When deploying personnel overseas, remuneration and relocation packages are critical when deploying personnel overseas on assignment. It will also be important not to overlook any adjustments to reflect the cost of living in the host country. This is because the overall remuneration offered needs to be suitably lucrative to incentivise staff to accept an international assignment in the first place.
In the guide, we look at what is known as the cost of living allowance (COLA), from what this means and when this should be provided, to how COLA rates should be determined for long-term assignments and how COLA compares to short-term allowances.
What is the cost of living allowance (COLA)?
When establishing a salary package for an employee who will be undertaking a long-term overseas assignment, employers will usually include a cost of living allowance, also commonly known as a COLA, as part of the assignment compensation package.
The COLA is designed to compensate the employee where the cost of goods and services are higher in the host location than in their home country. Most employers will adopt what is known as a home-based approach, by matching the employee’s home-country purchasing power while on assignment in the host location, so the employee is no better or worse off. This is achieved by undertaking a comparison of the cost of living in the home and host location, where the COLA should ideally represent the difference between the two.
Also described as a “goods and services differential”, by factoring in this differential, this will help to ensure that employees sent on international assignments will have broadly the same amount of income to spend, no matter what country or city they will be working in. A similar approach can also be adopted for employees being asked to relocate from one area of their home country to another, where the cost of living can again be significantly higher.
When to offer COLA
When being asked to undertake a long-term international assignment, together with all the upheaval and logistical issues that this will present for the employee, and potentially their family who may be accompanying them, the last thing that an employee will need to be worrying about is whether they will be able to make ends meet on their existing salary.
Financial considerations, and whether or not an employee can afford to live in an overseas location, will often be one of the primary factors affecting their decision-making when being asked to work overseas, especially when the assignment is in a location known to be costly when compared with prices back home or one where the home currency is weak against the host currency. As such, being offered financial reassurance that any increase in the cost of living will be met by the employer is therefore likely to result in a much higher assignee acceptance rate. By giving employees much needed peace of mind, they are also far more likely to succeed in their assignment overseas, in this way significantly reducing the risk and associated cost of early repatriation if the employee decides to return home.
Most companies with international relocation programmes that send employees abroad on assignments recognise that even though the employee will be gaining an invaluable experience that, of itself, is unlikely to represent sufficient incentive if they will struggle to manage financially. In many cases, in addition to COLA, employers may therefore also offer a relocation allowance as a means to financially compensate the employee, and any family members who will be accompanying them, for adapting to a different location.
How to set COLA rates
The COLA represents the difference in the cost of living between an employee’s home and host location when undertaking an international assignment. This is the adjustment that will need to be made to an employee’s salary package to ensure that they are no worse off financially when purchasing goods and services. As such, to calculate the applicable COLA, the employer will need to take the employee’s spendable income in their home country and deduct this from their host country spendable income. The spendable income is the amount of money or portion of an employee’s salary that they use to maintain their standard of living, for example, when paying for food and groceries, clothing, childcare and recreation.
However, to establish the host spendable income, the employee must also consider the cost of living index, known as COLI, for both the home and host cities. Below we look at how to work out the home spendable income, how to apply the COLI to this figure and use this to establish the host spendable income, together with the adjustment that needs to be made to an employee’s salary if they will be working overseas, ie; the cost of living allowance.
Determine the home spendable income
The home spendable income is based on different expenditure categories, including money utilised for buying everyday goods and services such as:
- Food and groceries, either at home or eating out
- Clothing and personal care
- Tobacco and alcohol
- Utilities, including any residential telephone line and broadband
- Household furnishings
- Medical expenses not covered by insurance
- Motor expenses, including fuel, insurance and vehicle maintenance
- Public transportation
- Domestic services, including childcare
- Recreational activities.
Employers can utilise spendable income tables derived from government statistics which report the amount of money, or portion of a person’s home salary, that an employee typically spends on goods and services in their home country to maintain their standard of living. However, any benefits provided by the employer, or fixed costs covered, while an employee is on an international assignment will need to be factored into this calculation to help determine what is spendable. These costs might include housing, healthcare, travel, utilities and tuition fees for dependents, where any expenditure items already funded by the employer will need to be excluded. Alternatively, some employers will instead utilise a fixed percentage, such as 60% of the employee’s net salary. Either way, the employer must decide the proportion of spendable income to which they will apply the COLA.
Determine the host spendable income
Once the net spendable income for the employee’s home country has been established, the employer will need to apply data from an independent data provider to determine the cost of living index (COLI) for both the home and host cities. The COLI is a theoretical price index that measures the relative cost of living over time or regions. This will then allow the employee to establish the spendable income needed for the host location in question.
The COLI measures the cost of hundreds of products and services in cities all around the world. Also described as a “market basket of goods and services”, this includes the cost of food, groceries, clothing, personal care, tobacco, alcohol, utilities, furnishings, medical expenses, motor expenses, public transport, domestic services and recreational activities.
When taking a baseline of 100 for the home city, where the market basket of goods and services for the host city has an index greater than 100, this will indicate a higher cost of living at the host location. For example, if the home city is London and the host location is New York, taking a central reference point of 100 for London and a COLI of 125 for New York, this means that the host location is 25% more expensive than the home location.
