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Updated Feb 16, 2024

What Is a Merit Pay Increase?

Learn the best way to implement a clear and consistent merit pay policy.

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Written By: Nicole FallonBusiness Ownership Insider and Senior Analyst
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This guide was reviewed by a Business News Daily editor to ensure it provides comprehensive and accurate information to aid your buying decision.

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It’s long been the case that when employees are promoted, they get pay raises. But there’s another reason you might increase an employee’s salary: They’re performing outstandingly in their current role. This is known as a merit pay increase.

HR executives should create a clear company policy governing performance-based pay increases, or else the good intention of rewarding your best employees could backfire. Below, you’ll learn exactly what a merit pay increase is, how it’s beneficial to your employees and your business, and how to create policies that result in effective merit pay increases.

Editor’s note: Looking for the right payroll service for your business? Fill out the below questionnaire to have our vendor partners contact you about your needs.

What is a merit pay increase?

A merit pay increase is when an employer increases an employee’s pay rate based on performance-related criteria that they previously agreed upon. The increase is typically calculated as a percentage of the worker’s current salary. For example, a worker who makes $57,000 may be eligible for a merit increase of 3 percent, or $1,710. 

This type of raise is used as a reward for exceptional performance and to help incentivize productivity in employees. It is a raise awarded on merit, as opposed to other factors, like a role change or cost-of-living adjustment.

“Employees expect merit increases or other types of compensation appreciation to be given for great work performance,” said Rick Hammell, executive chairman of the board at global employer-of-record provider Atlas. 

How do merit pay increases differ from pay raises?

Employees receive merit pay when they reach a set of goals agreed upon with the company. In contrast, pay raises may occur as part of a job promotion or as a percentage-based salary increase for an annual cost-of-living adjustment

An employee doesn’t necessarily need to exceed performance goals to get a general pay raise, but they must do so to warrant a merit pay increase.

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HR leaders and team managers should clearly outline the criteria for how employees can achieve a merit increase. When executives and supervisors set and measure goals for the business at large and for individual workers, staffers understand what they’re working toward.

Benefits of a merit pay policy and awarding merit pay increases

Why should employers bother with special pay raises? “A merit increase provides a sense of joy and excitement with longer career guidance and loyalty,” Hammell said. “This increases the [employee’s] desire to stay and continue contributing to the overall success of the business.”

Here are just a handful of the many reasons you might want to implement a merit pay policy and award pay increases to your qualifying team members:

  • A merit pay policy clearly outlines company goals and sparks motivation. By setting clear and measurable goals through a merit pay policy, an employee knows exactly what’s expected of them and how their work contributes to the company’s overall production and success. Knowing there’s a pay increase waiting for them if they can exceed specific goals can be a powerful motivator.
  • A merit pay policy prompts evaluations of employee performance and identifies the strongest and weakest performers. The merit pay process allows your business to recognize high-performing employees and identify low-performing ones. Managers can evaluate individual members of their workforce based on a set of specific goals relevant to that staff member. Those who exceed their responsibilities can receive merit pay increases and possibly future promotions, while managers can give underperforming employees steps to meet expectations.
  • A merit award builds employee loyalty. When your team knows they can increase their pay by doing better work, they might be more inclined to devote themselves to the company. They might also feel compelled to consistently deliver higher-quality work. An employee who earns a merit pay increase will feel recognized for their effort and will want to keep giving back to the company to obtain future increases.
  • A merit pay award boosts company morale. The more motivated your employees are, the more excited and engaged they’ll be at work, and higher engagement leads to higher-quality output. A merit pay increase drives performance and engagement, making it a surefire way to boost company morale and reap the resulting advantages.
  • A merit pay award helps retain top talent. Employees who are paid less than they deserve are more likely to leave. Merit pay increases are an obvious solution to this problem.

How much is a typical merit pay increase?

The average merit pay increase in 2023 was 3.8 percent of the employee’s salary, according to data from Mercer. The exact amount of a merit pay increase depends on your company’s budget, industry and criteria. Whenever the increase is awarded, your payroll service can adjust the employee’s pay amounts and tax withholdings accordingly. [Read related article: How to Choose a Payroll Software Provider]

Best practices for implementing merit increases

Keep these best practices in mind when you’re implementing merit pay increases at your business.

1. Develop a clear policy.

Awarding merit increases is a great way to incentivize employees. However, your policy must be reliable and consistent, as it will serve as a guideline for how workers can earn this additional pay. 

The policy should clearly state the metrics for achieving merit pay, the projected increased amount or range, and the timeline for receiving the pay increase once the employee reaches the agreed-upon goals. If the policy is unclear, workers may find it challenging to meet the criteria, or they may question why an increase wasn’t awarded. 

Managers should clearly explain the merit pay increase policy to employees during the onboarding process, amid midyear and annual performance evaluations, and any time the policy changes. 

