Compensation Budgeting Guide 2025: How to Plan Salaries, Raises, and Total Rewards
Compensation represents 50-70% of total costs for most organizations, making it your largest budget line item. Yet many companies approach compensation budgeting reactively, leading to budget overruns, pay equity issues, and costly turnover.
Strategic compensation budgeting aligns your talent strategy with financial realities, ensuring you can attract and retain top performers while maintaining fiscal discipline.
This comprehensive guide covers everything you need to build a compensation budget for 2025, from determining your raise pool to allocating individual increases to managing market pressures.
What is Compensation Budgeting?
Compensation budgeting is the process of forecasting and planning all employee-related costs, including base salaries, raises, bonuses, benefits, and other rewards for a defined period (typically one fiscal year).
A complete compensation budget includes:
Direct Cash Compensation:
- Current base salaries (starting point)
- Merit increases (performance-based raises)
- Promotional increases (level changes)
- Market adjustments (equity corrections)
- Cost-of-living adjustments (COLA)
- New hire salaries (for planned headcount growth)
- Bonus pools (annual incentives)
- Commission plans (sales compensation)
Equity Compensation:
- Stock options or RSUs (for growth companies)
- Employee stock purchase plans (ESPP)
- Phantom stock or profit-sharing
Benefits (often 25-40% of base salary):
- Health insurance premiums
- Retirement plan matching
- Paid time off (PTO)
- Life and disability insurance
- Professional development budgets
This guide focuses on base salary budgeting, the foundation of total compensation planning.
Step 1: Establish Your Compensation Philosophy
Before crunching numbers, define your compensation strategy:
Market Positioning
Where do you want to pay relative to market?
Below-Market Strategy (25th-40th percentile):
- When to use: Non-profit, strong mission, excellent benefits, early-stage startup
- Cost savings: 15-25% lower than market median
- Risks: Higher turnover, recruiting challenges
- Mitigations: Equity grants, flexible work, compelling mission, career growth
At-Market Strategy (45th-55th percentile):
- When to use: Most companies, balanced approach
- Cost implications: Competitive and predictable
- Benefits: Attracts solid talent, defensible positioning
- Approach: Match market median, allow variance by performance
Above-Market Strategy (60th-75th percentile):
- When to use: Tech companies, specialized skills, talent wars, strategic roles
- Cost premium: 15-25% above market median
- Benefits: Attract top talent, reduce turnover, competitive advantage
- Justification: High revenue per employee, critical skills, growth mode
Decision Point: Choose your target percentile. This drives your entire budget.
Performance Differentiation
How much variance in raises between high and low performers?
High Differentiation (Recommended):
- Top performers: 6-8% raises
- Solid performers: 2-4% raises
- Low performers: 0-1% raises
- Spread: 6-8 percentage points
- Culture fit: Competitive, merit-based, performance-driven
Moderate Differentiation:
- Top performers: 4-5% raises
- Solid performers: 3-4% raises
- Low performers: 1-2% raises
- Spread: 3-4 percentage points
- Culture fit: Collaborative, team-oriented, balanced
Low Differentiation (Not Recommended):
- Everyone: 2.5-3.5% raises
- Spread: 1 percentage point
- Culture fit: Egalitarian (but risks losing top performers)
- Risk: High performers leave for better opportunities
Decision Point: Higher differentiation retains stars but requires strong performance management.
Step 2: Determine Your Overall Raise Pool
The raise pool is total budget available for salary increases, expressed as percentage of current total salaries.
