What Is A Cost Of Living Allowance (COLA) / Goods And Services Differential (GSD) And How Is It Determined?
You have just accepted the role you have always dreamed about: a long term, international assignment in London! There are so many things to think about before leaving the US. Will you succeed in your new role? Will you fit in with your colleagues? Where will you live?
The one thing that you don’t want to have to worry about when taking an international assignment is whether or not you can afford it financially. You’ve always heard that London is a very expensive city, so how will you make ends meet on your current salary? Will your cost of living allowance cover your needs?
Financial considerations are top of mind for most potential international assignees–especially when the assignment is in an area known to be expensive or one where the home currency is weak against the host currency.
Most companies with international relocation programs that send employees abroad on assignments understand that even though the work and life experiences they are about to gain are priceless, the employees are unlikely to accept assignments that leave them worse off financially. These companies utilize a Cost of Living Allowance or a Goods and Services Differential to ensure their international assignees have the same amount of spendable income in their pockets.
First, let’s talk about spendable income. Spendable income is the amount of money or portion of the home salary the employee uses to maintain his standard of living. To determine what is spendable, one must consider the benefits the employer is providing or the fixed costs they are covering while the employee is on assignment. Typical international relocation benefits include housing, health care, allowances (transportation, utilities, etc.), hypothetical taxes, dependent’s education and more. The employer might provide these benefits in kind or they might be fixed costs in the home country. Subtract the monthly cost of all of these items from your monthly net salary (salary after taxes) and what is left is the Net Spendable Salary or Disposable Salary. The Net Spendable Salary is money that is utilized for items such as:
- Food / Groceries (at home or at a restaurant)
- Personal care
- Tobacco, alcohol
- Furnishings and household operation (including private residential telephone)
- Medical expenses not covered by insurance
- Automobile/vehicle maintenance, insurance and public transportation
- Domestic service
Cost of Living Index
After determining the Net Spendable Salary, the employer uses data from an independent data provider to determine the Cost of Living Index (COLI) for the home and host cities. The COLI measures the cost of hundreds of products and services (also called a ‘market basket’ of goods and services) in cities around the world. The market basket includes the goods and services mentioned in the Net Spendable Salary discussion above.
The Cost of Living Index utilizes a cost of index of 100 for your home city as a baseline. If the market basket of goods and services for the host city has an index greater than 100 that indicates the host city has a higher cost of living than the home location. If the market basket of goods and services for the host city has an index less than 100 that means the host city has a lower cost of living than the home location.
Here is a simple example:
Home City, USA
Home City, USA’s Cost of Living Index = 100
Host City – London, UK
London’s Cost of Living Index as it is compared to Home City, USA = 120 or + 20%
Therefore, London is 20% more expensive than Home City, USA
If an assignee’s annual net spendable salary is $75,000, the assignee would need 120 percent of that amount—an extra $15,000 per year—to maintain the same standard of living in London. Most employers spread the Cost of Living Allowance across the year’s pay periods. So for employers with a biweekly payroll, the employer would divide the $15,000 in this example by the year’s 26 pay periods.
In instances where the COLI is less than 100 and the host city is less expensive than the home city, most companies will allow their assignees to maintain the higher purchasing power and not require a reduction in salary.
Best practice for employers is to review the Cost of Living Index and current exchange rates annually and make any necessary adjustments. It is important that the assignee understand that the COLA is subject to review and will likely fluctuate while he is on assignment.
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Knowing international relocation trends and best practices will help you assess your global mobility policies in light of current realities.