What is a merit increase? A complete guide for HR managers

Keeping employees motivated and engaged goes beyond maintaining a great company culture. It also involves fair and rewarding compensation. A well-structured merit increase plan makes sure that a company recognizes its top performers for their contributions, helping them retain talent and boost morale.

Pay increases can take many forms, but merit pay stands out because it directly ties salary adjustments to performance reviews and measurable achievements. This approach can keep employees motivated, while also aligning individual performance with organizational goals.

In this guide, we explain exactly what a merit increase is, how it compares to other compensation strategies, and the best practices for implementing it effectively.

What is a merit increase?

A merit increase is a salary increase awarded based on an employee’s individual performance, achievements, and contributions to the company. 

Companies use these raises to reward top performers who consistently exceed expectations. Unlike standard pay increases, which may be automatic or company-wide, merit pay depends purely on measurable achievements in performance reviews.

Employees who bring measurable value, hit key goals, or outperform peers may qualify for merit increases. HR teams decide the amount based on factors like contributions, company budgets, and market conditions.

Merit increase vs. pay raise

The debate around merit increase vs. raise comes down to performance vs. general adjustments.

• Merit increases reward individual achievements. Employees earn them by excelling in their roles and driving results.
• Pay raises can happen for various reasons, like cost-of-living adjustments, promotions, or company-wide salary reviews. These don’t always reflect individual contributions.

For example, an employee who consistently outperforms targets might receive a merit increase, while everyone in the company could get a pay raise because of inflation.

Types of pay raises

Understanding the different types of raises helps HR managers choose the right approach for their workforce. Here's a breakdown of the most common types of pay raises: 

Merit raise 

A merit raise is a salary increase given to top performers based on their individual contributions to the company. Unlike across-the-board pay raises, merit raises link directly to performance and help businesses reward employees who exceed expectations. Companies typically offer an annual merit increase to employees who consistently deliver strong results.

Example: A sales executive who surpasses targets, leads successful client deals, and mentors junior staff may receive an annual merit increase to acknowledge their impact on company growth.

Annual raise 

An annual raise is a base salary increase that companies offer at regular intervals, usually once a year. Unlike a merit raise, this type of pay raise isn't necessarily tied to performance. It may be based on company policy, inflation, or industry standards. Almost every employee expects an annual raise as part of a competitive compensation package.

Example: A company conducting its yearly compensation review might decide to implement a 3% base salary increase across all departments to retain employees and remain competitive in the job market.

Equity-based compensation

Equity-based compensation provides an alternative to base pay increases by offering employees stock options, restricted shares, or profit-sharing plans. This approach gives employees a direct stake in the company’s success and can serve as a powerful long-term incentive. Unlike a standard pay increase, this type of compensation grows in value as the company succeeds.

Example: A startup might offer new hires a mix of equity-based compensation and a modest annual salary increase, so that employees remain invested in the company's long-term growth.

Seniority pay

Seniority pay is an adjustment to an employee’s salary based on tenure rather than performance. This type of reward acknowledges long-term commitment and experience within the company. Many industries, especially unionized workplaces, follow structured seniority pay scales.

Example: A manufacturing company may grant employees an automatic pay adjustment of 5% after ten years of service as a reward for their loyalty and experience.

Cost-of-living increase 

A cost-of-living increase is a base salary increase designed to help employees keep up with inflation. Unlike a merit raise, this pay raise has nothing to do with performance but ensures wages maintain their purchasing power. Government agencies and large corporations often implement these adjustments as part of their salary policies.

Example: A company in a city with rising rent and living expenses might offer a 2.5% base salary increase each year to help employees maintain their standard of living.

Reasons to implement a merit increase 

A merit increase does more than simply reward individual performance. It can strengthen employee engagement, boost motivation, and help businesses stay competitive in the job market. HR managers who implement structured merit pay plans have a great opportunity to create a results-driven culture where employees want to perform at their best. Here are some of the key reasons to implement a merit increase system:

Reward outstanding employee performance

High performers drive company success. A merit increase makes sure that employees who consistently exceed expectations receive tangible recognition for their efforts. When employees see that their hard work translates into financial rewards, they are likely to remain motivated to maintain and improve their performance.

This system can also reinforce a culture of excellence, where employees know that going above and beyond leads to career growth and higher earnings.

