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Updated Feb 13, 2024

What Is a Merit Pay Increase?

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Julie Thompson, Contributing Writer

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A merit increase can motivate top-performing employees and improve worker retention. However, implementing a merit increase successfully takes planning and strict guidelines. Before proceeding with merit pay, it’s essential to understand precisely what it is and how best to develop a system for pay increases over time.

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.

TipBottom line

The best online payroll services support merit pay and pay raises and make it easy to change pay rates. Read our Paychex review and our review of Gusto to learn about two top-tier flexible solutions.

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.

FYIDid you know

High merit pay increases in 2024 are a result of persistent inflation and hiring challenges in a tight labor market.

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.
TipBottom line

Improve your merit pay system by conducting regular stay interviews to assess your employees’ well-being and garner feedback. If employees leave, conduct exit interviews to learn what they liked and didn’t like about their compensation structure and work environment.

Merit pay FAQs

Businesses must first consider their merit pay budget when calculating merit pay increases. Determining if your company pays below market, at market or above market can help finalize your budget and decide how to grade your employees’ performance.

There are two ways to calculate merit pay increases: broadband and compa-ratio.


After determining your budget, review last year’s evaluations to find the average rating. Once the average rating has been calculated, set an average percentage increase, as in the example below. Work above and below the average to create tiered merit pay increases.

Example rating system:

  • Outstanding = 4.5 percent to 6 percent
  • Above average = 3.5 percent to 4 percent
  • Average = 2.5 percent to 3 percent
  • Below average = 0.5 percent to 2 percent
  • Unsatisfactory = 0 percent


This approach makes your most productive employees’ pay more competitive than their co-workers. Once an employee reaches a high payroll threshold, their raises are lower.

The compa-ratio approach keeps pay more evenly distributed while still compensating exceptional employees. For example, a worker who performs well but is low on the pay scale would receive a higher merit pay increase. In contrast, a worker with a lower performance receiving higher pay would receive a lower merit pay increase.

FYI: While an employee bonus or merit increase is great, you can also reward top performers with flextime and perks or by donating in their name to a nonprofit of their choice.

While merit pay can raise the bar on company standards, improve employee engagement and increase profits, there are a few disadvantages:

  • Manager subjectivity: In some cases, managers may distribute merit pay subjectively to favored employees. Fair merit pay increases require time to analyze each employee and effective communication to express why employees do or don’t receive them. Additionally, subjective merit pay increases can make top-performing employees feel slighted if they don’t receive the top percentage. Similarly, below-average employees may feel left out if their performance is improving but not being noticed.
  • Extra resources: Some businesses may not have the resources to complete annual evaluations and award merit increases.
  • Employee expectations: Once an employee receives a merit increase, they will expect the same increase in pay year after year. However, their performance could wane or the company could fall into financial straits and be unable to provide a merit pay increase.
  • Decreased company morale: Even with a solid system in place, merit pay increases can hurt company morale if employees compare their work. If the merit pay increases don’t line up in your employees’ eyes, it could cause a decrease in productivity and work quality.

Although it’s possible to negotiate a merit pay increase, managers may not have access to additional funds.

Merit pay programs usually have an overall budget for a set period. That budget is divided between managers. Each manager must be fair to their employees and divide it based on their evaluations of employees’ work performance.

However, don’t hesitate to ask if additional merit pay funds are available. Armed with your accomplishments, awards and market value salary, have an upfront conversation with your manager about your financial expectations.

Your manager should be able to provide a timeline for additional raises and provide you with the specifics on what you must do to receive the pay you deserve. If your manager asks you to complete skills by a specific date, stick to the deadline. Use this to your advantage when the next raise opportunity arises.

No. While a bonus can be based on merit (for example, when an employee achieves certain performance milestones), it is a one-time payment. A merit pay increase continues each pay period.

Management must set performance criteria to qualify an employee for merit pay. Managers must have regular performance appraisal discussions with employees to review each person’s performance and identify problems and areas of excellence.

During performance appraisals, employee performance should be compared to preset benchmarks established and communicated beforehand. Employees who fall short should be told how to improve to get a merit pay increase in the next appraisal cycle.

A merit pay increase should go into effect within a month of the performance appraisal in which the employee qualified. This timeframe is soon enough to serve as a motivating reward but gives enough time for your payroll personnel to make the needed changes.

Jennifer Dublino contributed to this article.

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Julie Thompson, Contributing Writer
Julie Thompson is a professional content writer who has worked with a diverse group of professional clients, including online agencies, tech startups and global entrepreneurs. Julie has also written articles covering current business trends, compliance, and finance.
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