What is a merit increase and how does it work? 

Financial incentives are key in creating attractive compensation plans to retain talent and motivate your people. While non-monetary benefits like flexible work schedules and wellness programs are valuable, generous pay remains one of the top reasons professionals choose to stay at—or leave—a job. 

In addition to competitive base salaries and ad-hoc bonuses, organizations can use merit increases to set achievable targets, recognize high performers, and inspire continuous growth. 

Here’s how merit increases work, why they matter, and how to implement an effective program that aligns with your company’s goals.

What is a merit increase or merit raise? 

A merit increase is a salary raise companies offer professionals for outstanding work achievements or performance. Depending on the industry and company, management may provide merit increases annually or after the successful completion of a project.

Merit increase vs. pay raise

Typically, companies offer pay raises annually or biannually for the entire workforce, department, or specific positions. Pay raises ensure that an organization’s salaries are competitive and align with the cost of living. While it’s completely acceptable for people to ask for a raise if they think their company underpays them, raises aren’t necessarily performance-based. 

Merit increases, on the other hand, are a direct reward for work performance. Businesses offer merit increases to highly valuable professionals in specific positions to encourage and show appreciation for productivity and accomplishments.

Why do companies give merit increases?

Companies incorporate merit increases to recognize top performers’ achievements and dedication. Merit increases can: 

• Recognize exceptional performance: Merit increases are a tangible way to reward team members for their outstanding work and significant contributions to company goals
• Boost productivity and morale: Acknowledging high performers can inspire all team members to improve their performance and create a productive, goal-oriented company culture
• Create a competitive advantage: In a competitive job market, merit increases can attract high-caliber talent looking for organizations that recognize hard work
• Encourage people to learn new skills: Tying compensation to performance motivates team members to improve their skills and enhance their value

Why should HR leaders care about merit increases?

A well-designed and effective merit increase program can boost retention and engagement. By rewarding high-performers with extra compensation, the company demonstrates how it values them and their contributions. Merit increases are another way to say: “Thank you, we appreciate your service.” 

Retaining high-quality colleagues and keeping them engaged can also minimize the number of new people a company recruits and hires, thus reducing costs. 

Who should get a merit increase?

Merit increases aren’t for everyone, and that’s okay.

Not everyone is a high-performance worker. Furthermore, paying an extra 3-5 percent compensation increase over several years or decades can be costly. 

That’s why merit increases are intended only for professionals with outstanding achievements who directly drive business goals.   

Make sure you offer merit increases to people only after undergoing a process of establishing merit increase criteria, evaluating performance reviews, and having executives review each candidate.

What is a standard merit increase?

The average merit increase stands at about three percent of a person’s current salary. Depending on the person’s performance and value to the company, merit increases range anywhere from one percent for lower performers to ten percent for top-tier professionals.

Merit increase practices vary across industries and depend on economic conditions, labor demand, and organizational priorities. According to Mercer’s latest US Compensation Planning Survey, projected 2025 merit increase budgets differ by sector:

• High tech and life sciences: 3.5 percent
• Healthcare services: 3.0 percent
• Retail and wholesale: 3.1 percent
• Consumer goods: 3.2 percent

Being aware of these trends can help HR professionals design competitive and equitable merit increase programs within their respective industries. Understanding how companies treat merit increases is also important for job seekers. Professionals can address this topic during the interview process to gauge whether a company’s annual compensation policies match their expectations and needs.

Factors impacting merit increases 

Offer merit increases to people after undergoing a process of establishing merit increase criteria, evaluating performance reviews, and having executives review each candidate. When determining your merit increase amounts, consider: 

• Performance: People who exceed their goals or make outstanding contributions often receive higher merit increases. 
• Budget: Companies typically set a budget for merit increases based on revenue, economic conditions, and other financial rewards. 
• Roles and responsibilities: Professionals in roles that drive core business objectives or include leadership duties may receive higher adjustments.
• Industry trends and market competitiveness: Companies adjust merit increases to meet or exceed industry standards. This keeps compensation packages in line with external expectations. 
• Seniority and tenure: A professional’s tenure or seniority can impact a merit raise if they’ve consistently contributed to the company over a long period. 

How to calculate a merit increase

After you determine your merit increase percentage, you can calculate the merit increase amount using these formulas: 

Merit increase example

To understand how to calculate a merit increase, let’s look at an example. Say you offer a three percent merit increase to someone who currently earns $80,000 annually and receives a monthly paycheck. 

Current salary x merit increase percent = annual raise

$80,000 x 0.03 = $2,400 annual raise

New salary / number of paychecks per year = new monthly salary

$82,400 / 12 = $6,866.66

To keep a merit increase within budget and the position’s salary range, HR leaders can collaborate with compensation managers to build a merit matrix: an easy-to-read grid that displays accurate calculations and competitive salary increases. 

How to determine and implement a merit increase process

Here’s how to create a merit increase process that benefits both your team and your organization.

1. Design a compensation philosophy

Adhere to an official compensation plan to keep your merit increases standard and consistent. A written compensation philosophy stops a company from veering off course, ensuring that every merit increase awarded strengthens the company in return.

2. Determine if merit increases will work

If you’re looking to show appreciation for a team member, a merit increase can be effective. But while valuable, they aren’t the solution for every organizational challenge.

For example, if your goal is to boost retention rates or tackle engagement issues, consider other factors too. Are people supported with the resources they need? Do their roles offer flexibility? Is the culture inclusive and encouraging? 

Answer these questions to determine whether a merit increase will address the underlying issues or if other improvements are needed first. Establishing a strong foundation ensures that merit increases—when given—will have the most impact.

