What is a Merit Increase? How to Calculate It?

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Organizations are always on the lookout for ways to inspire their teams and keep their top talent happy.

Among the many strategies available, such as monetary and non-monetary incentives, merit increases stand out as one of the most powerful tools. So, what exactly is a merit increase, and why does it matter so much?

In this guide, we’ll break down the merit increase meaning, explain how it works. From understanding its importance to learning how to calculate merit raises, this guide is designed to help HR professionals and employees alike navigate the world of performance-based salary increase.

What is a Merit Increase?

Merit increase definition (sometimes called a merit raise) is a salary adjustment given to an employee based on their performance. It’s not a general pay raise or a bonus, but a reward based on how well someone has performed in their role.

What makes merit increases so appealing is the fact that they are permanent, meaning they become part of the employee's base salary.

For that reason, merit increase is awarded for exceptional performance, and not as common as other types of increases. To be fair with the process, merit raises are given after employee performance reviews, considering things such as productivity, quality, leadership, and whether one has contributed to company success.

One of the benefits of merit-based salary adjustments for organizations is that merit increases are an effective way to motivate employees and align rewards with performance.

Merit increases vs Salary Adjustments

Any type of salary adjustment affects employee compensation but the reasons behind the increases change. Well, how do merit increases work? To understand it better, let’s take a closer look at what sets a merit increase apart from other salary adjustments.

A merit increase is a tool for rewarding employees with high achievements. As mentioned before, they are permanent salary adjustments, meaning they become part of the employee’s base pay once given.

On the other hand, salary adjustments like cost-of-living increases (COLA) are given to all employees, regardless of individual performance. This adjustment helps employees cope with inflation and increased living costs, and everybody in the organization gets the same increase.

The differences between merit increases and cost-of-living adjustments come down to purpose and how they’re applied. Merit increases are awarded based on performance, recognizing employees who goes the extra mile. While, COLAs are given to all employees.

A third type of salary adjustment is a general pay raise to keep the organization's salaries competitive to attract and retain talent.

Finally, bonuses are one-time payments given for the achievement of goals or milestones. Since bonuses do not affect the base salary of employees that is how it differentiates from a merit increase.

What is the average merit increase?

On average, merit increases are around 3%, but keep in mind, this is just the middle ground.

Many factors affect the merit increase percentage like individual performance, the organization’s pay structure, and even the industry you’re in. For employees who meet expectations, the increase may be closer to the lower end, around 1-2%. On the other hand, high performers, who go above and beyond, may see increases ranging from 5% to more.

So, while 3% is considered to be a benchmark, the actual merit increase will differ depending on the employee's performance and how your organization structures its pay.

What is a good merit increase?

A "good" merit increase depends on the organization’s budget. In general:

3%: Standard for satisfactory performance.

5% or higher: Reserved for exceptional contributions.

Remember, pay for performance should be meaningful to the employee while also fitting within the organization’s budget.

How to calculate merit increases?

Calculating a merit increase is simple, but it requires a bit of strategy. Here’s how to do it:

1. Set the Merit Pool: Set aside a portion of the organization’s payroll for merit raises, ensuring it fits within the payroll budget. Doing so helps keep salary adjustments in line with the company’s financial limits and objectives.

2. Evaluate Performance: Take a close look at each employee's performance. Use employee performance tracking tools, and feedback from managers to take account of how well they’ve contributed to the organization’s success.

3. Apply the Merit Percentage: Decide on a merit percentage based on the employee’s performance. Multiply their current salary by this percentage to determine the raise.

Example:

If an employee earns $50,000 and gets a 4% merit increase, the raise would be $2,000, bringing the new base salary to $52,000.

4. Be Transparent:

Communicate how the merit increase was calculated with employees and show how their performance influenced the decision and how the budget plays a role.

Why are merit increases so important?

Merit increases play an important role in building a culture of performance. When done right, they do more than just raise pay. They drive motivation, improve productivity, and align employees with organizational goals.

Rewarding High Performance

Merit increases recognize and reward employees who exceed expectations, which motivates other employees to raise their performance.

