It’s budget season, which means business owners are asking a familiar question: How much should we budget for pay raises next year?
Korn Ferry’s 2026 Global Total Rewards Pulse Survey, which included more than 5,500 organizations across 135 countries, found that U.S. employers are projecting an average total salary increase of 3.3% for 2027, with a median of 3%. HR Dive’s coverage of the Korn Ferry findings provides some additional context around what employers are planning.
But, and this is important, a 3% salary increase budget does not mean every employee should get a 3% raise.
Your budget is where you start planning. How you distribute that money should depend on your business, your market and, most importantly, employee contribution.
Start With Your Business, Then Check the Market
Before deciding what you can spend on pay raises, look at what your business is actually expecting in 2027. What does your revenue forecast look like? What are your expected margins? Are you planning to hire? Are there positions you know will need to change as the business grows?
A national salary survey can tell you what other companies are planning, but it can’t tell you what your business can afford. There isn’t one magic number.
For example, Mercer’s 2027 compensation planning research projects an average 3.2% merit increase budget and a 3.5% total salary increase budget among U.S. employers. Meanwhile, WorldatWork’s 2026–2027 Salary Budget Survey projects average U.S. salary increase budgets of 3.6%.
That range can be a starting point, but it’s not the entire solution.
Start by modeling a salary increase budget against your own financial forecast. A 3% pool can be a useful starting assumption, but calculate what that means in actual dollars—and remember that the cost isn’t limited to salary. Payroll taxes and some benefit costs can increase along with compensation.
Then look externally.
Salary benchmarking should be conducted annually. Compare jobs based on what employees actually do, not just their job titles. Responsibilities, geographic market, industry and company size can all matter when determining whether you’re making a reasonable comparison. SHRM’s guidance on salary benchmarking also emphasizes looking beyond job titles to the skills, qualifications and responsibilities associated with the position.
The goal isn’t necessarily to pay exactly what another company pays. The goal is to understand where you sit in the market so you can make an intentional decision about where you want to sit.
A 3% Budget Does Not Mean 3% for Everyone
If you have a 3% salary increase budget, it can be tempting to divide it evenly and give everyone approximately the same raise. It’s easy. It feels fair. And it avoids some uncomfortable conversations.
But compensation shouldn’t simply be based on inflation or the fact that another year has passed. Compensation should be based on contribution.
That means looking at performance against goals, impact on business results, increased responsibilities and the skills and capabilities an employee brings to the organization.
Employees need to have some control over the things they’re being measured against. An individual employee may not be able to control whether the entire company hits its revenue target. They should, however, understand their piece of the puzzle. They should know what success looks like in their role, what behaviors are expected of them and what they can do to increase their contribution.
When raises are based only on the overall success of the company, you can unintentionally send exactly the wrong message. Your high performers learn that trying harder doesn’t make much difference. Your lower performers learn the same lesson. Eventually, the performance of the team can suffer because you’ve removed one of the connections between contribution and reward. That’s why merit increases should be differentiated based on meaningful performance measures employees can influence.
Interestingly, the market appears to be moving in this direction as well. HR Dive reported on Payscale’s 2027 salary budget research, which found that fewer employers planned to use across-the-board—or “peanut butter”—raises in 2027 than had used them in 2026.
Not Every Pay Increase Is a Merit Increase
Another common mistake is putting every compensation issue into the same annual raise pool.
There are several reasons an employee’s compensation might need to change, and they shouldn’t all be treated as merit increases.
An employee may need a larger increase because they have taken on significantly greater responsibilities. A promotion may move someone into an entirely different salary range. Annual salary benchmarking may reveal that a position has fallen behind the external market. An internal pay equity review may identify inconsistencies between employees performing comparable work.
Those are different compensation decisions.
Separating merit increases, promotions, market adjustments and pay equity corrections gives you a much clearer picture of what your organization actually needs to spend.
This distinction shows up in broader compensation research, too. Mercer’s 2027 survey separates merit increases from total salary increases, with total increases also encompassing promotions, cost-of-living increases and other adjustments. This is also why we recommend conducting both external market benchmarking and an internal salary equity review every year.
If you spend your entire salary increase budget giving everyone the same percentage before doing that analysis, you may discover too late that you don’t have enough left to make the corrections that actually matter.
Look for Employees Whose Jobs Have Outgrown Their Pay
Job descriptions have a funny way of staying exactly the same while jobs change dramatically. This is especially common in growing small businesses. An employee gets hired to do one thing, becomes good at it, starts solving additional problems and gradually takes on more responsibility.
Two years later, you’re still paying them based on the job they were originally hired to do.
Annual compensation planning is a good opportunity to ask whether each employee’s responsibilities still match their job description, level and pay range. If the role has materially changed, don’t try to solve that problem by simply adding another percentage point to a merit increase. Determine what the job is worth now and whether the employee’s compensation appropriately reflects it.
Build a Salary Increase Budget You Can Explain
Once you know what your business can afford and what compensation issues need to be addressed, model the full-year impact. If increases become effective partway through the year, understand both the current-year cost and the annualized cost you’re carrying into the following year. Include payroll taxes and related benefit costs where applicable. Then determine how decisions will be made.
What evidence will managers use when recommending merit increases? Who approves promotions? What warrants a market adjustment? How will you address internal equity issues?
You don’t need to turn compensation planning into an enormous bureaucracy. You do need enough structure that two managers looking at similar situations aren’t applying completely different standards. Managers need to be prepared to explain the decisions. Korn Ferry’s latest survey identified reward communication as a significant weakness for organizations and pointed specifically to managers’ ability to explain pay decisions as an important part of the process.
Don’t Waste the Raise Conversation
One of the biggest mistakes we see companies make with raises is simply not communicating enough. A raise conversation is a great opportunity to reflect on the behaviors that helped the employee and the company succeed. It’s also an opportunity to highlight the behaviors that can take both of them to the next level. Don’t reduce that conversation to, “Good news. You’re getting a 3% raise.”
Tell the employee what they did well. Connect their contribution to the reward. Explain what you want them to continue doing. Then talk about where they can have an even greater impact in the coming year. Make the connection explicit. Research on reinforcement learning and its neural mechanisms has examined how people learn from differences between expected and actual rewards and outcomes. In the workplace, the practical takeaway is straightforward: don’t make employees guess which behaviors you value. Connect your feedback and recognition to the contribution you want to reinforce.
So, How Much Should You Budget for Pay Raises in 2027?
Start around 3% if you need a reasonable assumption for your initial budget. Current national salary increase projections generally fall in the low-to-mid 3% range, giving you a useful starting point for modeling costs. But don’t stop there.
Test the number against your revenue, margins and staffing plan. Benchmark your positions against the market. Review internal pay equity. Identify promotions and employees whose responsibilities have expanded. Then determine how much of your available budget should actually go toward merit increases.
Most importantly, don’t turn your salary increase budget into an automatic raise percentage.
The question isn’t simply, “How much are we giving everyone this year?”
A better question is, “What are we rewarding, what compensation problems do we need to solve, and what can our business sustainably afford?”
That’s the foundation of a compensation plan that works for both your employees and your business.
Need help building a compensation plan for 2027?
Red Clover can help you benchmark salaries, review internal pay equity and build a compensation plan that fits your business.