Industry Benchmarks for 2025
Based on compensation survey data:
| Industry | Average Raise Pool | Range | |----------|-------------------|-------| | Technology | 4.0-4.5% | 3.5-5.5% | | Financial Services | 3.5-4.0% | 3.0-4.5% | | Healthcare | 3.0-3.5% | 2.5-4.0% | | Manufacturing | 3.0-3.5% | 2.5-4.0% | | Retail & Hospitality | 2.5-3.0% | 2.0-3.5% | | Non-Profit | 2.0-2.5% | 1.5-3.0% | | High-Growth Startup | 4.5-6.0% | 4.0-7.0% |
Calculating Your Raise Pool
Method 1: Market Benchmark (Most Common)
Start with industry average, adjust for your circumstances:
Base Raise Pool = Industry Average
Adjustments:
+ Premium for above-market strategy (+0.5 to 1.5%)
+ Premium for critical talent retention (+0.5 to 1.0%)
+ Premium for high market movement year (+0.5 to 2.0%)
- Discount for below-market strategy (-0.5 to 1.5%)
- Discount for budget constraints (-0.5 to 2.0%)
Example: Technology company at market positioning:
- Industry benchmark: 4.0%
- At-market strategy: +0%
- Moderate retention pressure: +0.5%
- Final raise pool: 4.5%
Method 2: Affordability-Based (Budget-Constrained)
Calculate what you can afford:
Maximum Affordable Raise Pool = Available Budget / Current Total Salaries
Example:
- Current total salaries: $10M
- Available budget for raises: $350K
- Raise pool: $350K / $10M = 3.5%
Warning: If affordability-based pool is significantly below market (more than 1%), expect higher turnover and recruiting challenges.
Method 3: Competitive Necessity (Market-Driven)
Calculate what's needed to stay competitive:
Required Pool = (Market Movement % + Retention Premium %)
Example:
- Market salaries increased 5% year-over-year
- Need 0.5% premium for retention
- Required pool: 5.5%
If this exceeds budget, you'll face tough choices: reduce headcount, accept turnover, or find budget elsewhere.
Step 3: Build Your Salary Budget Model
Create a comprehensive salary budget spreadsheet:
Current State Baseline
Start with complete employee roster:
Required Data:
- Employee name and ID
- Department and job title
- Current base salary
- Last raise date and amount
- Performance rating
- Time in role
- Manager
- Compa-ratio (salary vs range midpoint)
Calculations:
- Department total salaries
- Company total salaries (baseline for raise pool calculation)
- Average salary by role/level
- Distribution by department
Example Baseline:
- Engineering: 40 employees, $5.2M total (52% of payroll)
- Sales: 25 employees, $2.8M total (28%)
- Operations: 20 employees, $2.0M total (20%)
- Company Total: 85 employees, $10M baseline
Planned Raises
Apply your raise allocation strategy:
Merit Increase Guidelines (example for 4% pool):
- Outstanding (10% of population): 6.0% raise
- Exceeds (30%): 4.5% raise
- Meets (50%): 3.0% raise
- Below (10%): 0-1.0% raise
Promotions (separate from merit or included):
- Typical promotion increase: 10-20%
- Budget: ~2-5% of population promoted annually
- Consider: Are promotions in the 4% raise pool or funded separately?
Market Adjustments:
- Identify employees more than 10% below market (compa-ratio less than 0.90)
- Budget for equity corrections: typically 0.5-1.0% of total payroll
New Hires (growth budget):
- Planned headcount additions
- Expected salary ranges for new roles
- Start dates (prorated impact)
Budget Impact Calculations
Critical distinction: Current year vs annual impact
Employee Example:
- Current salary: $100,000
- Raise: 5% = $5,000
- New salary: $105,000
- Effective date: July 1
Current Year Budget Impact (Prorated):
- July-December: 6 months
- Budget impact: $5,000 × (6/12) = $2,500
- Total current year cost: $100K (Jan-June) + $105K (July-Dec) × 0.5 = $102,500
Annual Budget Impact (Next Year):
- Full year at new salary: $105,000
- This is $5,000 more than current year baseline
- Critical: Next year's budget must include the full $5K
Why This Matters: Organizations often budget only for current year impact, then face "surprise" costs in following year when full annual impact hits.
Department-Level Budget
Roll up to department view:
| Department | Current Salaries | Raise Pool % | Raise $ | New Total | Current Yr Impact | Annual Impact | |------------|-----------------|--------------|---------|-----------|-------------------|---------------| | Engineering | $5,200,000 | 4.5% | $234,000 | $5,434,000 | $117,000 | $234,000 | | Sales | $2,800,000 | 4.0% | $112,000 | $2,912,000 | $56,000 | $112,000 | | Operations | $2,000,000 | 3.5% | $70,000 | $2,070,000 | $35,000 | $70,000 | | Total | $10,000,000 | 4.16% | $416,000 | $10,416,000 | $208,000 | $416,000 |
Step 4: Gather and Apply Market Data
Sourcing Market Data
Compensation Surveys (most reliable):
- Radford: Technology and life sciences ($5K-15K annually)
- Mercer: Broad industries, large datasets ($3K-10K)
- Culpepper: Startups and emerging companies ($2K-8K)
- Willis Towers Watson: Executive compensation ($5K-20K)
Online Tools (use with caution):
- Payscale: Free and paid tiers, reasonable accuracy
- Salary.com: Modeled data, less precise
- Glassdoor: Self-reported, often inflated
- Levels.fyi: Excellent for tech, limited to tech companies
- LinkedIn Salary: Limited data points
Best Practice: Use paid survey data for bulk of roles, supplement with online tools for spot checks.
