Updated: January 20, 2025
Small and medium-sized businesses that prioritize employee retention should know how to calculate a pay raise. That’s because keeping your team happy can go a long way to limit the expense of onboarding and training new hires, which tends to come with high turnover. In addition, most top talent expects fair pay (and occasional increases).
Typically, the longer a team member is with your business, the more likely they are to receive a pay raise. In fact, most companies provide raises once a year to align with cost-of-living adjustments. Employers determine these raises using either a flat rate or percentage increase — though percentage increases tend to be more common.
That said, knowing how to calculate a salary raise percentage can be tricky. In this employer’s guide, we will discuss some of the most common ways to give a raise, provide tips on how to calculate increases with examples, and point out the tax implications to be aware of.
Percentage increases vs. flat rate raises
Simply put, a percentage increase is usually the most equitable way to offer raises across the company while maintaining balance across various roles. For example, you might offer a 3 percent raise across the board. While the percentage is the same for everyone, the dollar amount can be quite different. An employee making $60,000 annually will see an increase of $1,800 for the year, but an employee making $40,000 annually will receive only $1,200.
A flat rate raise means everyone receiving the raise receives the same dollar amount. Instead of using a percentage to maintain the salary benefits between positions, seniority, or skill, you offer everyone the same raise, regardless. A flat rate is an excellent option for adjusting salaries for underpaid hires, dealing with budgetary constraints, or offering a one-time bonus.
Ideally, you would calculate a typical increase in salary using a percentage. This is a way of rewarding higher performers, maintaining salary equity, and adjusting for cost-of-living increases. With that in mind, let’s learn how to calculate a salary raise percentage.
Step-by-step process for calculating raise percentages
A pay raise percentage is not an arbitrary number. To make informed decisions, employers should review market data, cost-of-living adjustments, employee performance and tenure, and company budget to find a fair percentage. You can determine a fair increase by reviewing the latest data and salaries of professionals in similar roles to your employees.
For example, if you own a dental practice, the median pay for a dental hygienist was $87,530 in May 2023. Say that dental hygienists on your staff make $85,000 on average. What raise percentage would you need to use to match your staff’s salary to the national median? You can use a pay raise calculator to calculate the salary raise percentage or do the calculations yourself if you’re more mathematically inclined:
- Identify the previous salary: In this case, the previous salary is the salary of the dental hygienists on staff, about $85,000.
- Determine the new salary: Let’s base the new salary on the median of $87,530.
- Calculate the difference: $87,530 minus $85,000 equals $2,530.
- Divide the difference by the previous salary: $2,530 divided by $85.000 equals 0.0298.
- Multiply the result by 100 to get the percentage increase: 0.0298 times 100 equals 2.98 percent.
Most employers increase employee salaries by 3 percent to 5 percent annually, depending on tenure and experience. Still, before you commit to any payroll processing increase, ensure you examine all the contributing factors.
Factors influencing salary adjustments
Part of learning how to calculate a salary raise percentage is understanding that several factors come into play. To properly determine the percentage, you must assess what influences it, how it affects your employees, and your competitive position in the market.
Raises and the Consumer Price Index
Market metrics are helpful for calculating employee pay raises, allowing you to gauge the exact changes in inflation and the cost of living. The Consumer Price Index (CPI) is one such metric. The CPI measures inflation changes so employers can make cost-of-living adjustments to ensure a fair wage and salary increase while protecting their employees’ purchasing power.
Raises and merit statistics
Raise percentage adjustments should factor in cost of living, but another driving force is employee performance, also known as merit statistics. Most businesses perform annual performance reviews, assessing employee productivity, quality of work, attendance, and collaboration skills. Merit increases might account for a 1 to 5 percent wage increase, depending on performance.
Raises and industry benchmarks
Finally, because you want your business to remain competitive, you should base raises on industry benchmarks. If you aren’t paying your employees what other companies are paying theirs for similar positions, you’ll likely experience regular employee turnover. High turnover rates can lead to increased training costs and hiring expenditures, meaning you are eating into profits.
To learn more about how some employers approach the numbers, we spoke with Peggy James, a certified public accountant with over ten years of experience helping small businesses.
“One issue I’ve seen small business owners encounter is salary discrepancies that can emerge between long-term employees and new hires. Especially in a tight labor market, employers may be tempted to offer more money to entice a new hire without considering how the salary compares to what current employees in similar positions are being paid.”
— Peggy James, Certified Public Accountant (CPA)
The reason to be mindful of this is how long-standing employees might respond. Peggy explains, “It can lead to resentment from employees who may have worked for the business for many years and believe it’s unfair to pay a new employee more than current employees earn for doing the same or similar work.”
So how can you approach pay increases strategically?
Peggy provides this pro tip
“Doing some research on market salary rates before making an offer to a prospective hire can help to ensure you’re paying a fair wage. It can also be useful to periodically examine what you’re paying your current staff to make sure salaries are in line with what other employers are paying.”
— Peggy James, Certified Public Accountant (CPA)
Now that you understand the factors influencing salary adjustment decisions and how to calculate raises and percentages, let’s look at how raises affect your business’s tax liabilities.
Impact of raises on tax liabilities
Giving raises to deserving employees can be one of the best feelings for a business owner. It is a way of sharing the wealth and showing appreciation to your team. That said, tax liabilities can tamp down some of the excitement.
Withholding adjustments
As you’ve been learning how to calculate a salary raise percentage, you’ve simultaneously been calculating increases in tax liabilities. See, by raising wages and salaries, you create higher payroll taxes. These expenses bite into your profit margins through withholding adjustments — an increase in the tax debt owed for Social Security and Medicare through payroll taxes, on top of paying higher wages.
These adjustments can restrict investment opportunities in new equipment, research, or expansion. The greater expenses may also hinder recruiting and hiring efforts.
Tax bracket changes
Pay raises don’t only affect your tax obligations; they also affect your employees. While pay raises to lower-wage workers likely won’t complicate their tax filing status too much, higher-salary employees may experience a shift in their tax bracket — a range of income taxed at specific rates. Though the higher tax bracket won’t change what they’re paying on their original salary amount, employees may not realize that some of the extra money they make from a raise may be subject to a higher tax rate.
Even with more complicated taxes, raises are something to celebrate. When employees can share in a company’s profits, they typically experience higher rates of job satisfaction and happiness. That happiness can translate to greater productivity and retention rates for your business.
Considering benefits beyond salary
Monetary raises are only one option to offer. Most employees want jobs or careers that offer health insurance, retirement contributions, flexible hours, and a good work-life balance. As a small to medium-sized business owner, you might not have the capital for hefty raises, but you likely can incorporate some of these highly sought-after benefits into employee contracts.
While it’s important for an employee to understand their obligations to your company, it’s equally important for them to feel valued and seen. Offering health and retirement benefits demonstrates that you value an employee’s physical well-being. Flexible hours also show that you understand they have a life outside of work.
By combining a fair salary with benefits, you can increase the morale of your workforce. Employees who love their jobs and company are more productive and often better with customers, which can improve brand image and reputation.
Bottom line: how to figure a salary increase percentage makes good business sense
Rewarding top-performing employees with a salary raise for a job well done can benefit everyone at an organization. On one hand, it helps employees feel appreciated and keeps them looking for ways to contribute to an organization. For employers, it can help keep longstanding employees from looking at other job opportunities and have an overall positive effect on work culture.
With most in-house payroll software, you can calculate and make salary adjustments in just a few easy steps, customize pay structures, and even integrate other HR functionality. Best of luck as you keep growing your team in the year ahead and our team is ready to answer your questions!
