- Merit pay is a pay-rate boost used as a reward to help incentivize productivity and high performance in employees.
- 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.
- Developing a reliable and consistent merit pay increase policy is key, as it sets firm guidelines for awarding additional pay.
- This article is for business owners who want to explore performance-based pay increases, implement a merit pay increase policy, and boost employee productivity and morale.
Organizations that award merit pay increases to employees can build loyalty, boost company morale and retain their top talent.
"Employees expect merit increases or other types of compensation appreciation to be given for great work performance," said Rick Hammell, CEO and founder of Elements Global Services. "A merit increase provides a sense of joy and excitement with longer career guidance and loyalty. This increases the desire to stay and continue contributing to the overall success of the business."
According to a U.S. compensation planning survey by Mercer, 90% of today's organizations use individual performance as a metric for adjusting employees' base salaries. However, HR executives should create a clear company plan for performance-based pay increases, or the good intention of rewarding your best employees can backfire.
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Here is a comprehensive guide to merit pay increases, and how to create a merit pay increase policy for your employees.
What is a merit pay increase?
A merit pay increase is when an employer increases an employee's pay rate based on the criteria they previously agreed upon. The increase is typically calculated as a percentage of the employee's current salary.
This type of raise is used as a reward to help incentivize productivity and high performance in employees, while motivating their peers to do the same.
"Throughout my career, I have always encouraged people to look beyond the role and envision what needs to get done, always being two or three steps ahead," Hammell said. "Those that [align] with this philosophy can move up the corporate ladder quickly. This then encourages others to walk the same avenue."
Merit pay increases are different from a pay raise. Employees receive merit pay when they reach a set of goals agreed upon between them and the company. Pay raises may occur as part of a job promotion or as a percentage-based salary increase for an annual cost-of-living adjustment (COLA).
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.
Benefits of awarding merit pay increases
There are various reasons for awarding merit pay increases. First, it's a way to clearly outline and state your company's goals for the staff. By setting clear and measurable goals, a worker knows exactly what's expected of them, and how their work contributes to your company's overall production. Knowing there's a pay increase if they can exceed specific goals can be a powerful motivation to perform well.
Another benefit of merit pay increases is that they allow your business to recognize high-performing employees – and, just as importantly, identify low-performing employees. Managers can evaluate their workforce person-by-person based on a set of goals, not by the team as a whole, to discover the best employees.
Those who exceed their responsibilities can receive merit pay increases and possibly future promotions, while managers can give employees who aren't pulling their weight some steps to address those discrepancies.
How much is a typical merit pay increase?
During the coronavirus pandemic, many employers temporarily decreased or paused their merit pay increases because of budget constraints. However, for 2022, most organizations plan to bring merit raises for executives, management, professional employees and support staff back to their pre-pandemic 3% average, according to a survey by benefits consulting firm Willis Towers Watson.
The exact amount of a merit pay increase depends on what your company can afford, its industry and the specific determined criteria for earning a pay increase. [Read related article: How to Choose a Payroll Software Provider]
Best practices for implementing merit increases
These are a few critical factors to keep in mind when implementing merit pay increases:
1. Develop a clear policy.
Merit pay 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 are awarded their additional pay.
This policy should clearly state the metrics for receiving merit pay, the projected increased amount or range, and when the employee will receive their pay increase once they achieve their goals. If the policy is unclear, employees may find it challenging to meet the criteria for a pay increase.
Managers should clearly explain the merit pay increase policy to employees during the onboarding process, amid annual performance evaluations and anytime the policy changes.
"I would advise business leaders to present ... opportunities to receive additional payment," Hammell added. "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. Listen to employee feedback.
Incentive programs – such as merit pay – allow managers to receive constructive feedback from their employees. Those who create the merit pay policy can reevaluate the outlined goals and incentives to see if the metrics are too challenging to achieve, too easy or at the right level.
Employees should also give their opinions on the incentives to coordinators. Some may prefer a merit pay increase, while others may opt for certain benefits or prizes as a reward. By listening to and receiving employee feedback, managers can create a fair merit pay increase policy with metrics and incentives that remain motivating for everyone.
3. Train your leaders.
Merit pay programs don't just measure the quality of an employee's output; they also measure the effectiveness of your organization's managers. A successful management team must be able to support its workforce.
A merit pay increase policy shows how effective managers are at providing help and resources to the employees who report directly to them. When managers hold themselves accountable for their employee's merit pay success, there's a greater overall sense of teamwork.
4. Communicate changes regularly.
Once a merit pay increase policy is established, managers should frequently evaluate the process 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 adjust the policy.
Anytime managers make a policy change, they must inform employees of the modifications and how these changes might impact their daily work.
Frequently asked questions
Here are some of the most common questions about merit pay increases:
What department handles merit increases?
The responsibility of implementing a merit pay increase system can vary. Typically, multiple members from different departments are involved in creating and implementing this policy.
Management and HR will often collaborate to discuss the policy, its incentives, how to measure success and how to implement the policy across the workforce. Responsible parties should also collaborate with the accounting department to know what incentives are financially possible and how to distribute them when they're reached.
How can you track and manage pay increases?
When an employee reaches the established goals to earn a merit pay increase, their manager will usually report the increase to HR and accounting. HR and accounting will make the necessary 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 HR features, such as Rippling (read our Rippling review for more information) or ADP (see our ADP review), employees can log in to view and confirm their new salary through a self-service portal.
Is a merit increase the same for all employees?
Merit pay increases differ depending on your organization's industry and an employees' role. This is why it's important for your company to clearly define its merit pay policy. While not every pay increase will be the same, they should all follow the policy. Managers must be transparent about who is eligible for merit pay, and how different departments and employees can achieve it.