What Is A Merit Pay Increase? (And Why It Matters)

By Matthew Zane
Aug. 4, 2022
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Rewarding employees for outstanding performance is a good strategy for retaining top talent and motivating others. One way that firms incentivize quality performance is by offering merit increases.

But companies can’t grant merit increases willy-nilly. Without a proper plan in place, employees can become frustrated with a system that doesn’t clearly define a path to a bigger paycheck.

We’ll go over precisely what constitutes a merit increase and how to position yourself to earn a sizeable pay bump.

Key Takeaways:

  • A merit increase is a pay raise based on objective measures of performances.

  • The standard merit increase is around 3%.

  • Merit increases can be awarded as an annual raise or in response to exceptional work.

  • Merit raises are usually handed out proportionally based on what the company’s budget is for raises.

  • Effective merit increases are transparent, standardized, and continuous.

What Is A Merit Pay Increase?

What Is a Merit Increase?

A merit increase is a pay raise that an employer gives to employees based on an objective measure of performance over a set period. Companies can award merit increases annually or as a direct response to phenomenal work.

A common way to dole out merit increases is by giving all employees an incremental raise based on performance, with top talent receiving the highest percentage raise. The idea is to reward the most productive, highest-performing workers and motivate others to improve.

How Does Merit Pay Work?

Merit pay is usually part of a more extensive budget process. Organizations will set aside a merit pool for the fiscal year that will support pay raises. A company may set aside enough to give every employee an average merit increase of 3% in a typical situation.

Then, managers can allocate the money in the pool to employees based on their performance, with top-performers earning more than a 3% raise and sub-par employees receiving less than a 3% raise or no raise at all.

Notably, the percentage raise an employee receives for a merit increase is not solely based on performance. One factor that comes into play is the employee’s current salary relative to the salary range an employer offers for a given position.

So an employee who earns compensation on the low end of that range and exceeds performance expectations can receive a more significant merit increase than an exceptional employee whose salary is already on the high end of that range.

If a company wants to reward an exceptional employee whose salary is already at the maximum for their position, they can award a bonus as a different form of merit pay. On the flip-side, an underperforming employee who is already “overpaid” may not receive any merit increase or bonus at all.

In other words, don’t be bummed if you don’t receive as significant a merit increase as you think is warranted – you might already be near the top salary someone in your position can earn, based on strict pay guidelines set out by HR.

Why Do Merit Increases Matter?

Merit increases matter because when they are done properly they end up benefiting both the employee and the employer.

Some advantages of merit increases include:

  • Encourage productivity. Most employees will work better if they know their efforts will be rewarded. Merit increases incentivize productive behavior and can give employees something to aim for as a goal.

  • Improve retention. Employees that feel valued for their efforts are more likely to stay around. This helps reduce the cost of hiring and onboarding new employees.

  • Creates accountability. Knowing that their work is being monitored for financial gains, employees will feel more responsible for their actions. In turn, the employer is also held accountable to reward good behavior.

  • Clarifies roles and responsibilities. Merit increases help clarify what needs to get done to achieve exceptional work. This allows employees to understand their role and how they can surpass expectations.

Keys to an Effective Merit Increase Policy

Merit increases are a superb way to reward the best employees and incentivize everyone to do their best work. However, they only work if a company sets clear metrics for evaluating performance.

Companies should start with their big-picture goals, then break those down into departmental objectives. Department heads can then communicate how they will measure performance and what employees can do to earn a merit increase. This process has three major requirements to be effective and successful:

  • Transparent. Employees need to know exactly what criteria a company uses to evaluate worker performance and determine merit increases. Without transparency, employees can become confused about how best to prioritize their tasks in order to earn a merit increase.

  • Standardized. Management needs to come up with a regimented system for merit increases. With the process standardized, employees will see a reliable and straightforward path toward earning a merit increase.

  • Continuous. An annual performance review is not frequent enough to allow employees to make adjustments. Employers need to offer ongoing feedback so employees can alter their priorities and align them with broader company goals.

What Is a Standard Merit Increase?

Viewed broadly, the average merit increase that firms offer is around 3%. The size of your merit increase may depend on which department you work in and how key that department is for achieving the company’s broader goals. An employee’s current salary relative to the salary range for that position is also a factor.

A worker whose wage is already maxed out may receive a bonus instead of a merit increase. You can ask a company you’re interviewing with or already work for how they handle merit increases.

The data reveals a sizeable difference in merit increases between below-average workers and top-performers. The Society for Human Resource Management (SHRM), using data from consultancy Willis Towers Watson and WorldAtWork’s salary budget survey, found that 90% of organizations use individual performance ratings to determine salary adjustments.

The study determined that companies rated an average of 11.7% of their employees the highest possible rating, 33.1% an above-average rating, 58.2% an average rating, and 5.2% a below-average rating.

