How Do Raises Work?

Navigating the process of receiving a pay increase involves far more than simply waiting for an annual review and hoping for the best. While the outcome is always a higher number in your bank account, the mechanism behind how that raise is determined, categorized, and approved reveals a lot about an organization's compensation philosophy and the current economic climate. ^[3] Understanding these mechanics is the first step toward effectively managing your career progression and negotiating effectively when the time comes.

# Raise Categories

Raises generally fall into distinct buckets, each serving a different organizational purpose, from rewarding individual achievement to managing external economic pressures. ^[2][5][9] Categorizing a raise helps clarify whether it is performance-based, equity-based, or simply an attempt to keep salaries current with inflation.

The most common type is the merit increase. This is directly tied to an employee’s performance evaluation, rewarding demonstrated value, exceeding expectations, or achieving specific goals during the review period. ^[6][9] Merit raises are usually discretionary and tied to the company’s overall budget for salary increases based on individual merit. ^[6]

In contrast, a cost-of-living adjustment (COLA) is not about individual performance at all. Instead, these adjustments are designed to help employee salaries keep pace with rising costs in the general economy, often driven by inflation. ^[2][10] If the cost of living rises by 3%, a COLA aims to grant a 3% raise so that the employee’s real purchasing power remains the same. ^[10]

Another structural change involves promotional raises. These occur when an employee officially moves into a higher-level role with greater responsibility, scope, or seniority. Because the job itself has fundamentally changed, the resulting pay increase is typically substantial compared to a standard merit increase. ^[5]

Companies also issue market rate adjustments. These happen when internal pay scales are found to be lagging behind what competitors are paying for similar roles in the current job market. If your role’s market value has increased significantly, the company might issue an adjustment to bring your compensation in line with industry standards, regardless of your recent performance review. ^[2][5]

Finally, you might encounter retention raises. These are often proactive or reactive measures taken specifically to keep a valuable employee from leaving, sometimes in response to a competing job offer or based on internal compensation analysis flagging an employee as severely underpaid relative to peers. ^[5]

# Performance Reward

Merit increases form the backbone of performance-based compensation cycles in many organizations. ^[6][9] Managers assess an employee’s contributions over a period—typically a year—and then assign a rating. That rating directly influences the percentage awarded from the company’s predetermined merit budget. ^[6]

It is important to recognize that merit budgets are finite. A company might allocate a total budget pool equivalent to 3% of the total payroll for merit increases. If this pool must be distributed, an employee receiving a rating just above the "meets expectations" level might receive a 2.5% raise, while an exceptional performer might receive 4.5%. ^[6] This means that high performers are often effectively funded by the relatively smaller increases given to those who only meet the standard. If you are performing well but receive a raise at the company average, you are likely receiving exactly what the budget allows for your performance tier, even if you feel your contribution was higher than average. ^[9]

A key distinction often made in compensation planning is between a raise that increases your base salary versus a one-time bonus. A raise, whether merit-based or otherwise, permanently changes your annual base salary moving forward, impacting future raises and retirement calculations. A bonus is a one-time payment separate from your base rate of pay. ^[6]

# Inflation Effect

When inflation rises, a salary increase that is equal to the inflation rate is often perceived as a neutral event rather than a true gain. If you receive a 3% raise, but the Consumer Price Index (CPI) for your region has increased by 3.5% over the same period, your nominal salary went up, but your real purchasing power has actually declined by 0.5%. ^[10]

This dynamic means that even solid performance raises can feel disappointing if they don't meaningfully outpace economic depreciation. This is why many employees look for COLA adjustments separate from performance reviews—they are essential for maintaining the lifestyle the current salary afforded the previous year. ^[2][10]

When negotiating, understanding this context is helpful. If your base salary has not seen an increase outside of an annual 2% merit bump for three years, while inflation has averaged 4%, you are demonstrably behind. In this scenario, advocating for a market or equity adjustment becomes a priority, as the merit system alone has failed to keep your total compensation relevant. ^[3]

# Role Promotions

A promotion is perhaps the most straightforward path to a substantial pay increase because the basis for the adjustment is the role itself, not just individual output within the existing role. ^[5] When you transition from, say, a "Software Developer I" to a "Software Developer II," your responsibilities—including technical complexity, mentorship duties, or project ownership—have demonstrably shifted upward. ^[5]

Historically, many companies anchor promotional increases to specific ranges. While merit increases might fall between 1% and 5% in a standard year, a promotion might trigger an immediate base salary increase of anywhere from 8% to 15%, depending on how far below the new salary band your previous pay was. ^[5] If your old salary was already at the high end of the previous band, the promotional raise might be smaller, but it must still place you within the acceptable range for the new, more senior position. ^[2] If the existing salary is already within the target range for the new job, the increase may be minimal, which can sometimes feel anticlimactic after a major achievement.

# Timing Approval

The timing of a pay raise is often dictated by administrative and budgetary cycles rather than pure performance timing. ^[4] Most structured raises—merit and COLA—are processed during the annual performance review cycle. This allows Human Resources and Finance departments to forecast budgets accurately for the coming fiscal year. ^[4]

However, the approval process usually involves several checkpoints. The immediate manager observes performance and typically proposes a rating and corresponding raise percentage. This proposal then moves up the chain of command for review. Finance teams must verify that the proposed increase fits within the department's allocated salary budget for that cycle. ^[1][4] HR ensures compliance with internal equity rules and established pay grades before the final compensation letter is drafted and approved by senior leadership. ^[1]

Because this process is tightly scheduled, requests made outside this annual window—often called "off-cycle" adjustments—are usually reserved for exceptional circumstances. For example, a retention raise triggered by an external offer or a mid-year promotion moves outside this standard flow because the business risk of delay is too high. ^[5]

If you are aiming for a mid-cycle raise based on new responsibilities absorbed mid-year, it is beneficial to track these added duties meticulously, perhaps documenting them in a running document. When you approach your manager, frame the discussion around the changed job scope that occurred in month six, not just the compensation you feel you deserve in month nine, making it easier for them to justify an immediate adjustment outside the established annual timeline. ^[4]

# Percentage Math

When you receive the offer, the raise is almost always presented as a percentage of your current base salary. ^[7] Knowing how to quickly calculate the resulting new salary is fundamental. The calculation is simple:

$$\text{New Salary} = \text{Current Salary} \times (1 + \text{Raise Percentage})$$

For instance, if your current salary is $$60,000$and you are offered a$4%$raise, you calculate$1 + 0.04 = 1.04$. Then,$\60,000 \times 1.04 = \62,400$. ^[7] This final number is the crucial figure, as it dictates future earnings, including the base upon which your next merit increase will be calculated. ^[3]

It is also worth noting that payroll taxes and other withholdings are calculated against this new, higher base salary, meaning the net dollar amount you take home will be slightly less than the percentage increase applied to your gross pay. ^[10]

# Future Planning

Ultimately, how raises work depends on the specific context: Why are you getting one? If your salary is moving due to external factors like inflation or market pressure, you are maintaining your position relative to the outside world. If it is moving due to merit or promotion, you are achieving internal recognition and advancement. ^[2][9] A healthy career path usually involves a combination of all these factors over time—small annual adjustments maintaining ground, punctuated by larger jumps for promotions that signal a true change in your professional value to the company. ^[5] Always check if the raise quoted is on your base salary, especially if you are also receiving a bonus or stock options, to ensure you understand the long-term impact on your earnings power. ^[6]