers over 90 percent of the population. CPI-W can fit hourly crews, and the SSA COLA works only as a reference point. Whatever you pick, name the series and the time period in writing.

How do I avoid wage compression?

Check every employee paid close to the new minimum wage before the increase takes effect. Then raise their rates enough to restore the dollar or percentage gap they had. Budget those raises with your COLA so both land on the same paycheck.

How much is a $2 raise per week?

A $2 weekly raise adds $104 a year before taxes. On an $880 weekly check, that works out to about 0.23 percent. A $2 hourly raise is far bigger, adding $4,160 over a 2,080-hour year.

Do employers have to give cost-of-living raises?

Generally, no federal law requires a cost-of-living raise. Check your state rules and any contract or union agreement, since those can set raise terms. Without such an agreement or rule, a COLA is generally a budget choice you make each year.

Disclaimer: This article is for general informational purposes only and does not constitute legal, tax, or financial advice. Consult a licensed professional for guidance specific to your situation.

Pincus Schiff

Pincus Schiff is a payroll software specialist at Friday App, where he helps businesses simplify payroll, stay compliant, and automate their workflows. He writes about payroll best practices, compliance, and the latest in workforce technology.