VIRTUAL HR DEPARTMENT – COMPENSATION AND BENEFITS: MERIT INCREASES

Merit Increase Documents

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Merit increases are generally provided on an annual basis, either at a common time for all employees or at a date close to the employee’s anniversary date. Merit increases generally are based on the ratings received by employees in their annual performance appraisal. The concept of pay for performance is important for creating and communicating to employees an effective compensation program that rewards and encourages high performance levels.

In creating a merit increase policy, the major considerations are budget, maintaining market competitiveness, and rewarding and reinforcing desired behaviours and results. It is advisable to create a model that will be used on an ongoing basis and that can be adjusted each year based on the financial results of the company, elements such as general economic conditions, unemployment rates and availability of qualified labour in your local market, and general and/or industry trends related to pay.

It is common to establish the merit increase amount as a percentage of the target rate for each band. Utilizing this approach instead of increases being a percentage of current base salary provides for simplified budgeting, and prevents the problem of widening salary gaps between employees.

The merit increase grid can be created using fixed increase percentages or amounts, or the system can offer flexibility to managers to provide them the ability to differentiate between employees who may have received the same performance rating, but where it is felt that one is deserving of a larger or smaller increase than others.

Following are examples of merit increase grid structures that utilize the base salary grid model described above and the rating scale from the Performance Appraisal section of this website. Annual salaries are used in the example, but the models work equally well for hourly wages.

Merit Increase Grid – Example 1

Performance Rating Increase % if Current Salary is
Below Target Salary
Increase % if Current Salary is
Above Target Salary
Exceptional (E) 4.50% 3.50%
Quality – High (QH) 3.25% 2.25%
Quality – Solid (QS) 2.0% 0%
Quality – Developing (QD) 1.0% 0%
Improvement Required (I) 0% 0%

In Example 1, a fixed percentage rate is used for each performance rating level, regardless of salary band. There is a noticeable difference in the merit increase percentage associated with each performance rating level. This will help to reinforce the pay-for-performance concept and clearly reward your top performers. The merit increase percentages are lower in the ‘Above Target Salary’ column, as the increase amount is also reinforced by the fact that they are being provided a salary/wage level that employees with lesser performance are unable to attain. The room in the salary band between target and maximum salaries is also limited, so a slightly lower increase percentage is recommended so that a high-performing employee can receive merit increases for a couple of years once they surpass the target salary.

Merit Increase Grid – Example 2

Performance Rating Increase % if Current Salary is
Below Target Salary
Increase % if Current Salary is
Above Target Salary
Min. Default Max. Min. Default Max.
Exceptional (E) 3.75% 4.5% 5.25% 2.75% 3.5% 4.25%
Quality – High (QH) 2.5% 3.25% 3.75% 2.0% 2.25% 2.75%
Quality – Solid (QS) 1.5% 2.0% 2.5% 0% 0% 0%
Quality – Developing (QD) 0% 1.0% 1.5% 0% 0% 0%
Improvement Required (I) 0% 0% 0% 0% 0% 0%

In Example 2, the merit increase percentage for each performance rating level can be selected from a range. The default provides a common starting point for employees in each performance rating level. Managers can then decide on whether to award the default amount or adjust the merit increase percentage up or down, with minimums and maximums established. From a budgeting perspective, it can be useful to establish the percentages in the grid by using your merit increase budget to determine what the default amounts would be. Managers who wish to provide increases between default and maximum to certain employees would need to make corresponding decreases to other employees, providing increases between minimum and default. This way, managers are provided a budget, guidelines and a higher level of flexibility in managing their staff versus the fixed-percentage model in Example 1.

Merit Increase Grid – Example 3

The following salary-band information and fixed-percentage merit increase grid show the merit increase amounts that employees would receive based on their current salaries and performance ratings.

Salary Band Minimum Salary Target Salary Maximum Salary
4 $28,250 $34,000 $37,500
Performance Rating Increase % if Current Salary is
Below Target Salary
Increase % if Current Salary is
Above Target Salary
Exceptional (E) 4.5% - $1,550 3.5% - $1,200
Quality – High (QH) 3.25% - $1,150 2.25% - $800
Quality – Solid (QS) 2.0% - $700 0% - $0
Quality – Developing (QD) 1.0% - $350 0% - $0
Improvement Required (I) 0% - $0 0% - $0

In order to make salary administration easier, the increase amounts are rounded to the next highest $50 increment. Rounding could also be done in $100 increments to further simplify the numbers. This can be a little more challenging with hourly wages, but using increments of $0.25 or $0.50 can offer some simplicity.

If the merit increase that is determined by this process would result in a QS or lower-rated employee receiving a salary/wage greater than the target salary, then the increase amount would be reduced to an amount such that the employee’s new salary would be the target salary. The same is true for QH- or E-rated employees and the maximum salary.

In the box at the right side of this page, you will find a Merit Increase and Salary Budget Calculator that you can use to project the costs associated with the merit increase grid that you determine through the process outlined above. Using the grid examples above, you can create various merit increase scenarios and then, by loading your current employee salary data into the calculator spreadsheet, you will be able to determine the budget implications of each scenario by entering the appropriate merit increase amounts. If you or someone on your team is very good with MS Excel, you can create a database that will automatically fill in the merit increase amounts based on the salary band, performance rating and target salary of each employee.