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Why merit increases pay dividends for keeping top-performing employees

January 12, 2022 - 13 min read

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What is a merit increase?

4 reasons why merit increases are important

Is a merit increase the same as a promotion?

Merit increase vs. pay raise

Who should get a merit increase?

What is the average merit increase?

3 steps to calculate merit increase

For many employees, there’s no better feeling than getting recognized.

In the past, rewards for high-performing employees appeared in the form of words of praise or recognition. In recent times, however, the hard work of high performers now warrants a boost in compensation by way of a merit increase. 

In the US, merit increases are common practices across workplaces. In 2020, an average budget of three percent of base salary was earmarked for merit raises. This number can go as high as five, or even 10 percent, depending on the organization.

This guide will examine the concept of merit increase and the importance of this practice. Because merit increases differ from other forms of pay or pay increases, it's important to understand the differences. We'll look at eligibility and employees who are most likely to qualify for merit increases. 

What is a merit increase?

Let's say your employee has exceeded your expectations. The annual performance review revealed their contributions mapped directly to company goals. This may be appreciated with a percentage increase in base salary.

How much a merit increase will depend on the portion of the overall salary being considered. This amount is typically around an average of 3%. However, different employees may receive different percentage increases. This all depends on their contributions to company success.

A merit increase encourages hard work through rewards and recognition. It also improves employee morale and stimulates excellent job performance

4 reasons why merit increases are important

It's beneficial for companies to adopt a system that connects hard work with financial rewards. Not only will it benefit the employee, but the organization, too. 

The advantages of merit increases include:

Track progress

When monetary rewards other than salary attach to a worker’s effort, the company keeps an extra eye out for individual performance.

This may be seen where the organization sets out particular goals for the month, quarter, or year. The employees that can meet these goals are rewarded by employers.

Clarify company objectives

By attaching incentives to certain goals, the company communicates its priority objectives. There is no ambiguity about what employees are to focus on, and how their contributions will impact the company and personal earnings. 

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Encourage productivity in the workplace 

When workers are aware that their direct efforts may result in a pay raise, there is a higher chance their efforts will map to company objectives.

In the past, employees may put in an average performance throughout the month without incentive. But the possibility of a merit increase can stimulate additional effort geared towards company goals.

Improve retention

In a setting where employees are rewarded beyond a salary for their efforts, there is likely to be a reduced incidence of worker turnover

Employees will remain in a workplace where they feel valued. The knowledge that direct effort will result in additional benefits, is sure to encourage worker retention. Beyond that, companies increase their accessibility to top talents.

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Is a merit increase the same as a promotion? 

In short, no. A merit increase is a reward for good performance but it doesn’t mean the employee is getting a promotion. With a merit increase, the employee grows their compensation but remains in the same job.

Think of a merit increase as a form of recognition and appreciation. A promotion comes with career advancement. Oftentimes, this means increased job responsibilities, more contributions, and a new title.

Merit increase vs. pay raise

At its core, a merit increase is simply a bump in the earnings of a worker. But, this description, while accurate—fails to take into account the true characteristics of the increase.

Merit pay is directly tied to the performance of a worker about company goals and objectives. It is a reward to the employee for putting in additional effort.

In comparison, a pay raise is an increase in base salary. This raise is usually in recognition of the time spent working at the organization, or other factors such as cost of living adjustments.

Top performers are usual suspects where a merit increase is concerned. By contrast, a pay raise may not be dependent on accomplishments.

Who should get a merit increase?

Merit increases — though separate from a promotion — are used to reward successful performance. Many organizations and human resources (HR) professionals look at employees who are excelling in their roles.

As mentioned, employees who receive merit increases don’t receive an increase in responsibilities. This is why it’s important to use merit increases as a reward for your employees in addition to recognition and appreciation.

Here are some factors to keep in mind when determining who should get a merit increase: 

  • The employee is in good standing and performing well (as noted in the performance review) 
  • Pay increase funds are available 
  • Leadership has recommended merit increases for employees under consideration 
  • The employee under consideration for a merit increase is within the salary pay range for their position 

What is the average merit increase?

The average merit increase is around 3%.

But as we look ahead to 2022, that number will likely change. The Great Resignation (or Great Reshuffle) has brought on a war for talent. With a record number of employees leaving their jobs, organizations are doing everything to retain their talent.

Experts estimate merit increases reach as high as 5%. In fact, Grant Thornton found that more than half of HR leaders in the US expect their organizations to raise the average merit increase to more than 5%. More companies are also increasing things like eligibility for employees to receive a cash bonus. 

Merit increases vary depending on job function and department. Some organizations examine how certain departments are contributing to the company’s goals. Current salary (especially relative to the salary or compensation range) is also a factor to consider.  

Merit increase and cost of living adjustments

As time goes on, it tends to be accompanied by a persistent change in prices known as inflation. Inflation causes an increase in the cost of goods and services, a difference that can affect the purchasing power of workers. 

To remedy this increase in prices, cost of living adjustments (or colas) are made. These adjustments refer to a salary boost to support higher prices in the economy. Colas may also be provided to retain employees that may move to a city with higher costs of living. 

3 steps to calculate a merit increase

Introducing merit raises into an organization is a sure way to retain workers and reward performance. To properly model this system for a company, the following steps may be observed:

Examine how the role impacts the business 

While different parts make for the success of a business, a company should consider the impact of merit increases. Organizations implementing merit increases should ensure that the merit increases impact company objectives. 

This may include roles that are hard to replace within the company. Likewise, positions whose setbacks can seriously affect company performance should be carefully compensated.

Rewarding excellence with merit bonuses in these roles may help to reduce the risk of turnover and errors in the business. Ultimately, this can improve company efficiency and earnings.

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Impartially grade performance 

Beyond performance reviews, examine an employee's efforts in the workplace holistically.

Organizations should look at some of these key factors when determining merit increases: 

  • Observations by superiors 
  • Standing with colleagues
  • Attention to detail

Critically observe whether merit increases with improve efforts 

Merit raises can encourage retention and boost the morale of high-performing employees. However, this system alone may not be enough to keep employees satisfied at the workplace if other factors are lacking. 

Before implementing added compensation, the company should examine how the employee experience. Some enhancements include additional paid time off, increased benefits offerings, or more flexibility. 

Where it is established that a merit increase will improve operations, the company may choose to pay every employee the same merit bonus of say 3%. Alternately, higher-performing workers may be rewarded with a 5% bonus, with others making 2%.

In other scenarios, only the high-performing roles most critical to company business will receive a 5% raise. Everyone else will be entitled to a 2% increase in salary. Where possible, every employee in a critical role in the company will receive a 5% bump regardless of contribution to company goals.

Last word on merit increases

Choosing the merit pool as a source for rewarding employees is a positive move for any organization. 

With available resources, companies can boost employees' morale and productivity. Ultimately, organizations will see growth in revenue granted by this system.

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Published January 12, 2022

Madeline Miles

Madeline is a writer, communicator, and storyteller who is passionate about using words to help drive positive change. She holds a bachelor's in English Creative Writing and Communication Studies and lives in Denver, Colorado. In her spare time, she's usually somewhere outside (preferably in the mountains) — and enjoys poetry and fiction.

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