Enhance workplace motivation and efficiency

Employees work harder when they know their performance directly impacts their earnings. A well-structured merit pay plan can foster motivation by rewarding those who contribute the most to the company's success. This approach can also encourage efficiency, as employees focus on high-impact tasks that drive results.

Knowing that performance reviews directly influence salary adjustments can push employees to maintain high standards.

Strengthen competitive position in the job market

Companies that offer merit increases often attract and keep top talent. Skilled professionals typically look for workplaces that recognize hard work and achievements. A competitive compensation structure that includes pay increases for outstanding performance signals to job seekers that the company values its employees.

In industries where talent competition is fierce, a strong merit pay system can be a deciding factor for candidates choosing between employers.

Promote skill development and growth

A merit increase system can encourage continuous learning. Employees who want to earn higher salaries seek opportunities to improve their skills and take on new challenges. This benefits both the employee and the company, as a workforce with a commitment to learning and growth generally leads to better innovation, productivity, and overall business success.

By linking pay increases to development, companies can build adaptable, forward-thinking, and highly skilled teams. 

Pros and cons of merit increases

A merit increase offers strong incentives for employees to excel, but it also comes with challenges. When implemented correctly, it can strengthen retention, productivity, and workplace morale. However, if handled poorly, it can create financial strain or lead to unhealthy competition among employees. Here’s a look at some of the key pros and cons:

Pros

• Enhances retention of top talent: Employees are more likely to stay when they see a direct link between their performance and pay increases. Without merit raises, high performers may leave for better-paying opportunities.
• Improves overall productivity: Knowing that salary growth depends on contributions can push employees to stay focused and efficient. A merit pay system encourages strong individual and team performance.
• Reduces recruitment and hiring costs: Retaining top talent can lower hiring expenses and minimize disruptions from turnover. A structured merit increase plan can be a great way to keep skilled employees engaged over the long-term.
• Creates a positive work culture: Recognizing achievements through merit raises can foster trust and motivation. Employees who feel valued often contribute more and maintain higher morale.

Cons

• Neglects non-monetary incentives: Raises motivate employees, but career development and workplace flexibility matter too. Companies that ignore these factors risk losing engagement.
• Strains budget: Tight budgets can make merit increases inconsistent. Without proper planning, businesses may struggle to maintain a fair and sustainable system.
• Promotes short-term motivation: A merit increase creates an initial boost, but the effect can fade over time. Employees may start expecting raises as a given rather than continually improving their performance.
• Creates competition: Employees may see each other as rivals rather than teammates if only a few receive merit increases. This can lead to tension, lack of collaboration, and a cutthroat work environment.

4 steps to calculate a merit increase  

A structured approach can help ensure that merit increases remain fair, objective, and financially sustainable. Managers need to assess performance accurately, measure financial contributions, and use a clear framework for decision-making. Here are the key steps to follow when calculating merit pay:

Step 1. Analyze the financial contribution of employee performance

A merit pay decision should reflect the employee’s measurable impact on the company’s bottom line. Managers must assess how an employee’s work has contributed to revenue growth, cost savings, or productivity improvements. This step makes sure that raises go to employees who create real business value rather than those who simply meet expectations.

Example: A sales executive who secured major contracts bringing in $1 million in revenue would qualify for a higher merit pay increase than an employee whose contributions had no direct impact on profitability.

Step 2. Conduct an objective performance assessment

Evaluating an employee’s work objectively prevents favoritism and bias in performance reviews. Managers should use key performance indicators (KPIs), peer feedback, and goal completion rates to measure success. Standardizing assessments encourages consistency across departments and prevents subjective decision-making.

Example: A customer service representative might receive a merit increase based on a 98% customer satisfaction score and a reduction in average response time, demonstrating measurable improvement.

Step 3. Measure the impact of a merit increase

Before finalizing a merit increase, HR teams should evaluate how the raise will affect company finances and salary structures. Increases must align with budget constraints while remaining competitive with market standards. Overspending on merit pay can strain resources, while underpaying top performers can drive them to competitors.

Example: A company planning a 4% merit increase for high performers must assess whether it can sustain similar adjustments in future years without negatively impacting financial stability.

Step 4. Develop a structured merit matrix

A merit matrix helps standardize salary adjustments based on both performance levels and current pay positioning. This tool ensures that employees in similar roles with comparable contributions receive fair and proportionate increases. It also helps balance merit pay with internal equity and market competitiveness.

