What Is a Merit Pay Increase?

What is merit pay?

Merit pay is performance-based compensation given to employees who excel at their jobs. For example, employees who meet specific business goals within a set timeframe may be rewarded with merit pay.

Merit pay acts as a financial incentive for an employee’s hard work and usually takes the form of a raise. In some companies, additional recognition may come as an employee bonus or promotion. However, you should establish explicit requirements regarding merit pay increases or employees who don’t receive one may create a toxic work environment. 

“A focus on merit pay is a great way to motivate your employees, especially if you have a lot of new hires looking to establish themselves and clear, objective performance metrics you can use to track performance,” explained Hayden Cohen, CEO of Hire with Near. “Good compensation packages will include some merit-based elements along with raises for seniority and cost of living.”

Merit increase vs. pay raise

Merit pay is awarded to employees for reaching company goals or exceeding expectations. In contrast, pay raises are often modest — usually 1 percent to 5 percent — and typically are given to all employees based on tenure or to keep up with cost-of-living increases.

“A merit increase is a pay raise that rewards employees for their performance while a pay raise is a general increase in salary,” explained Jess Smith, chief people officer at Hays America. “[A merit increase] is designed to reward employees on performance to help motivate colleagues to do their best work and help accomplish the organization’s goals.”

Daniel Space, a senior human resources (HR) director and HR content creator, clarified that all merit increases are pay raises — but not all pay raises are merit-based.

“We usually see three primary types of pay increases,” Space explained. “Merit is the most common, [followed by] market adjustments, where someone is performing the same role but the market now pays that role at a much higher rate and, finally there are promotions in which someone’s responsibility has increased and so their pay is raised to compensate for their additional responsibilities.”

Dovilė Gelčinskaitė, senior talent manager at Omnisend, sees merit-based pay as more effective than standard raises.

“Often, salaries get raised simply to keep up with inflation and industry trends, not necessarily to reward great performance,” Gelčinskaitė noted. “Merit increases, on the other hand, inherently tie compensation to an employee’s actual contributions. Here, there’s greater capacity for increased motivation and aligning individual performance with company goals.”

What is a standard merit increase?

A standard merit increase is what a company offers for its performance-based monetary incentives. According to Mercer’s United States Compensation Planning Survey, the average 2024 merit increase was 3.3 percent among reporting companies. That’s down from 4.4 percent in 2023.

However, Space noted that in many corporations, the actual average is closer to 2.8 percent — often not enough to keep up with inflation. “It doesn’t keep up with the rising cost of living,” Space explained, “so it often leaves workers feeling they’re still behind, even after a raise.”

Keep the following in mind: 

• Standard merit increases vary: A company’s standard merit increase may fall below or above the national average.
• Other forms of compensation may apply: Some businesses offer additional perks, such as more paid time off, better health insurance or flexible schedules to offset a lower merit increase.
• Merit pay can differ by department: Departments aligned with business growth goals — like marketing, if expanding reach is a priority — may receive larger increases than others, such as customer service.

Benefits of merit pay

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

• Merit pay engages employees in company goals: By outlining quarterly goals or annual benchmarks, you give employees clear performance standards. When they exceed those expectations, you can reward them — just as they’ve rewarded the company with increased revenue or customer growth.
• Merit pay can identify weak links: Teamwork is essential, but burnout can happen if one or more team members consistently underperform. Merit standards help managers recognize who’s exceeding expectations and who may need additional support or coaching to meet employee performance goals.
• Merit pay can reduce risk: Clear performance benchmarks show employees where they stand — below average, average or above average. Merit-based incentives help retain top performers while reducing the risk of overpaying underperforming staff.
• Merit pay encourages employee growth: When pay is tied to performance, employees are more motivated to improve their skills, invest in their careers and engage in training and professional development opportunities.
• Merit pay promotes trust in management: A transparent merit pay policy gives employees a clear path to advancement. When managers follow through on those expectations, it builds trust and can improve collaboration across teams.

