The Problem with Annual Pay Increases

January 6, 2007

How much extra pay did your efforts at work earn you last year ?

What Incentive?
I’m not sure how the 3.5% annual merit increase I received yesterday is supposed to motivate me to work hard in 2007. Don’t get me wrong, I’m grateful to have a steady job and that my pay is increasing at all. However, I don’t think our system of annual merit increases offers much in terms of incentives for me to be a better worker.

Scarcity Mentality
At the end of the year each department gets a shared pool of money to allocate to its employees for the merit increase, so all of us in my group are competing for the same fixed amount. The amount of the pool is a certain percentage of the current combined salary of the group; the percentage is based on how well the company did financially during the year.

So if Human Resources decides our group pool is 2.5% of our current salaries, then the baseline merit increase for each person is 2.5%. If someone did a really good job that year you can increase their percentage but that means you have to take away from the amount you give someone else.

Is the Work Worth the Money?
What usually happens is that most people get right around the baseline increase, the poor performers get maybe .5 – 1% less, and the top performers get .5 – 1% more. That means I could work my butt off all year and earn just $300 – $600 more than the guy next to me that had a horrible year. Taken over the course of a year, this breaks down to a few extra dollars a workday.

With the exception of some time off for the holidays, I’ve been working long hours the last few weeks to make sure our projects are a success. It doesn’t seem to me that a few extra dollars a day is worth the time away from my family and the stress I’ve been under.

The Alternative
One thought I’ve had repeatedly is that I should put in the bare minimum at work and concentrate my efforts on earning alternate income from home. It would be a difficult thing for me; I always like to perform the best in all that I do. However, working hard just to keep my salary up with inflation doesn’t seem to lend itself well to enjoying life and building wealth. If I’m going to be slaving away, mine as well be working for myself.


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Ben Edwards, the founder of Money Smart Life, saved up enough to buy a Nintendo back when he was 12 years old. When he used the money to buy shares of Wal-Mart stock instead, he knew he wasn't like the other kids... His addiction to personal finance has paid off for his family and now he's helping you to afford the life that you want. Check him out on the web at Google Plus, Twitter and Facebook.

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9 Responses to The Problem with Annual Pay Increases

  • Ben

    Good point Tim. The skills you learn at one job can always be applied elsewhere if you’re not being rewarded for your efforts by your current employer.

    My problem is that I’m already starting to feel the chafe of the golden handcuffs; my 4 weeks of annual vacation would be sorely missed if I changed companies.

  • Tim

    Depending where you are in your career and what you do, working hard has its own reward that can be much better than the salary increase. You learn whatever you can from your work. Then get promoted or find another job with higher pay or responsibility.

  • T

    An interesting post.

    I don’t know if this is universal, but in my company, performance reviews have grown to be an elaborate and time consuming mechanism. So much so that it has me wondering and looking closely for company motivation.

    I have two observations about them. One, creating an apparatus of advancement that is seemingly in the hands of employees, but also increasingly bureaucratic and complex. The second, what constitutes a median performance characterization now describes thorough-going self-sacrifice.

    The alternative you outlined is appealing, but I would substitute the negative “bare-minimum” with increased efficiency to meet your commitments and nothing more. In my experience, what counts in the long run is not you putting the extra hours, but being reliable and consistent in producing quality results. It may also give you the strength and capacity to pursue other work in your spare time.

  • moneysmartz

    mbhunter, I’ve never heard of Michael Masterson, I’ll have to check him out. Thanks!

  • mbhunter

    If there’s a hard ceiling on your earnings (which it sounds like there is, unless you can get promoted to Vice King or something like that) then frankly it really doesn’t make sense to bust your hump. Thumbs up for the alternative! I mean, don’t endanger your job, but if you’re consistently performing well above average you should be compensated for it, and if you’re not, then seek alternatives. You might enjoy Michael Masterson’s books and his free newsletter Early to Rise if you’re not subscribed already.

  • moneysmartz

    Enough Wealth, I agree my increases have compounded out to higher dollar amounts than they were years ago but the system still doesn’t motivate me to excel at my job. Working long hours every day for only a few hundred extra bucks doesn’t seem to make much sense.

    I could either 1) find a new job that has a better system or 2) stay where I am, stop working so hard, and focus on making extra money myself. Right now I’m going with option #2, we’ll see how it goes.

  • jim

    I think the “compounding” point is a joke and just something managers tell high performers so they don’t leave the company for more money elsewhere (i’m not arguing its correctness). If you were to get 3.5% and Bad Employee gets 2.5% on a $50,000 salary, after ten years you only make around $600 more than that guy per month, before taxes. That is, of course, assuming inflation is 0%. If inflation is 3% per year, you still beat Bad Employee by $600 per month but you beat yourself ten years ago by $2800 for your troubles.

    Your job’s annual performance evaluation process sound eerily familiar to my former employer’s process… and based on what I know from my new company, that process sucks.

  • Enough Wealth

    I think you should remember that an increase of “only” 3.5% is not just for this year – it flows on to next year, and, indeed, compounds whatever increase you get next year. While Joe slack getting a 1% increase makes your 3.5% “merit” increase seem not worth the effort, just take a few seconds to calculate the effect on your salary compared to Joe Slack’s if you get 3.5% each year for the next ten annual reviews, and he gets the 1% minimum year after year.

    BTW – this is one of the reasons that “merit” pay rises are really a bad investment from an employers point of few – a good worker may get 3.5% the first year, but if they then perform poorly the next year they’ll still get the 1% minimum ON TOP OF the same 3.5% increase from the previous year that they keep on getting in perpetuity. It’s much better to give larger, one off “bonus” amounts to reward workers for merit, and just give everyone the same basic rise.

  • Lazy Man and Money

    I like the alternative. That’s exactly what I’m going to be doing within reason. Every employer I’ve ever been with has only looked out for them. I’ve worked for some start ups where I built at least 25% of the technology infrastructure and came away with the ability to buy stock options worth .05% of the company. It just doesn’t seem to pay. I greatly recommend looking out for yourself first.