Determine the difference between the home and host spendable
The home spendable income that has been adjusted for cost of living is referred to as the host spendable income, where the host spendable income comprises two parts: the amount the employee would have spent on goods and services while living at home, plus a cost of living allowance (COLA), if applicable. This is therefore the host location currency equivalent of the home country spendable income amount, supplemented by the COLA.
Applying the London to New York example used above, where the host location is 25% more expensive than the home location, this means that if an employee’s net spendable salary is £50,000, the assignee would need to be paid 125% of that amount — so an extra £12,500 — to maintain the same standard of living in New York as they enjoyed in London.
Most employers will spread the COLA across the year, where the £12,500 would by divided by the year’s 12 pay periods for those paid monthly. To arrive at the total gross assignment package, the portion of home net salary not indexed is added back to the host spendable, plus any assignment-related allowances and benefits, then grossed up for host country tax.
What types of factors can affect COLA rates?
There are various factors that can affect the cost of living, and therefore the amount of salary adjustment needed for an employee to maintain the same standard of living, including currency fluctuations or price changes in the home and host countries.
The COLI and exchange rates are linked, where any variances to the exchange rate will also affect the index and, in turn, the COLA. For example, if the currency of the employee’s home location weakens against the host location currency, additional home currency will be needed to maintain the same standard of living and the COLA will need to be increased. When it comes to changes to the home and host country expenditure patterns, the effect on the cost of living allowance will depend on the overall difference in price changes. If inflation in the host location is higher than back home, the difference in cost of living between the two countries will rise and the COLA will again need to be increased.
As a matter of best practice, employers should therefore regularly review the COLI and applicable exchange rates, perhaps bi-annually, or at least on an annual basis, to see what differences arise from any previous calculation and to make any necessary adjustments.
It is also important for employees to be made aware that the COLA is subject to regular review and that this will likely fluctuate over the course of their long-term assignment.
In some instances, the cost of living in the host location may be less than the cost of living in the employee’s home city. In these circumstances, the COLA will be a negative rather than a positive number. In cases where the COLI is less than 100, and the host location is therefore less expensive than the home location, most employers will allow their employees to maintain the higher purchasing power and not require a reduction in salary, in this way increasing the employee’s standard of living in the host city. This scenario will also often be used by employers to help incentivise staff to accept an overseas assignment.
However, regardless of whether or not a salary adjustment is needed, employers should always be completely clear and transparent about their approach to any positive or negative COLA, and how this has been calculated, so as to avoid any unnecessary confusion or concerns. It should also be made clear to employees when any reviews will be undertaken.
How does COLA compare to short-term allowances?
In the same way that most employers should always consider providing a suitable cost of living allowance to any employee deployed overseas on a long-term assignment, consideration must also be given to any additional costs for short-term assignments. This is because an employee is unlikely to want to work overseas, even temporarily, if this will leave them worse off financially. While practice can vary on how to compensate employees for living costs incurred during a brief assignment, many short-term assignees will often retain their home compensation and benefits, and continue to be paid through home payroll, but receive a fixed cash allowance to cover daily expenditure in the host location.
The net effect for the employee when it comes to adjusting an employee’s salary to incorporate a cost of living allowance for a long-term assignment, when compared with any additional costs being covered by the employer for short-term assignments, is broadly the same. However, when it comes to short-term assignments, employees will need to feel reassured that their expenses will actually be covered in full, especially as those whose families remain at home will have household living costs to cover in two countries.
The cost of a daily cash allowance approach can often work out higher to the employer than when applying a COLA, comparably speaking, where cash allowances are designed to cover all expenses in full, rather than being a top-up to protect an employee’s purchasing power. However, uptake may be low for short-term assignments if an employee’s entire expenses are not met by the employer. Equally, uptake will be low for any long-term assignments where any COLA is not fairly calculated or regularly reviewed.
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For expert advice and guidance with remuneration and relocation packages for overseas assignees, including the use of cost of living allowances, contact us.
Cost of living allowance FAQs
What is the overseas COLA allowance?
The overseas cost of living allowance (COLA) represents the difference in the cost of living between an employee’s home and host location when undertaking an international assignment, in this way ensuring that they are are no worse off financially.
What is a cost of living allowance global mobility?
A cost of living allowance, also commonly known as COLA, is the difference paid to an employee by their employer where they will be working long-term in a location that is more expensive to live than their existing location.
Last updated: 6 February 2024
Author
Founder and Managing Director Anne Morris is a fully qualified solicitor and trusted adviser to large corporates through to SMEs, providing strategic immigration and global mobility advice to support employers with UK operations to meet their workforce needs through corporate immigration.
She is a recognised by Legal 500 and Chambers as a legal expert and delivers Board-level advice on business migration and compliance risk management as well as overseeing the firm’s development of new client propositions and delivery of cost and time efficient processing of applications.
Anne is an active public speaker, immigration commentator, and immigration policy contributor and regularly hosts training sessions for employers and HR professionals