How to Budget for Pay Raises Budgeting for next year’s pay increases can be a difficult task. It depends on an endless list of factors like revenue, expenses, inflation, cashflow, business performance, individual employee performance, the economy, what your competition is doing, and even global events. A Willis Towers Watson study reported that 99 percent of surveyed employers felt obligated to hand out monetary bonuses on an annual basis. However, organizations shouldn’t increase pay just because employees are expecting it. Be intentional in your planning. Make sure your organization and your employees will benefit from the strategy to drive individual and organizational performance. To help you identify how to budget for raises next year, we’ve provided you with several elements to factor into your planning and ensure you’ve considered not only the pay increase, but also the additional costs associated with increasing pay. Cost of Living Cost of living is the bread and butter of pay increases. It reflects how much more, year over year, we pay for living necessities, such as housing, food, gas, clothes, transportation, and health care. Cost of living indexes allow you to compare the cost of living between different cities, states, and regions. Changes in the cost of living also drive the Consumer Price Index, which is how the government measures inflation and changes in the prices of goods and services. A cost of living adjustment (COLA) is an increase in income, based on the cost of living in a certain area. The Social Security Administration announces the federal cost of living adjustment on social security benefits annually, which can be a good baseline for anticipating what portion of your pay increases should be based on cost of living. The most recent numbers show a 0.3 percent increase in Social Security benefits for 2017. The 2018 increase is estimated to be significantly higher, but we’ll wait and see! If the cost of living in the nation, region, or state increases, then you should consider budgeting for cost of living raises to stay competitive and current. Individual Performance The most common type of pay increase is a combination of cost of living and merit pay, based on an employee’s performance. While a basic annual increase, accounting for cost of living and average performance, is two percent to three percent, an incentive or merit pay increase is often closer the four percent to seven percent range. The most recent PayScale Index reveals annual wage growth is up 2.4 percent this year. As you budget, are you budgeting for the same increase for everyone, or do you know you have some star performers to reward and retain? There’s a danger in budgeting just a three percent increase in compensation year-over-year, since this limits what you can provide to your top performers to retain them. Individual performance can be rewarded in many ways, and determining your basis for rewarding performance at budgeting time will help you create a better and more accurate estimate. Here are three effective ways: Traditional percentage increases can be given at any time of year—will you give them at a certain time of year or on employee anniversaries? The timing of your increases significantly affects your budget planning. Will you give bonuses? What time of year? Are they based on performance or production? If you need a certain amount of income before issuing a bonus, these are easier to plan for in your budget. If you’re giving bonuses regardless of performance or organizational performance, this is more of a fixed cost. Do you reward employees with non-cash incentives? This could include additional benefits, more time off, perks, or gifts. Ensure you’re budgeting accordingly! High-Demand Jobs In our tight labor market, there are some jobs that are in higher demand than others. That means some of your employees may warrant a higher percentage raise increase, based on their job duties, industry, and how competitive the labor market is in your area. In fact, Forbes revealed that people who stay at a job for more than two years get paid 50 percent less. Conduct some external and internal salary benchmarking and order a market compensation report from a reputable vendor for your high-demand positions to ensure your compensation package is competitive. Having your finger on the pulse of supply and demand for the jobs you’re hiring for or adding will help you keep pace with the marketplace and retain your talent. You’ll also be able to budget smartly and effectively for the next budget cycle. Turnover Did you forget to budget for turnover? You’re not alone! Just how much does it cost you to recruit, advertise, interview, hire, train, and integrate new employees? Estimates are at least 20 percent of annual pay, and more for manager or executive-level positions. Take a look at your turnover trends and what it costs in overtime, training, equipment, and recruiting dollars for you to cover for an exiting employee and adding a new one. Consider Benefit Cost Increases Increased pay can often result in increases in benefit costs. Your employees may not realize that in addition to their salary, your organization also pays for a good portion of their benefits, not to mention payroll costs, taxes, workers’ compensation, and life insurance. As you work through your labor budget, make sure to account for any increased benefits and taxes, which are based on the amount of an employee’s pay. This includes: Workers’ Compensation. State and federal income and unemployment taxes. Social Security and Medicare employer contributions. 401(k) contributions. Life and disability insurance premiums. Instead of giving out higher pay raises, one option is for your organization to boost your benefits instead. This could mean offering profit sharing, improving your 401(k) program, adding PTO benefits, increasing contributions toward health benefits, or adding perks. P.S. Did you remember to budget for your next health insurance renewal? The national trend in medical insurance premium increases has been between 5 percent and 12 percent over the last few years. This is one of the most concerning trends for U.S. businesses. Timing is everything so make sure you know at what point in your budget year your health insurance renews and that you’ve planned wisely for an anticipated increase. If you Can’t Give out Raises… Then be transparent about why you aren’t giving raises this year. It’s best to have a communication plan in place, so it’s clear to your employees the reasons why there are no raises. Is it because you didn’t perform well enough financially or other unknown expenses came up? Then communicate that, so your employees aren’t left confused, frustrated, and in the dark. Work with your Aureon HR Business Partner to determine what you CAN do if increases aren’t an option. Additional Considerations In addition to everything else we’ve covered, here are some more questions to consider when budgeting for next year’s pay increases: Did you miss the mark on this year’s compensation budget? Why? Are you appropriately budgeting for growth? Are you budgeting for employee development and training? Do you need to budget for a new location or office space? Are you budgeting for additional employees? Are there any opportunities to reduce your labor budget? Is there anything you need to do now to reduce turnover? Budgeting for raises can be difficult and stressful, but it’s helpful to determine your organization’s compensation structure and examine cost of living and other industry reports to base your employee compensation on. Whether you give out raises or not, you should always make it known to your employees that their work is valued and appreciated, and you couldn’t do what you’re doing without them. Are you ready to budget? Sarah Charlier As a Human Resources Business Partner for Aureon HR, Sarah Charlier engages directly with Presidents, CEOs, and Executive Leadership in organizations to identify and execute strategic human resources initiatives. She serves as a business partner by leading executives and managers through employee relations issues, technical labor law compliance, preparing managers to effectively manage employee performance, and creating and adapting HR processes to best serve the organization.