Employees who received the highest possible rating received an average salary increase of 4.6%. Those with an above-average rating got a 3.6% bump, average rated employees received a 2.7% increase, and below-average employees received a 0.7% salary increase. In other words, top performers received an average raise of 70% larger than employees rated as average.

If your company offers smaller merit increases than those given above, don’t immediately panic and call shenanigans. Organizations have several ways to reward excellent performance, like providing extra perks, such as more paid vacation time or a company car.

And for employees who are salary-capped, a bonus can function as a once-off monetary reward that is as valuable as a merit increase.

Merit Increase vs. Pay Raise

Merit increases are a type of pay raise that employees only earn if they meet specific criteria. They rely on managers and team leaders to evaluate the performance of employees.

This evaluation clearly sets them apart from Cost of Living Adjustments (COLAs), which are not impacted by a worker’s performance at all but by the inflation rate. It also differentiates merit increases from arbitrary pay raises based on an employee’s duration at the company.

While companies have some flexibility in awarding merit increases, the metrics and requirements the company sets out determine the size of an employee’s raise. This system helps firms pay their workers a competitive wage based on their market value and internal value.

Ultimately, employers need to publicly state their goals and communicate the metrics by which they will measure each employee’s performance. Employees need to understand that significant merit increases will not be granted to average or below-average workers so that they are adequately motivated to work at their highest level.

So while companies typically grant annual pay raises and COLAs regardless of performance, merit increases are only awarded to employees who meet or exceed expectations in their position, which should ultimately promote the firm’s goals as a whole. Merit increases create a culture of healthy competition, increasing retention of top employees, and contributing to a more robust workforce.

How to Get a Merit Increase

Hard work pays off, so working to your fullest potential is the first step in earning a substantial merit increase. In conjunction with hard work, follow these steps to maximize your chances of a merit increase.

  • Study the rules. You can learn about your company’s policies for merit increases in your employee handbook or through a meeting with your manager or an HR rep. Understanding what expectations your company and department have set for your performance is a crucial step in setting yourself up for a merit increase.

  • Look back. When determining how best to prioritize your time and effort, it’s a good idea to review your past feedback. You can see what metrics you’re hitting and where you can improve, and how those metrics relate to company guidelines for merit increases. Then, you can align your goals with those set out in the guidelines.

  • Keep track of your excellence. While a company should have methods for measuring success, it can’t hurt to keep a personal account of your accomplishments.

    You are the best person to advocate for yourself, so keep track of your achievements and mention them often enough that your supervisors can’t fail to notice. That way, when it comes time to review your performance, your manager will already have your awesomeness fresh in her mind.

  • Watch competitors. One way to ensure that your company’s structure for merit increases is fair and competitive is to watch how their competitors do things.

    If you find that you are being offered lower raises (by percentage) than competitors, then you can use that information to advocate for structural changes (or just a bigger raise for yourself, if you’re a top-performer).

    If a bigger raise isn’t in the offing, you can also use this information to start applying to companies that offer more competitive benefits.

Merit Increase FAQ

  • What is a merit increase in salary? Merit pay, or a merit increase, is a pay raise based on a specifc set of guidelines provided by the employer. At a company with a pay-for-performance structure, an employee who exceeds goals set out by management will be eligible for a salary increse at set review times, usually quarterly.

  • Is a 5% merit increase good? The average pay raise is between 3-4%, so a 5% merit increase can certainly be considered good. Also note that while a 5% salary bump may not look like much on your paycheck, these small changes compound over time.

    For example, somoene with a starting salary of $50,000 who earns a 5% salary increase annually will end up with a salary of $63,814 after 5 years. That’s more than a 25% increase overall.

  • Is a merit increase a raise? Yes, a merit increase is a raise. It does not require you to perform additional tasks, so it isn’t a promotion. And it is a permanent increase in your salary, so it isn’t a bonus.

    Merit increases, like all raises, depend on your company’s budget. They also depend on your department’s most important metrics for success and your value in the marketplace and internally.

  • What’s a good merit increase? It depends on your definition of “good.” If good means above average, than anything above 3-4% can be considered a good merit increase.

    To take a more holistic approach, though, you should continuously check in on your market value. You don’t need to be a serial job-seeker or job-hopper, but keeping your finger on your industry’s pulse will help keep you informed as to what a “good” salary for your position is.

    At the end of the day, making sure that your overall compensation is fair is what matters most, not the percentage change from your previous salary.

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Matthew Zane

Matthew Zane is the lead editor of Zippia's How To Get A Job Guides. He is a teacher, writer, and world-traveler that wants to help people at every stage of the career life cycle. He completed his masters in American Literature from Trinity College Dublin and BA in English from the University of Connecticut.

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