Escalating inflation coupled with an increasingly competitive labor market have made retaining employees more critical than ever. But, finding a way to keep retention numbers high and keep payroll within budget can be a challenging balancing act, even for seasoned employers. When is the right time to increase salaries, what do employees expect, and how much should those increases be—if they’re even necessary at all?
We’re answering those and other commonly asked employer questions about annual salary increases here.
How much is the average annual salary increase?
Over the past decade, the average annual salary increase has hovered between 3 to 5 percent. That said, it’s important to note that a variety of factors can impact those annual raise amounts, ranging from occupation and industry to whether that raise is given as part of a promotion, or a new role or title.
In addition, Payscale’s Annual Compensation Best Practices Report shows that the COVID-19 pandemic and its aftermath have also had a significant impact on salary increases, as well.
According to the report, in 2019, 82 percent of companies increased employee base pay with two-thirds of those giving raises of 3 percent or less. In 2020, the number of companies giving raises decreased from 82 percent to just 63.7 percent.
To quote directly from the Payscale 2021 Report:
“A majority of organizations (74.3 percent) said that they gave an average pay increase of 3 percent or less to employees in 2020, which is slightly higher than the 71 percent that predicted they would give 3 percent or less in 2020. An increase of 3 percent or less has been standard for almost a decade, but is less than economists have said workers need for the economy to recover to pre-Great Recession levels.
“For 2021, only 64.2 percent of organizations said they plan to give a base pay increase at all. Of the organizations giving pay increases, 67.2 percent said they plan to continue giving an average base pay increase of 3 percent or less. The average pay increase in 2021 could be higher than in 2020. However, this depends on organizations who have not yet decided (26.1 percent).”
See the full 2021 Compensation Best Practices Report here.
4 types of pay raises
In addition to amount, employers should look at the types of raises they want to give, and the rationale behind them. These different raises could include:
1. Cost of living raises
Cost-of-living raises, also known as cost-of-living adjustments (COLAs), are pay raises that are provided to counteract inflation—rising prices in the economy. Cost-of-living raises are designed to keep employee pay on par with the current cost of living.
This year, with the economic impact of the COVID-19 pandemic, inflation rates are significantly rising. According to the Bureau of Labor Statistics, the Consumer Price Index, which measures the average change over time in the prices paid by urban consumers for a market basket of goods and services, like housing, clothing, food, recreation and medical care, shows an inflation rate of 5.3 percent from 2020—2021 (as of September 2021).
This means that if employers give employees a 5 percent pay raise, they can maintain the same level of buying power that they had the previous year. Given that the average annual pay raise is typically less than 5 percent, employers (and employees) may find themselves in a difficult predicament this year.
Please note, it’s important to understand the difference between nominal wage increase and real wage increase. Nominal wage increase is that pay raise in a dollar amount, while real wage increase takes inflation into account. For example, if an employee made $50,000 last year, and this year she made $55,000, her nominal wage increase was $5,000. However, if the inflation rate is 2 percent, her real wage increase was only 8 percent, not 10 percent.
2. Merit increases
Merit pay raises, or performance-based pay raises, are given as rewards for excellent work from an employee. Employers use these types of increases to keep top-performing employees engaged and motivated, and let them know, in a very tangible way, that they are appreciated.
Data shows that an employee’s work really does matter when it comes to how much they receive in a merit-based pay increase. The WorldatWork Salary Budget Survey 2019-2020 showed that organizations budgeted a 3.6 percent pay increase for high performers, 2.5 percent for middle performers, and 0.6 percent for low performers.
3. Equity raises
An equity raise is used to ensure that employees receive equal pay for equal work. This has been an emphasis particularly in combating the gender wage gap. In 2021, Payscale’s research found that women earned 82 cents for every dollar earned by men, and that similar, racial pay gaps are prevalent, as well.
According to Payscale’s Diversity, Equity, and Inclusion (DEI) report:
“American Indian and Alaska Natives see the largest uncontrolled pay gaps relative to white men; women in this group earn $0.69 and men $0.86 for every dollar earned by a white man. Possibly influenced by the COVID-19 recession, this pay gap has worsened by 6 cents from last year for women, when American Indian and Alaska Native women had a pay gap of $0.75.”
