How to Calculate a Merit Increase and Use It Effectively

Calculating a merit increase is critical in compensation management. It means figuring out how much to raise an employee's salary based on their performance, skills, and contributions.

The calculation of the merit increase process needs careful thought to be fair and match the company's goals. Once calculated, a merit raise can be used effectively to recognize and reward employees for their hard work, motivate high performance, and retain top performers.

This guide covers everything about merit increases, including how they differ from promotions and pay increases, and how to calculate and use them in your organization.

What is a merit increase?

A merit increase refers to a salary bump given to employees for outstanding performance and contributions to the company. These pay raises are usually given yearly or after completing a project, and they motivate employees, help retain them, and reflect their value in the job market.

To calculate it, multiply the merit percentage by 100 to convert it to a decimal number. Then, multiply the decimal amount by the employee's current salary. Finally, add the calculated increase to the current salary to determine the new employee salary.

For example, if an employee earns $50,000 and receives a 5% merit raise, the increase is calculated by multiplying $50,000 by 0.05, which equals $2,500. Adding this to the current salary gives a new salary of $52,500.

Why does merit raise matter?

Merit pay increases matter because they can significantly impact employees in positive ways. Some key benefits include:

• Recognition and appreciation: When employees' hard work is acknowledged with a pay raise, it boosts employee morale and shows the company values their contributions.

• Increased job satisfaction: Feeling valued can increase job satisfaction and overall happiness.

• Employee retention tool: Competitive salaries help retain top talent, and merit pay increases reward employees for their performance, which reduces the urge to seek better opportunities.

• Motivation for continued excellence: Merit pay increases link strong performance with financial rewards, which motivates employees to strive and exceed expectations.

• Fairness and equity: Linking raises to performance shows a commitment to fairness, creating a positive work environment where employees feel valued for their contributions.

Is a merit increase permanent?

Yes, a merit increase permanently boosts your base salary, unlike a bonus. This means all your future paychecks will reflect the higher amount, recognizing your ongoing strong performance.

Merit increase vs pay increase

The difference between a merit increase and a pay increase is that the former is specifically tied to an employee's performance. It rewards strong work, exceeding expectations, and achieving goals. In contrast, the latter can be any raise, like cost-of-living adjustments, or promotions. It can be temporary, like bonuses, or permanent, like merit pay increases. Both types can boost morale, but merit pay increases are based on individual performance.

Merit increases in 2024

Organizations are planning for slightly lower merit increases in 2024, with an average merit increase of 3.5%, down from 3.8% in 2023. In the US, employers are budgeting 3.9% for total salary increases for non-unionized employees in 2024, a slight decrease from the 4.1% budgeted in 2023.

What is a fair merit increase?

A fair merit pay increase depends on performance, the company's payroll budget, and the market rate for the position. Typically, it rewards strong performers with a raise between 3% and 5% of their salary. This increase is on top of cost-of-living adjustments and recognizes contributions while keeping pay competitive in the job market.

Is a merit increase of 3% good?

A 3% increase is decent, but what's seen as a good increase can vary based on factors like the employee's performance and the organization's compensation philosophy.

What is a merit increase of 5%?

A 5% increase is a raise given to recognize an employee's strong performance and contributions. For example, someone earning $60,000 would see their salary increase by $3,000 annually.

Factors that affect merit increase decisions

Merit pay increase decisions are influenced by various factors that organizations consider when rewarding high employees for their performance and contribution. Here are some of them:

Employee performance

The biggest factor in deciding merit raises is how well employees have done their jobs, met goals, and helped the company. Employers look at performance reviews and how employees have contributed to the organization.

Company budget

The organization's finances are key to deciding merit raises. HR professionals need to make sure the budget for raises is manageable and fits the company's financial plans.

Market competitiveness

Employers consider market trends and what competitors are doing to make sure they're offering competitive pay. This helps them attract and keep the best employees. Compensation Software provides salary range data for different positions and experience levels in specific areas. This helps set fair base salaries by comparing an employee's current salary with market data for their role to decide if a merit raise is justified.

Company performance

The overall performance of the organization can affect merit raises. When business is good, companies may give bigger raises, but during tough times, they may give smaller ones.

Employee potential

Employers also think about an employee's potential to grow when deciding on raises. Employees who have a lot of potential might get bigger raises to encourage them to stay and keep helping the company succeed.

Retention risk

Employers might give merit raises to valuable employees to keep them from leaving. If there's a chance that top talent might leave, companies may use raises to convince them to stay.

Internal equity

It's important for companies to be fair. Employers make sure that raises are given out fairly based on how well employees do their jobs and how much they contribute to the company. Compensation Software's Reporting feature helps assess internal pay differences by employee group and generate equal employment opportunity reports for protected classes like age, ethnicity, and gender.

How to calculate a merit increase and utilize it for your company

Calculating a merit increase involves evaluating how well employees are doing and using that evaluation to give them a raise. Here's how to do it for your company, with the help of Salary.com's Compensation Software:

1. Step 1: Conduct performance evaluation

   Evaluate each employee's performance based on factors like job responsibilities, skills, achievements, and contributions. Conduct these evaluations yearly, twice a year, or quarterly, as per your company's rules.

2. Step 2: Establish a merit matrix

   A merit matrix decides how much of a raise each employee gets based on their performance rating. It lists different performance levels (like below, meets, or exceeds expectations) with matching raise percentages. This keeps raise decisions fair and consistent for everyone in the organization. Compensation Software's Merit Modeling feature helps you analyze the cost of a merit increase program and create matrices based on performance and market data. It also provides insights into employee performance and market competitiveness.

3. Step 3: Calculate merit increase per employee

   After you've done performance evaluations and set up the merit matrix, you can figure out how much of a raise each employee gets. Multiply their current salary by the raise percentage in the merit matrix for their performance level. This gives you the amount their salary will go up by.

4. Step 4: Communicate, implement, and continuously improve

   After figuring out the merit raises, tell employees about them. Explain why they're getting the raise and how it fits with the company's objectives and values. Give out the raises on time and ask employees for feedback to make the process better next time.

   One way to show transparency in employee pay is by providing Total Compensation Statements. Compensation Software can create these statements, giving employees an overview of their compensation. These statements also highlight an employee's role in the organization and show their value.

Calculating and using merit increases effectively is important for motivating employees, recognizing their contributions, and retaining top talent. To do this, follow the steps above and utilize a strategic tool like Compensation Software. This rewards high performers and boosts business success.