Boosting Employee Engagement

When employees understand that their performance affects their pay, they feel more invested in their work. Knowing their efforts contribute to both personal and financial growth motivates them to aim higher. As a result, employee engagement and loyalty increase.

Attracting and Retaining Top Talent

Merit increases show employees that their hard work pays off, and this helps with employee attrition rates because, with merit raises, employees are likely to stay committed and keep up with the good work.

But it doesn’t stop there. Merit baser raises also make your organization attractive to top talent. People want to work for organizations that value their efforts and offer rewards for success.

Driving a Results-Oriented Culture

Incorporating merit increases into your performance management cycle motivates employees to reach organizational goals. With monetary incentives in place, employees get much more motivated to achieve results that support the organization’s growth.

Long-Term Motivation

Merit increases are more than just a one-time boost like bonuses. They add up to an employee’s base salary, and it's a great way to motivate employees to keep delivering!

So, without a doubt, merit increases keep employees engaged and ready to contribute to the organization’s success for the long run.

How to integrate merit increases into your HR strategy?

Want to boost employee motivation, performance, and retention all at once? Integrating merit increase policy and procedure into your HR strategy checks it all for you.

But here's the thing, it’s not only about handing out raises. It’s about connecting pay to performance in a way that motivates your workforce!

Connect Merit Increases with Organizational Goals

Merit increases should never be random. Aligning them with your organization’s goals ensures that every raise motivates employees to push for the results that matter the most.

Make Goal Alignment Effortless with Teamflect

To seamlessly connect merit increases with organizational goals, you need an all-in-one performance management solution: Teamflect.

Versatile Goal Types: Set individual, group, team, or department goals to fit your requirements.

Custom Tracking: Track progress using metrics that matter most to your organization, choose what works for you.

Cascading Goal Structures: Link goals to parent or sub-goals to create alignment across your organization, ensuring every employee understands how their efforts contribute to larger objectives.

Show Employees the Connection Between Performance and Pay

Transparency is crucial here. Employees need to understand exactly how their performance translates into pay increases. It’s not enough to just say, “Good work gets rewarded.” Be clear about what specific behaviors, achievements, or results will lead to merit raises.

Conduct comprehensive performance reviews with Teamflect

Keep Goals Front and Center: Integrate goals and OKR tracking into performance reviews, ensuring alignment with organizational objectives stays top of mind.

Spot High Performers with the 9-Box Talent Grid: Gain insights into potential and performance using Teamflect’s 9-box talent grid.

Leverage AI-Assisted Decision-Making: Let Teamflect’s AI tool analyze performance metrics and review content to provide data-driven recommendations.

Plus, with Teamflect’s Recognition Module, you can turn recognitions into a reward point system that inspires motivation.

Customizable Badges: Tailor recognition badges to align with your organization’s values and milestones.

Assign Points for Achievements: Add a gamified twist by awarding points for your employees' contributions. Celebrate successes in a way that’s engaging and meaningful for your employees.

Make more informed, accurate decisions about merit increases with Teamflect!

Keep an Eye on the Results

Don’t just hand out merit increases and move on. Continuously track and evaluate their impact. Are employees more engaged? Is performance improving? Is turnover decreasing? Employee surveys will give you the insights you need to make any adjustments.

Transform Feedback Collection with Teamflect Surveys

Tailored Templates for Every Need: Access a library of customizable survey templates to address all your feedback goals from employee engagement to pulse surveys and everything in between.

Automate for Consistency: Schedule and automate surveys to ensure regular feedback collection without depending on manual follow-ups.

AI-Powered Efficiency: Let Teamflect’s AI generate survey questions. Analyze results with AI, helping you identify trends and address concerns.

Teamflect’s survey features empower your organization to stay connected and responsive to its people’s needs.

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Written by

Emily Helen Arnold

Emily Helen Arnold is a content writer at Teamflect. She is obsessed with organizational behavior studies and loves writing/thinking about how a carefully designed people strategy can transform a company.

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