Example: A company might create a merit matrix where employees rated as "exceeding expectations" receive a 5% increase, while those rated "meeting expectations" receive 2%, ensuring consistency.

How much is a merit increase?

The average merit increase can vary significantly based on industry, company size, and employee performance. Most companies offer between 3% and 4% annually for high performers. Some industries with very strong competition or high revenue growth may offer larger merit-based raises, while others may fall well below the average.

Essentially, a merit increase depends on the company’s compensation strategy, budget, and how much it values performance-based salary adjustments. Businesses looking to retain top talent often make sure that merit pay remains competitive within their industry.

Here’s how average merit increases compare across different sectors:

• High-tech and life sciences: 3.5% 
• Healthcare services: 3%
• Retail and wholesale: 3.1%
• Consumer goods: 3.6%

Companies that prioritize performance-based compensation structures tend to offer higher merit increases. Businesses with tighter budgets or lower margins may provide smaller adjustments or alternative forms of compensation, such as bonuses or stock options.

4 factors that influence merit increases

Merit increases depend on multiple factors beyond employee performance. HR managers must consider financial constraints, industry benchmarks, and internal pay structures to ensure fairness and sustainability. Here are four key factors that can influence merit pay decisions:

1. Employee performance and contributions

An employee’s impact on business success plays a central role in determining their merit increase. Managers assess contributions beyond basic job duties, such as exceeding targets, improving processes, or taking on leadership responsibilities. Those who deliver measurable results that drive company growth typically receive higher merit pay adjustments.

For example, an engineer who streamlines production to reduce costs by 15% brings more measurable value than someone who meets expectations without optimizing processes. Companies prioritize employees who make a tangible difference when it comes to merit pay. 

2. Available budget and financial constraints

A company’s financial health directly affects its ability to provide merit increases. Economic downturns, revenue fluctuations, and unexpected expenses may force leadership to adjust salary budgets. Even when employees perform exceptionally well, limited funds can cap the size or frequency of merit pay adjustments.

Organizations experiencing strong growth may allocate larger budgets for merit raises, while those facing financial strain may limit raises or supplement them with bonuses. HR teams must balance competitive compensation with long-term fiscal responsibility.

3. Market trends and competitive salary standards

Industry salary benchmarks help businesses determine fair and competitive merit increases. If competitors offer higher raises, companies risk losing top talent to organizations with more attractive compensation packages. Conversely, paying significantly above market rates can create financial strain or internal pay imbalances.

Regular compensation benchmarking allows HR teams to align merit pay with market expectations. Companies that fail to monitor industry trends may struggle to retain high performers or overextend salary budgets unnecessarily.

4. Experience, seniority, and length of service

Employees with extensive experience or long tenure may receive larger merit increases, especially if they continue to expand their contributions over time. Senior employees who mentor colleagues, manage complex projects, or develop specialized skills bring additional value beyond their day-to-day responsibilities.

However, tenure alone doesn’t guarantee higher merit based pay. A long-serving employee who performs at the same level year after year may receive a smaller merit increase than a newer team member who consistently outperforms expectations. Companies must balance loyalty-based adjustments with performance-based rewards.

Best practices for implementing merit increases

A structured merit pay system can ensure fairness, maintain employee motivation, and align salary decisions with company goals. Without clear guidelines, companies can risk inconsistent salary adjustments that may lead to dissatisfaction or disengagement. Managers who follow best practices can effectively reward employees while keeping salary structures equitable and financially sustainable. Here are some of the best practices to keep in mind when implementing merit increases:

1. Foster transparency in merit-based decision-making

Employees need to understand how their employer makes merit pay decisions. When salary increases feel unpredictable or unclear, employees may assume favoritism or bias plays a role. Companies should establish clear criteria for rewarding performance, communicate expectations in advance, and explain how managers evaluate contributions.

2. Equip managers with skills for effective performance evaluations

Managers must assess performance accurately to make fair merit pay decisions. Without proper training, some may struggle to differentiate between solid performance and truly exceptional contributions. Companies should provide evaluation training, set clear performance benchmarks, and use standardized review processes to ensure consistency.