Equity raises can be used to combat these wage gaps and restore fair pay throughout the organization. This effort to ensure equal treatment in the workplace can also be an incentive to attracting new talent.
Equity raises can also be given in a few other scenarios, including salary compression issues, including:
- A long-term employee is receiving low pay relative to a new hire
- Salaries between a supervisor and employees have compressed
Equity raises are also in order when a casual employee—one who only works as needed with no guarantee of hours or future work—transitions to a full-time position with the company.
Unlike a merit-based pay increase, which increases employee pay based on performance, without changing his or her current position in the company, a promotion is typically a pay increase accompanied by a new title and an increase in responsibilities. For instance, promoting someone from an individual performer to a supervisory role that includes managing direct reports, budgetary responsibility or added accountability would be considered a promotion and likely include a pay increase.
4 factors impacting a pay increase
In addition to varying reasons why employers increase pay for employees, the amount of those pay increases also can vary, based on a number of different factors, including geographic location, industry, experience level, and the economy.
The growth and economic health of the employer’s geographic location plays a factor in pay raises and pay increase amounts.
We recommend taking a look at the Payscale Index, which tracks quarterly changes in total cash compensation for full-time, private industry employees in 19 job categories, three company sizes and 15 industries across 32 major Metropolitan Statistical Areas (MSAs) in the United States. This is a valuable and helpful resource to understanding how your specific location may affect how you offer pay increases to your employees.
Your company’s industry also plays a role in wages and pay increase amounts. Typically, growth industries—such as solar energy, artificial intelligence, or cybersecurity, among others, have larger than average increases. At the same time, sectors like education and transportation have recently reported lower than average increases.
3. Experience and performance
Most employers conduct performance reviews or performance appraisals with their employees annually or semi-annually to discuss achievements, highlight areas for improvement and set goals for the coming months or year. Based on how employees meet or exceed these goals can help determine their pay raise amount
4. The economy
The trajectories of the local and national economy can have an impact on salary increase amounts. Recessions, for example, could cause companies to decrease pay raises when they see decreases in company sales or lackluster growth.
Learn more about the economic impact on wages and raises in Payscale’s Compensation Best Practices Report.
When to give an employee a raise
Deciding when to give employees a raise can take a combination of soft skills and hard data. For example, many organizations utilize technology to track activity, identify which employees are generating the most leads or handling the highest volume of work, and factor this data into their salary increase plan. Payroll software can also determine what you’re paying employees, and when they last had a raise.
Employers can give raises based on a number of additional factors, including:
- When an employee has achieved something significant for the company
- When an employee brings positive morale and sociability to the workplace
- When an employee brings a unique talent or skill to the workplace and would be difficult to replace
- To show an employee loyalty and appreciation after going through a difficult time in the company
- When an employee takes on new responsibilities unasked, or goes above and beyond their job expectations
These are only some of the catalysts or events that could trigger a salary increase.
Changing Jobs to Increase Pay
As an employer, it’s important to be cognizant of one vital fact: typically, changing jobs is one of the fastest ways an employee can get a pay raise. In fact, the Workforce Vitality Report produced by Automatic Data Processing (ADP), shows that job-switchers earn an average of 4.9 percent year-over-year, while jobholders see a wage growth of 4.5 percent. However, it’s not the same in every region, or in every industry:
- West: 5.9 percent wage growth for switchers – 4.9 percent for holders
- Northeast: 6.9 percent wage growth for switchers – 4.4 percent for holders
- South: 4.8 percent wage growth for switchers – 4.3 percent for holders
- Midwest: 2.2 percent wage growth for switchers – 4.4 percent for holders
However, by proactively providing merit increases, COLAs, and ensuring your talent is paid fairly and equitably, you can give your employees good reasons to stay with your company, and not go looking elsewhere.
For more information and insights, please check out Payscale’s guide on how to increase employee retention.