“I would advise business leaders to present … opportunities to receive additional payment,” Hammell said. “By effectively communicating these opportunities of growth in an employee’s current position or in other positions within the company, business leaders can reemphasize their loyalty and investment to their employees.”

2. Train your leaders. 

Merit pay programs don’t just measure the quality of an employee’s output; they also gauge the effectiveness of your organization’s managers. A successful management team must be able to support its workforce and the objectives laid out for each employee. Supervisors should be trained not only on the merit pay policy itself but also on how they can help their direct reports meet the requirements.

A merit pay program can show managers’ effectiveness in providing help and resources to their team members. A staffer who fails to qualify for merit pay may lack adequate tools and support from their supervisor. When managers hold themselves accountable for their employees’ merit pay eligibility, there’s a greater overall sense of teamwork. 

3. Listen to employee feedback.

Incentive programs such as merit pay allow managers to receive constructive feedback from their employees. Based on that feedback, leaders who maintain and enforce the merit pay policy can reevaluate the outlined goals and incentives to see if the metrics are too challenging, too easy or at the right level. 

Employees should also provide feedback on the incentives. Some may prefer a merit pay increase, while others may favor certain benefits or prizes. By listening to and receiving employee feedback, managers can create a fair merit pay increase policy with metrics and incentives that are motivating for every team member.

4. Communicate changes regularly.

Once a merit pay increase program is established, managers should evaluate the process frequently to see how it’s working. If they realize something’s wrong — for example, if many employees aren’t reaching their merit pay goals — they should examine where adjustments are needed. 

Any time managers make a policy change, they must inform employees of the modifications and how these changes might affect their daily work. 

If your merit pay policy changes, managers should discuss these adjustments in person or via a video conferencing service. There should also be written documentation.

FAQs about merit pay increases

Find answers to some of the most common questions about merit pay increases below.
Management of merit increases can fall to a variety of company departments and leaders. Typically, multiple members from different departments are involved in creating and implementing the policy. Senior management and HR leaders often collaborate to discuss the policy, its incentives, metrics for success, and implementation of the program. They should then collaborate with the accounting and payroll department to determine what incentives are financially possible and how to distribute them. In addition, supervisors in all departments need to know how to evaluate employees for merit increase eligibility.
You can track and manage pay increases with human resources, accounting and payroll software. When an employee reaches the established goals and earns a merit pay increase, their manager will usually report the increase to the HR and accounting teams, who will make the necessary back-end changes to implement the monetary increase. If the business owner is in charge of HR and finances, they can use one of the best payroll software providers to make and monitor salary changes. If your company uses payroll software with self-service HR features, such as Rippling (read our Rippling review) or ADP (see our ADP review), workers can log in to view and confirm their new salary through their employee portal.
A merit increase is not usually the same for all employees. Merit pay increases differ depending on the organization’s industry and the employee’s role, along with other factors. This is why it’s important for your company to clearly define its merit pay policy. While not all pay increases are the same, they should all follow the same standard policy for qualification. Managers must be transparent about who is eligible for a merit pay increase and how employees in different roles can earn one.
A bonus is a one-time extra payment an employee might get for achieving a certain goal or as an end-of-year "thank you" during the holiday season. It’s entirely separate from the employee’s regular pay and doesn’t affect how much money they receive per paycheck each pay period. It is additional compensation awarded on a single occasion. A merit pay increase, on the other hand, is a permanent bump in an employee’s salary, so all of their paychecks after the increase will be larger. However, both types of compensation are generally rewards for high performance.
No, merit pay increases do not start automatically. Instead, a finance manager or HR staff member must, in accordance with your merit pay increase policy, adjust the employee’s salary in your payroll processing system. Thereafter, each of the employee’s payments will reflect their increased salary. The payments will still be distributed automatically, but the salary increase must be implemented manually.

Some employees’ work merits more pay

Your best-performing employees may deserve more money than they’re earning, and bumping their salary shouldn’t be an arbitrary process. Instead, write up a merit pay increase policy — but keep it open to change — to ensure consistency across performance-based raises. You’ll give employees the salary their work calls for, all while keeping things fair to both your team and your organization. When you do merit pay increases the right way, everyone wins.

Max Freedman contributed to this article. The source interview was conducted for a previous version of this article.

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Written By: Nicole FallonBusiness Ownership Insider and Senior Analyst
Nicole Fallon is a small business owner with nearly a decade of experience overseeing day-to-day business operations. She and her co-founder self-funded their company and now lead a team of employees across multiple disciplines. Fallon's first-hand experience as an entrepreneur running a staffed business has given her unique insight into startup culture, budgeting, employer-employee relationships, sales and marketing, and project management. Fallon's business expertise is evident in her work with the U.S. Chamber of Commerce, where she analyzes small business trends. Her writing has been published in Forbes, Entrepreneur, and Newsweek, and she enjoys collaborating with B2B and SaaS companies.
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