3. Minimize bias and ensure equitable treatment

Unconscious bias can distort merit pay decisions, leading to disparities in salary adjustments. To prevent this, HR teams should implement structured review processes, use data-driven performance metrics, and cross-check evaluations across different managers. Consistency in assessments makes sure that every employee has an equal opportunity to earn a reward based on performance.

4. Actively seek and consider employee input

Employees should feel involved in discussions about merit pay and performance expectations. When employees understand the evaluation process and have opportunities to provide feedback, they are likely to become more engaged in their own development. Encouraging dialogue also helps managers fine-tune salary structures based on employee concerns and expectations.

Payroll and raises made simple with Rippling

Managing merit pay, general pay raises, and overall compensation can be complex without the right tools. Rippling Payroll simplifies everything by allowing you to run payroll fast, while seamlessly merging performance reviews and salary adjustments into a single automated workflow.

Rippling’s all-in-one workforce management platform unifies HR, Payroll, IT, and Spend in one place. So, instead of juggling multiple systems, you can automate payroll changes, bonuses, and salary adjustments based on real-time performance data from a single source of truth. 

Automate payroll and merit increases

Rippling’s global payroll system eliminates manual processes by syncing all HR data directly with payroll. When an employee earns a merit increase, Rippling automatically updates compensation records, benefits, and tax calculations without extra work from you.

Streamline performance reviews and compensation management

Performance management plays a key role in determining merit increases and pay adjustments. Rippling helps businesses create structured performance reviews, align salary increases with measurable results, and make data-driven compensation decisions.

Manage core HR functions in one place

Rippling provides an all-in-one solution that scales with business growth. Whether processing merit increases, administering equity-based compensation, or handling global payroll, Rippling automates the heavy lifting. This means you can focus on strategy rather than spreadsheets.

FAQs on merit increases 

Is a merit increase of 3% good?

A 3% merit increase falls within the standard range for most industries, but whether it is "good" depends on multiple factors. Competitive industries with strong demand for skilled professionals may offer merit increases closer to 4% or higher to retain top talent. In contrast, companies facing financial constraints or operating in lower-margin sectors might offer smaller adjustments.

Beyond percentage comparisons, the effectiveness of a 3% merit increase depends on how well it aligns with company performance, industry benchmarks, and employee expectations. If top performers consistently receive only the minimum increase, they may start looking for opportunities elsewhere. Companies should review their compensation strategy regularly to ensure merit-based raises remain competitive and rewarding.

Is a merit increase permanent?

Yes, a merit increase is typically a permanent adjustment to an employee’s base salary. Unlike bonuses or one-time incentives, a merit increase raises the employee’s annual earnings going forward. Once in place, this increase affects all future payroll calculations, including overtime pay (if applicable) and benefits tied to salary levels.

However, a company’s financial health and market conditions can influence long-term salary structures. In rare cases, businesses may restructure pay scales or introduce salary freezes if economic challenges arise. While merit increases generally remain in place, companies should clearly communicate that continued salary growth depends on sustained performance and business viability.

What is a good merit increase?

A strong merit increase effectively rewards high performance while remaining sustainable for the business. Many companies consider 3%–5% a good range, but top performers in highly competitive industries may receive 6% or more when their contributions significantly impact business success. The best merit increases strike a balance between recognizing outstanding work and maintaining financial stability.

A good merit increase also reflects market conditions and employee expectations. If salaries lag behind industry benchmarks, even a 5% merit increase may not be enough to keep high performers engaged. Companies should benchmark pay structures regularly to ensure that merit raises remain competitive and in alignment with employee contributions.

Is merit increase the same as a promotion?

No, a merit increase and a promotion serve different purposes. A merit increase is a salary adjustment based on performance, without changing an employee’s job title or responsibilities. A promotion, on the other hand, involves moving an employee to a higher role, typically with increased duties, decision-making authority, and compensation.

An employee may receive both a merit increase and a promotion if they're excelling in their current role and demonstrating readiness for a leadership position. However, some companies separate these processes, using merit increases to reward strong performance within a current role and promotions to recognize career advancement.

This blog is based on information available to Rippling as of March 5, 2025.

Disclaimer: Rippling and its affiliates do not provide tax, accounting, or legal advice. This material has been prepared for informational purposes only, and is not intended to provide or be relied on for tax, accounting, or legal advice. You should consult your own tax, accounting, and legal advisors before engaging in any related activities or transactions.