3. Choose a merit matrix

HR leaders and compensation managers can collaborate to determine which merit matrix fits their business. They can ask themselves:

• Should the matrix focus solely on performance or factor in an individual’s position within their pay range? 
• What percent increases are feasible?
• Should higher performers receive a larger increase than others?

HR leaders should consider the message the merit matrix system conveys to their people. For example, offering top-performers a higher merit increase percentage than others may inspire others to improve their work ethic.

4. Determine who qualifies for a merit increase 

First, decide which roles qualify for a merit increase. Identify which positions and people in your company can significantly impact your business’s success and evaluate how difficult it is to find someone to replace that person or fill that role. Bain & Company uses the example of restaurant prep cooks, where top performers are only about two or three times more productive than the baseline. At the other end of the spectrum, leading trial lawyers can be six or more times more productive than others in their field due to the increased specialization and scope for creativity. 

Once you’ve chosen the roles, incorporate a dynamic performance review system to evaluate the team members currently in those positions. Based on the performance evaluation data, you can develop challenging yet attainable objectives that qualify those people for a merit increase. Make sure the criteria are realistic: You want the requirements to spark hard work while still respecting work-life balance. 

5. Make the criteria accessible to everyone

Communicate the merit increase criteria by including them in the employee handbook and explaining them to managers. This gives your professionals a level playing field where everybody knows which benchmarks qualify them for a boost. In theory, the more people who qualify for a merit increase, the better. With the right matrix, increased revenue will counterbalance the rise in gross wages.

6. Objectively assess performance

Use a combination of regular performance reviews, feedback on leadership and teamwork, and analytics tools to minimize bias and create a better-informed perspective. This data-driven approach reflects measurable contributions while keeping the process transparent and motivating.

<<Download these free performance review templates.>>

7. Communicate the merit increases

Communicate when, why, and how you’re awarding the merit increase so team members understand the process and value of their contributions. 

• When? HR leaders can provide merit increases throughout the year so that every time someone reaches a set goal, HR can reward them for their performance with a competitive, budgeted merit increase that drives engagement and productivity.
• Why? Refer back to your merit matrix and explain why your team member qualified for a merit increase. 
• How? Award a merit increase either face-to-face or through a video call if you’re a remote team. 

Merit-based pay pros and cons

Merit-based pay encourages high performance, supports the retention of top talent, and aligns individual efforts with organizational goals. But before finalizing your merit-based compensation strategy consider: 

• Potential for bias: Without clear criteria, merit-based pay can unintentionally favor certain groups and affect morale.
• Impact on non-fiscal benefits: Merit pay shouldn’t be an organization’s only retention strategy. Consider other benefits your people care about, like career development opportunities, a great work-life balance, and flexible work schedules.
• Budgetary constraints: Frequent or large merit increases can strain budgets, particularly for organizations with limited resources.

Alternatives to merit increases

If a merit increase isn’t the best fit, you can use other compensation strategies to reward and motivate your people. 

Cost of living adjustment (COLA)

COLAs are periodic pay adjustments that help keep wages in line with inflation and rising living costs. Unlike merit increases, these usually apply across the board rather than reflect individual performance.

Promotion 

A promotion almost always includes a change in role or responsibilities, often accompanied by a pay increase to reflect the higher expectations of the new position. While merit increases recognize the quality of someone’s current performance, promotions signal readiness for greater responsibility or a new career phase.

Incentive pay

Incentive pay is a variable or one-time payment for when professionals achieve specific, measurable goals. Payments tie into specific projects or short-term outcomes, such as quarterly sales targets or the completion of a major initiative. This motivates team members toward immediate objectives. 

Unlike merit pay, incentive pay doesn’t alter base salary and doesn’t occur each period—it’s only for when the team member meets their set goals.

Equity or stock options 

Equity and stock options are forms of compensation that give team members a stake in the company, often allowing them to purchase shares at a set price after a certain period. 

Equity compensation creates a sense of ownership and aligns a colleague’s interests with the company’s success, which can be especially appealing in startups and high-growth organizations.

Skill-based increases 

Skill-based pay rewards team members for learning new tools, technology, or methods that add value to their roles. These increases support continuous learning and help people expand their contributions to the team.

Bonuses

A bonus is a recurring reward based on company performance, department results, and a person’s performance. It’s often planned and expected, like an end-of-year bonus or holiday gift. Compared to incentive bonuses, which are tied to specific achievements, standard bonuses reward overall contributions. They can be a percentage of a salary (like a 15% bonus) or a set amount (like a $15,000 bonus). 

Include merit increases in your modern HR strategy

Well-implemented merit increases are great tools for HR professionals to boost retention and productivity. If you plan a fair, sustainable merit increase process and communicate it transparently, you can retain top performers, raise your revenue, and keep your team enthusiastic and engaged. 

For more information, check out our guide to the best benchmarks and strategies for merit increases.

Merit increase FAQs

What is a good merit increase? 

A good merit increase reflects someone’s performance and contributions. It often ranges between three and five percent of their current salary. High-performing professionals or those who’ve achieved exceptional results may receive merit increases of up to ten percent. 

Is a merit increase permanent?

Yes, merit increases are generally a permanent adjustment to a person’s base salary. Unlike temporary bonuses, merit increases reflect a long-term recognition of value and commitment to rewarding outstanding performance.

What is the average merit increase?

The average merit increase falls around three percent of a professional’s current salary. Companies may adjust this average based on the overall performance levels within the team or budget constraints. 

While three percent is standard, some top-performing team members may receive higher merit increases in more competitive industries.

Is a five percent merit increase good?

A five percent merit increase is generally considered good since it exceeds the typical increase of three or four percent. 

What is a merit increase of five percent?

A five percent merit increase is a significant boost for top performers who exceed expectations and make a substantial impact on business goals. A five percent adjustment shows an organization’s dedication to rewarding excellence and encouraging a goal-oriented culture.