Cost of Living Adjustment Rider: What It Is and How Much It Costs

Disability insurance has a long list of policy decisions, including choosing optional riders to enhance your coverage. One popular add-on is the cost of living adjustment (COLA) rider, which adjusts your disability income to keep pace with inflation. But this policy feature can be expensive, so it’s often first on the chopping block. 

Keep reading to learn who needs to add a cost of living adjustment rider for adequate income protection.

What is a cost of living adjustment rider?

The cost of living adjustment rider is an optional disability policy provision that automatically increases the benefit amount to account for inflation. COLA increases are typically made annually based on a fixed percentage or in accordance with the Consumer Price Index for All Urban Consumers (CPI-U). 

Policyholders often misinterpret how the COLA rider works. Benefit adjustments kick in when you’re on a claim receiving monthly benefits — not while you’re healthy and working. 

Examples of COLA riders from the top insurance carriers

Cost of living adjustment riders vary by insurance carrier, as do the costs associated with each option. Here are the current COLA options from the top disability insurance companies responsible for underwriting own-occupation policies. These carriers are known as the “Big 5”.

Principal COLA riders

Principal disability insurance policies have two COLA rider options. The first option below is the most commonly selected.

• Option 1. Your benefit increase will be calculated on a compounded basis as determined by the change in the CPI-U each year up to a maximum of 3%.
• Option 2. The benefit increase is calculated on a compounded basis as determined by the change in the CPI-U each year up to a maximum of 6%.

Note if the change in the CPI-U index is zero or negative, your monthly benefit will remain the same.

Ameritas COLA riders

Ameritas offers two options for COLA riders. The first option below is selected almost exclusively by policyholders.

• Option 1. Your monthly base benefit will be increased by the lesser of 3% compounded annually or the change in the CPI-U on each anniversary of the date of disability.
• Option 2. The base policy benefit is increased by the lesser of 6% compounded annually or the change in CPI-U on each anniversary of the date of disability.

Note you have a qualified right to purchase the increased amount under this COLA rider upon recovery and return to your occupation.

Guardian COLA riders

Guardian provides three COLA options:

• Option 1. After being totally or partially disabled for 12 months, your monthly benefit will increase by 3% compounded annually.
• Option 2. After 12 months of disability, you’ll receive increases between 3% to 6% each year based on changes in the CPI-U. 
• Option 3. Benefit adjustments begin on the fourth anniversary of the date of disability. Your monthly benefit will increase each year by 3% compounded annually.

Note there’s no limit on the number of annual increases that can be made before the end of your policy.

MassMutual COLA rider

MassMutual only has one option for a cost of living adjustment rider.

• Option 1. After 12 months of disability, your benefit will be increased at an annually compounded rate of 3%.

Note that MassMutual’s COLA rider will also increase benefits for its social insurance rider, extended partial disability benefits rider, own-occupation rider and catastrophic disability benefit rider (if any are in force).

Standard COLA riders

Standard disability insurance comes with two COLA options. The first option below is most commonly selected.

• Option 1. Monthly benefits are increased each year by up to 3% of the previous year’s benefit amount, compounded. The actual percentage will be based on the average annual change in the CPI-U for that year.
• Option 2. Benefits are increased by up to 6% of the previous year’s benefit amount, compounded.

Note you have the option to purchase the benefit increases provided by this COLA rider during your disability.

How much does the COLA rider cost?

A COLA rider can boost your disability payout when it’s needed the most, especially if you’re disabled early in your career. But it can also significantly increase the cost of your disability policy.

The cost of the COLA rider will vary depending on the policyholder’s age. This is because the younger you are, the longer the time horizon on the policy. But it’s safe to assume the COLA rider will account for roughly 20% of the total cost of the policy.

Reasons you might exclude the COLA rider

If you’re young and in the early stages of your career, you should include a cost of living adjustment rider to round out your disability coverage. But there are a few scenarios where you might consider opting out of this add-on.

Scenario 1: The cost of disability insurance is an issue

Disability insurance can cost several hundred dollars a month, which can put a dent in your budget at any age. If cost is a problem, you can alter aspects of the policy’s structure to make it more affordable. This might include changing the benefit period or elimination period or removing policy riders altogether.

We don’t recommend removing true own-occupation coverage or residual benefits from your policy. But you might skip including the cost of living adjustment rider if you need to lower the price of the policy. Alternatively, you could drop catastrophic disability insurance benefits to help with cost.

Scenario 2: You’re in your late 40s, 50s or 60s

If you’re in your late 40s to early 50s (or older), you should have more assets to help deal with the impact of inflation. Plus, you can purchase a larger base benefit than, say, a resident or fellow. So, it probably makes more sense to use the cost savings of removing the COLA rider to buy additional coverage at your age.

Should you add a cost of living rider to your disability insurance policy?

Long-term disability insurance can protect your specialty income, allowing you to maintain your ideal lifestyle. But you need a strong definition of disability and policy riders that enhance your coverage.

A cost of living adjustment rider will provide relief from the impact of inflation and rising costs of living in your area. But you won’t benefit from the COLA rider until you're on a disability claim. And if you’re not on a claim for long, you won’t have as much to gain from paying the costs that come with including a COLA rider. 

That said, we’re all feeling the effects of inflation. It’s easier to see how being on a disability claim long-term (e.g., five to 10 years) could eat away at a policy’s base benefit, thereby, reducing your overall purchasing power.

It’s worth speaking with an independent insurance agent to discuss coverage options and costs in the context of your own financial needs and risk tolerance level.

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