If you are struggling to understand the difference between merit pay vs incentive pay, let us break it down for you.

The terms ‘merit’ and ‘incentive’ pay are often used interchangeably because of their similarities. Just like incentive pay, merit pay motivates employees to be more productive as they are compensated based on their performance. However, there are key differences that can distinguish them.

Let’s look at what makes merit pay different from incentive pay so that you know which one you should implement to reward your employees.

Merit Pay Vs Incentive Pay: The Key Differences

Merit Pay

One of the main aspects that differentiates merit pay from incentive pay is that merit pay is a permanent increase in your employees' salary or wage. Incentive pay is generally a one-time reward.

Since merit pay is a permanent increase in employees’ pay, it serves as a strong motivator. Employees work to improve their performance so they receive a raise.

Merit pay is generally controlled by management because it can be subjective.

If a manager notices that an employee is performing better than another, that employee may receive higher compensation through merit pay. Supervisors can recommend an employee for a merit award but the final decision usually comes from the HR department.

The effectiveness of merit pay as a tool for enhancing individual performance is debated, with only 20% of employers considering it effective.

All employees should have an equal opportunity to earn merit pay. When a company is performing well, merit pay can be offered more often. It can also be scaled back when there is an economic downturn and profits decrease to preserve cash flow.

Related: How Does Merit Pay Differ From A Bonus?

Incentive Pay 

Whereas merit pay is an individual employee reward, incentive pay can reward individuals, teams, or even the company itself.

Incentive pay can also be monetary or non-monetary. Non-monetary incentive pay includes paid holidays or memberships. 

When employees need a quick push to meet their goals or enhance performance, you can use incentive pay to motivate them as it is only a temporary reward.

In some organizations, it’s common practice to use incentive pay to reward employees when their efforts help reduce costs. The temporary nature of the incentive plan and the decrease in company costs can result in a high return-on-investment over the long run. Furthermore, the resulting increase in productivity due to incentive pay can help boost sales and overall employee engagement.

The size and function of the business determine the implementation of incentive pay. In a production-based company, incentive pay depends on the amount of production. 

Incentive pay is effective for retaining employees and signing employees to be part of your company. Merit pay, however, is only given to an employee once they have met set criteria to earn the reward. 

Related: Is Incentive Pay A Bonus (Guide For HR)

Conclusion

Merit pay and incentive pay appear to be similar on the surface, which is why people have used them interchangeably before. However, they have key differences that are important to understand.

Merit pay is an individual reward, whereas incentives can be awarded to individuals and teams. 

Merit pay involves a long term commitment but incentive pay is typically only a one-off increase in compensation and does not have long-term implications. With all these points in mind, we can confidently solve the merit pay vs incentive pay debate.