The end of a year is generally the time for business owners and managers to sit down and navigate the often difficult process of determining employee raises. There are a couple of approaches you might take when it comes to boosting salaries: You can offer your workers merit raises or cost-of-living raises. The question is: What's the right move for your business?

Merit raises

Merit raises are designed to reward employees for the work they do and the effort they put forth. To figure out how to specifically implement merit raises, you might institute a system that ranks employees from strongest to weakest based on performance, and then reward those who rank at the top of that list with the highest boosts. At the same time, you might decide that workers who underperform don't get a raise at all, since they haven't earned it.

One person handing a check to another


Cost-of-living raises

Cost-of-living raises are designed to help employees retain their buying power in the face of inflation. Since living expenses tend to climb over time, the only way to keep up is to get enough of a raise each year to match those general increases. In recent years, the typical cost-of-living raise has hovered around the 3% mark, mostly to match the general rate of inflation.

Which type of raise should you implement?

The benefit of giving out merit raises is the ability to reward strong employees who deserve the added compensation without feeling compelled to boost the salaries of workers whose performance doesn't warrant an increase. That way, your employees who put forth a strong effort will feel appreciated, and those who don't get a boost will get a much-needed wake-up call to step up their game. Merit raises can also lead to better employee retention, as those who are rewarded appropriately will be more likely to show their loyalty.

On the other hand, merit raises can be complicated to calculate and implement. You'll need to determine how to measure performance among your employees and how it correlates to actual dollars. You also might then deal with potential backlash from workers who feel they made a strong effort but weren't rewarded appropriately.

Cost-of-living raises, on the other hand, are much easier to work with. Once you determine what percentage salaries should go up by, you simply apply it across the board so that everyone's income rises proportionally. That way, all workers are treated equally, and you're less likely to run into a scenario where specific employees feel slighted.

Then again, when you give out an across-the-board cost-of-living raise, you often end up rewarding folks who don't deserve it. You also risk demotivating your top performers by treating them the same as everyone else. And unless you're particularly generous with that raise, you might have a large number of employees come back and tell you that the increase you gave out wasn't enough.

Clearly, there are pros and cons to either approach, so your best bet is to think about how much money you have to work with on the raise front and what goals you're trying to accomplish with it. If retaining top employees is a high priority, then merit raises might be the better choice. If consistency tops your list, then cost-of-living raises simplify the process and make things easier in that regard. No matter which option you choose, remember that your employees are lucky to be getting a raise at all -- even if it isn't the exact sort of boost they were hoping for.