Merit Increase: Everything You Need to Know
The idea behind giving out merit raises is to reward the employees who are the most productive and highest-performing7 min read
A merit increase, also known as a merit bonus, means that an employee will get a bump in their normal salary, based on a previously agreed upon policy of conduct, such as above average efficiency and performance.
Why Merit Increases Matter
You can boost morale and build a happy and loyal staff of employees, which also helps retaining top employees, by rewarding those deserving of it with unexpected pay raises or bonuses. The idea behind giving out merit raises is to reward the employees who are the most productive and highest-performing. This, in turn, gives other employees an incentive to do better in hopes of getting that extra bump in their own paycheck.
Handing out a merit raises on the fly, however, does not have the same effect as if there is a well-planned program tied to certain performance measures, says Laura Kerekes, chief knowledge officer at Think HR, a human resources consulting company.
If merit raises are done well, it’s an effective tool for retention of your best employees, stimulates productivity in others and makes for good performance management.
Who Should Get a Merit Raise?
In order for businesses to determine who should get an extra financial incentive, they have to first compose the goals of the firm regarding bonuses and merit raises.
Human resources departments devise a strategic plan for the year, and then pass that down to individual departments for them to adapt to their objectives. Departments then take those strategic plans and create the metrics that the individual employee will have to meet to earn a merit raise.
After a department creates a plan, it needs to communicate to employees exactly what they will need to do to earn a merit raise, or even a bonus. There needs to be some flexibility in the program, but not so much that an employee who thinks they have earned a merit raise does not receive one. This will result in company policy having a negative effect on employee morale.
This is especially important when working to retain high-performing employees. Sometimes the market moves so quickly that it is important to give out a raise several times a year, especially if an employee is being enticed by a competitor.
While normally there is a standard rate for a merit increase in any given year, businesses always can give more or less, usually depending on what they can afford to give, or how much a particular employee already earns in benefits, such as health insurance, or vacation days.
Other companies will set benchmarks that employees must meet, benchmarks that enable a business to meet its goal for the year, which help an employee determine whether or not they may be eligible for a merit increase of bonus.
Merit Increases vs. Pay Raises
Merit raises are often made in an effort to motivate other employees. Sometimes, however, they can quickly breed resentment among other employees if they don’t think the pay increases are being awarded in a fair and just manner.
If a company publicly establishes the goals that are necessary to be met in order to be considered for a merit raise, it can avoid any unpleasantness among the ranks, which can lead to employee turnover, or even an employee grievance or lawsuit against the company.
Employees need to understand that merit increases are based on above-average performance and having a good attitude in the workplace, not just what is considered to be deserved based on how long an employee has been at the company.
How Do COLAs Affect Merit Raises?
Cost of Living Adjustments, also known as COLAs, mean that that your pay depends on the Gross Domestic Product, or GDP – the costs of products or services that a person regularly buys in the course of a given year. COLAs are made annually to the income of those receiving Social Security and disability benefits receive.
When it comes to services such as Social Security, the government allocates money to each recipient in order to be able to buy enough food and other necessities of life that they need in order to survive. The Social Security Administration tries to keep the money they distribute to each recipient in line with cost of living adjustments. This is not always the case, especially if inflation has made the cost of living estimates too high for them to afford the necessary payout to each recipient.
Merit Increases are rarely based on cost of living adjustments. Instead, they are almost always based on an employee’s performance over the last year that is above and beyond what is expected of them.
The Forces That Drive Merit Increases
There are two primary forces at work when an employee is offered a merit increase:
- How valuable the employee is in the marketplace. This is considered the market price.
- How important an employee’s efforts are worth to the company for which he works. This is called internal worth.
If all non-cash factors are identical, such as the quality of an employee’s management, the employee’s potential for career advancement, the benefits they receive, etc., then companies are free to pay above market price based on internal value. In contrast, businesses can’t expect to pay too much below the prevailing market price for long and still retain their employers, whether or not the workers are above average or just keeping pace.
Changes That Can Justify a Merit Raise
There are different ways an employee’s performance can affect whether or not they receive a merit increase.
As opposed to a merit increase, if a company thinks that an employee’s improved performance is not likely to improve every year, they may elect instead to pay the employee a one-time bonus to recognize current performance, while motivating them to keep up the good work in order to earn another bonus.
However, a software developer with three years of experience at the same company has more inherent worth than one with two years of experience. This is simply a fact of the marketplace. The longer an employee remains employed at the same company, without disciplinary measures taken against them, the more that employee deserves to receive a merit raise.
Reductions in buying power of 4 percent a year or more during a recession are not uncommon. Available data shows that, during the last major recession, in the early 1990s, wage increases were 4 percent below the Consumer Price Index, or CPI, each year. A 5 percent pay increase when inflation is at 9 percent is, in reality, a wage cut.
The Market Price for a Job or Employee
A company most often will use the median, or 50th percentile market pay, when offering an employee a job. However, whichever market percentile a company uses as a target is a business plan decision, which is up to each company individually.
Other businesses, such as Wal-Mart, for example, offer the low end of the market, or about 25 percent, to their employees. This is based on the fact that such companies are trying to control labor costs. They have procedures in place to bring employees up to speed quickly, so that they can get the maximum benefit of a new hire as the company usually has a high employer turnover rating.
COLAs or Merit Increases
Any changes that take place in the marketplace, for the employees of a certain business, at least, are the thigs that determine the changes in an employee’s pay.
Cost of Living Adjustments, or COLAs, have virtually no impact on a worker’s performance. When the company is going through a recession, it is common for yearly pay increases to be well under the current rate of inflation, if a company issues wage increases at all.
Merit increases are not offered even if a company decides that a specific is working above his expected performance. If that employee is already receiving a salary that is par with the current market, then they will not likely receive a merit raise.
On the other hand, junior employees, or even an employee who is working at or above their experience level, needs to receive regular, healthy, merit increases so that they stay motivated to stay with the company.
Defining Individual Merit Increases
Managers may reward performance most effectively by sensibly allocating their merit pool.
Merit increases may be used to identify an employee's contributions, performance, and the previous year's achievements.
When considering merit increases, it may be helpful to visit annual salary review quick cards, performance reviews, off-cycle merit increases, lump sum merit payments, and deferred merit increases.
People with good performance may be recognized with review increases at or above the recognized merit allocation amounts. Those with ordinary performance may receive smaller amounts. If an employee doesn’t meet expectations for performance, they may not earn a merit increase at their review. Instead, a company may have a policy in place that grants a three- to six -month time period in which the employee can work to improve their performance and subsequently earn a merit increase
An employee should familiarize themselves with company policy in any job regarding merit ranges and specific merit allocation, to understand how their level of performance corresponds. An employee also should take the opportunity to speak with someone in the human resources department about how they can improve their performance to earn merit increases at the company.
The Most Important Aspects of a Fair Merit Increase
- Transparency - Clearly, a merit increase needs to be transparent to the employee, to be fair. So, discuss with employees how these increases are determined and what criteria are used to evaluate their performance.
- Reliability - Along the way, performance-management training for all managers will help standardize how your company talks about salary with your employees.
- Frequent feedback - If individual performance is looked at solely during a yearly review, employees are missing out.
Annual performance reviews don’t allow employees enough chance to improve; they need continual feedback, so they can always strive toward growth.
If you need help setting up a fair company plan for handing out company merit raises, you can post a legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and have an average of 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.