Best practices for setting up merit pay

Consider the following best practices when developing merit increase standards to help prevent employees from becoming disgruntled or confused:

• Plan your merit pay carefully: Transparency in business is essential. Nothing frustrates employees more than a vague, inconsistent policy. Create a clear, consistent merit pay policy across departments and ensure everyone understands how it works.
• Ask for input: When setting up a merit increase for a team or department, ask for their feedback before finalizing the policy. Keeping employees in the loop promotes an employee-centric culture and increases buy-in.
• Set your goals strategically: Smith recommends using the SMART [specific, measurable, attainable, relevant and time-based] goals framework when defining performance criteria. Also, consider whether certain goals carry more weight than others. “If yes, you can think about adding a weighting to each goal,” Smith added.
• Be transparent about merit pay policy changes: It’s essential to be transparent when making any changes to your merit pay policy. This is especially important if an employee is close to earning a raise and new requirements may affect their eligibility. “Companies must be very forthright with employees about calculations like compa-ratios and the expectations tied to performance,” Space advised. “This ensures everyone understands how raises are determined.”
• Ensure managers are trained to grant merit pay: Managers are responsible for awarding merit pay increases to the employees who earn them. Provide adequate training so managers feel confident discussing performance and pay with their teams. Remind them that it reflects well on their leadership when their team is motivated and consistently striving to exceed goals. Additionally, teach managers how to evaluate employee performance fairly and objectively to eliminate bias and subjectivity from the process.
• Run reports and analyze data to monitor merit pay: Track your merit increases to see how many employees qualify, how they impact payroll costs and what’s working — or not — in your merit pay system. 
• Ensure your merit pay system is company-wide: Avoid concentrating merit increases within a single department or team. Offering performance-based rewards across the organization helps maintain consistency, boosts employee engagement and keeps operations running smoothly. Hold regular calibration meetings with department managers to ensure performance is evaluated fairly and merit pay is awarded consistently.
• Share with employees how decisions are made: Cohen cautioned that distributing merit pay without clear criteria can make it feel like popularity pay. “Make sure your merit pay system is based on clear, transparent performance metrics,” Cohen advised. Consider using performance reviews to explain how the merit pay program works and outline the steps employees need to take to be successful. 

How employers should approach merit pay negotiations

As a business owner or manager, you want to reward your top performers — but you also have to keep an eye on the budget. Striking the right balance isn’t always easy. Here are some practical tips to help you navigate merit pay negotiations with fairness and confidence:

• Lean on established metrics: Andres Lares of the Shapiro Negotiations Institute recommends creating transparent, measurable criteria for merit pay that align directly with business goals. “This provides an objective foundation for discussions and reduces subjective disagreements like personal opinions or managerial bias,” Lares explained. “When you establish the metrics with your staff beforehand, the negotiations focus much more on achievements rather than arbitrary judgments like personal bias.”
• Set clear expectations (with some flexibility): Be upfront with employees about the guidelines for merit pay discussions and any budget constraints — while keeping some decision-making flexibility private. You’ll be able to set realistic expectations and let employees know there’s a cap on available funds. Full transparency isn’t required, but genuine openness builds trust and helps prevent misunderstandings or resentment down the line.
• Come prepared with data: Lares recommends documenting each employee’s specific contributions, market value and future potential before beginning negotiations. “By coming prepared with concrete examples of how they’ve made an impact, you’ll make decisions based on objective facts rather than guesswork,” Lares advised. “Preparing this way will help you counter any arguments an individual staff member has on perceived bias and inconsistent evaluations.”
• Focus on shared goals, not confrontation: Lares says merit pay discussions don’t have to be confrontational — they can be collaborative conversations about connecting individual growth with broader company goals. “When employees feel heard and valued, they’re more likely to accept outcomes even when financial results don’t meet their initial expectations,” Lares added.

Taking this overall approach can turn stressful negotiations into valuable two-way conversations that motivate staff and build longer-term loyalty to your business.

Julie Thompson contributed to this article.