There’s a simple way to boost your employee retention rate: Pay your team more. Bonuses, raises, and above-average salaries are the most compelling reasons why people stay in their jobs long term.
Most employers would love to give their workers a raise every year. But financially, that’s simply not sustainable. For small business owners seeking to find the right mix of compensation while keeping an eye on their bottom line, here are some things to consider when offering raises.
Raise, bonus, or another benefit?
The first step in considering whether or not to offer a raise is to establish some criteria that merit a pay increase. Raises are just one way to show your employees that you appreciate their hard work; therefore, clarify from the outset what types of compensation you can offer.
A compensation mix generally involves some of the following incentives:
- Pay increase (raise): Usually a set percentage based on the employee's pay. Employee pay raises result in a permanent increase in payroll expenses.
- Bonus: A variable cost (one-time payment) tied to sales or production volumes, for example.
- Benefits: Flex hours, a travel stipend, or tuition reimbursement are examples of incentives that can be easier on your bottom line while still showing employees you’re invested in their success.
The fact is that most employers won't always be able to pay their employees more on a long-term, permanent basis. A tough business year might call for bonuses rather than pay raises, for instance. In your compensation policy, outline how you will reward employees with a combination of these incentives according to business conditions.
Create pay raise criteria
There is a time and place for pay raises. Many businesses offer small pay increases every year, but for small businesses, raises can be used to reward specific employee achievements. Consider offering raises for the following reasons:
- To reward loyalty: Traditionally, businesses offer a pay raise to employees who stay at the company through thick and thin. A 10-year anniversary, for example, is a good time to give a raise.
- When the cost of living increases: This type of raise is companywide, or it’s applied to individuals if, for instance, an employee is moving to open a new location in a more expensive city.
- When an employee develops a new skill: “Skills-based compensation is a compensation system that rewards employees based on their skills and competencies rather than their job title, seniority, work history or qualifications,” writes Figures. “This is seen as a fairer, more effective way of determining pay, since it ties compensation directly to the employee’s value to the business. It can also help create a culture of continuous improvement as employees are motivated to build on their skills to earn more.”
- To reward great work: Of course, if someone is consistently working hard, achieving results, and contributing to the success of your small business, they deserve a raise.
If you’re not sure your business can consistently pay higher salaries, opt for performance-based bonuses or an alternate incentive. “The variable cost structure of a bonus package helps business owners during times of low sales or production volumes. Pay raises are permanent, but bonuses keep payroll costs lower when the revenue isn't there to pay them,” wrote Investopedia.
[Read more: 5 Ways to Get Promoted]
If you’re not sure your business can consistently pay higher salaries, opt for performance-based bonuses or an alternate incentive.
How to structure raises based on performance reviews
Employees who do great work deserve to be rewarded. Also known as a merit increase, performance-based raises are pegged to measurable results to ensure increases remain fair and objective.
Create a framework that makes it clear how an employee’s performance is tied to a financial incentive. Use objective metrics, such as how an employee’s work contributed to revenue growth, cost savings, or higher productivity. Make sure you use a standardized employee performance review across all departments and teams.
From there, you can assess what’s financially feasible for your company to offer as a reward for great work. “A merit matrix helps standardize salary adjustments based on both performance levels and current pay positioning,” wrote Rippling. “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.”
Raises based on performance reviews can vary depending on the industry. Rippling estimates that most companies offer between 3% and 4% annually for high performers, while Indeed reports that performance-based bonuses are around 1% to 5% of an employee’s base salary.
How much should you offer in raises and bonuses?
There are different types of bonuses, and, as a result, bonuses range in value. You can also offer employees a combination of bonuses. For instance, an employee could receive a holiday bonus in addition to a signing bonus.
Most raises fall in the range of 3% to 5% of an employee’s salary. When you compare this number to the cost of replacing an employee — which is estimated to be 20% of their annual salary — raises seem affordable.
Cost-of-living adjustments are a little easier to calculate. The U.S. Social Security Administration (SSA) publishes cost-of-living adjustments based on the U.S. Bureau of Labor Statistics' Consumer Price Index for Urban Wage Earners and Clerical Workers. For instance, the SSA announced a 2.5% increase for 2025 in October 2024. This increase gives you a good benchmark for adjusting your employees’ salaries.
Timing considerations for pay raises
Conventional wisdom suggests that the best time for pay raises comes during performance reviews or at the end of the year. However, tying raises to performance reviews may have an inverse effect.
“Consider moving away from annual salary reviews. They encourage staff to work harder in the months leading up to the review. A better option might be on-the-spot raises. Not only does it keep your staff on their toes, it gives them immediate feedback for a job well done,” said the experts at Xero.
Moving away from annual raises also removes the impression that pay increases are a “given.” “Showing up and doing your job earns you a paycheck, not a raise,” wrote Chris Ronzio in Inc.
Raises and bonuses should reward your top performers when the company is doing well. Enforce raise criteria, proactively offer raises outside of performance reviews, and offer alternate compensation when you can’t afford long-term pay increases to show your employees you value their time and effort.
Wage transparency laws and raises
States have different wage transparency laws that are worth consulting before you establish your pay raise policy. Essentially, wage transparency laws require companies to disclose wage information to employees and job applicants in particular situations. ADP offers a useful state-by-state wage transparency law guide, providing more information for your specific location.
Some states require openly sharing information about compensation increases associated with promotions. For example, laws like the Colorado Equal Pay for Equal Work Act require employees to be informed of pay ranges with promotions. Consult the wage transparency laws specific to your area to make sure you stay compliant.
Mistakes to avoid when announcing raises
If and when you decide to give raises, be as transparent as possible in your communication. Let employees know the reason for the pay increase — great business performance, cost of living increase, or something else. Transparency sets the expectation moving forward and helps your team understand if the raises are a one-off or merit-based.
Experts also recommend having a solid strategy in place before making the announcement. “If you make changes to pay with no strategy, you will have employees lined up at your door to negotiate their own salary change,” said Lane Transou, President of HR consulting firm Lane Transou & Associates Inc.
Be aware that employees who don’t get raises still should be recognized and supported. If you are giving merit-based raises, schedule time with those who didn’t reach their performance metrics. Learn more about what they need to be successful and how you can boost their performance for the next round of raises.
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