What Is a Merit Pay Increase?

What is merit pay?

Merit pay is performance-related pay given to employees who excel at their jobs. For example, employees who reach particular business goals in a specific period may be rewarded with merit pay. Merit pay is a financial incentive for an employee’s hard work and can include a pay increase, a bonus or a promotion. The first merit pay increases were introduced in 1908 in the education sector of Newton, Massachusetts.

Merit pay can help you recruit new employees, hire top talent, improve employee retention and boost productivity. However, you should establish explicit requirements regarding merit pay increases or employees who don’t receive one may create a toxic work environment.

Merit increase vs. pay raise

Merit pay is given to an employee for reaching a company goal or for going above and beyond expectations. In contrast, pay raises are often a small percentage of the employee’s income (usually 1 to 5 percent) offered to all employees who’ve worked at the business for a specific period or to account for cost of living increases.

Pay raises can be a safer option than merit increases because they avoid hurt feelings and are perceived as fair. However, your payroll costs can become unsustainable if all your employees receive regular pay raises and turnover is low.

What is a standard merit increase?

A standard merit increase is what a company decides to offer for its performance-based monetary incentives. According to Mercer’s United States Compensation Planning Survey, the average 2024 merit increase is expected to be about 3.5 percent. This average is down from 4.4 percent in 2023 as wages become more in line with the years before the COVID-19 pandemic.

Any given company’s standard merit increases may be lower or higher than the average. Alternatively, a business might offer employees other tangible incentives like more paid time off or better health insurance to compensate for a lower-than-average merit increase.

Additionally, specific departments may have higher or lower standard merit increases, depending on a business’s goals. For example, if a business aims to improve market reach, the marketing department may see a more sizable merit increase than customer service.

It’s crucial to watch your overall merit budget because merit increases can max out a top performer’s salary. Changing incentives to one-time bonuses can still reward top-performing employees without bumping their salaries to management levels.

Benefits of merit pay

Merit pay can bring numerous benefits to businesses, including the following: 

• Merit pay engages employees in company goals: You can’t grow your business without an active workforce. By explaining quarterly goals or annual benchmarks,  you provide a performance standard for each employee. Once an employee exceeds those standards, you can reward them just as they’ve rewarded you with more customers or revenue.
• Merit pay can identify weak links: Working as a team is essential, but any team can burn out if there is a weak link (or two). By setting merit increase standards, managers can easily see which employees pull their weight and which workers need guidance to meet employee performance goals.
• Merit pay can reduce risk: The standards set for merit increases let workers know if their performance is below average, average or above average. Since merit increases encourage employees to work harder by providing a financial incentive or promotion, companies can retain top talent and reduce the risk of overpaying below-average employees.

Best practices for setting up merit pay

Managers or employers who develop merit increase standards should follow best practices to prevent employees from becoming disgruntled or confused by the new program. Consider the following best practices:

• Plan your merit pay carefully: Nothing is worse than a confusing new policy that lacks transparency or doesn’t account for all situations. Develop a consistent policy across departments. Employers, managers and employees should all be versed in the guidelines so everyone is on the same page.
• Ask for suggestions about your merit pay policy: When providing a merit increase for a department or team, ask for their input before finalizing the policy. If part of the merit increase guidelines are unclear, managers and employees can voice their opinions and offer suggestions. Keeping your team in the loop helps create an employee-centric culture that will help your business thrive.
• Be transparent about merit pay policy changes: You must be transparent about making any policy changes. Transparency is especially crucial if an employee is close to reaching their salary increase and your policy change means additional requirements are needed to receive their financial reward.
• Ensure managers are trained to grant merit pay: Managers are responsible for giving merit pay increases to the employees who deserve them. Give your managers adequate training so they are confident when addressing their team. Let managers know that it bodes well for them to have a team that strives to exceed goals and is motivated to receive merit pay.
• Run reports and analyze data to monitor merit pay: Monitor your merit increases so you know exactly how many employees qualify, what the added payroll costs are and what is working or not working with the merit pay system.
• Ensure your merit pay system is company-wide: Try not to concentrate your merit increases within one department or team. Offering benefits to employees company-wide for outstanding performance can keep your company running smoothly and encourage worker engagement.

Jennifer Dublino contributed to this article.