Job Matching
Match your jobs to survey data:
Match by Responsibilities, Not Title:
- Your "Software Engineer III" might be survey's "Senior Software Engineer"
- Compare: scope, experience, skills, reporting relationship
Adjust for Company Size:
- Large companies (1,000+ employees) pay 10-20% above small companies
- Apply adjustment factor: Small Co. × 1.15 = Large Co. equivalent
Geographic Adjustment:
- San Francisco/New York: +30-40% vs national average
- Seattle/Boston: +20-30%
- Austin/Denver: +10-15%
- Midwest/South: -10-20%
- Rural areas: -20-30%
Example:
- Survey median for "Financial Analyst" (national, mid-size company): $75,000
- Your company: Large, San Francisco location
- Adjusted market: $75,000 × 1.15 (size) × 1.35 (SF) = $116,000
Using Compa-Ratios
Compare employee salaries to market:
Compa-Ratio = (Employee Salary / Market Median) × 100
Interpretation:
| Compa-Ratio | Position | Action | |-------------|----------|--------| | Less than 85 | Significantly below market | Urgent market adjustment needed | | 85-95 | Below market | Prioritize for larger raises | | 95-105 | At market | Standard merit increases | | 105-115 | Above market | Moderate raises, earned position | | Greater than 115 | Well above market | Minimal raises, bonus focus |
Budget Allocation Based on Compa-Ratio:
Give larger raises to employees below market (compa-ratio less than 95) to bring them to competitive levels, even if performance is just "meets expectations."
Step 5: Model Different Scenarios
Create three budget scenarios:
Conservative Scenario (Budget-Constrained)
Assumptions:
- Raise pool: 3.0% (below industry average)
- Limited promotions: 2% of population
- No market adjustments
- Minimal new hires
Implications:
- Higher turnover expected (10-15%)
- Difficulty recruiting
- Morale risk
- Acceptable if: Strong culture, mission-driven, or temporary constraint
Budget: Lowest cost option
Base Scenario (Market-Aligned)
Assumptions:
- Raise pool: 4.0% (industry average)
- Normal promotions: 5% of population
- Targeted market adjustments: 0.5% of payroll
- Planned hiring pace
Implications:
- Competitive positioning maintained
- Normal turnover (8-10%)
- Can attract solid talent
- Recommended baseline
Budget: Market-competitive cost
Aggressive Scenario (Talent-Focused)
Assumptions:
- Raise pool: 5.0% (above market)
- Generous promotions: 8% of population
- Proactive market adjustments: 1% of payroll
- Accelerated hiring
Implications:
- Strong retention (5-7% turnover)
- Recruiting advantage
- High morale and engagement
- Only sustainable if: Revenue growth supports, critical talent year, or strategic investment
Budget: Premium cost
Present all three scenarios to leadership with cost and risk implications. Let business priorities dictate choice.
Step 6: Address Common Budgeting Challenges
Challenge 1: Market Moved Faster Than Budget
Situation: Market increased 6% but your pool is 3%.
Solutions:
- Option A: Adjust pool upward (requires CFO approval and budget increase)
- Option B: Target increases to critical/at-risk employees only
- Option C: Supplement with bonus or equity instead of base increases
- Option D: Accept higher turnover and adjust expectations
Best Practice: Monitor market quarterly, adjust budget mid-year if major movement occurs.
Challenge 2: Compression (New Hires Earning More Than Existing Employees)
Situation: Market increased 20% over 3 years, but existing employees got 3% annual raises. New hires earning 10-15% more than experienced employees.
Solutions:
- Immediate: Create separate adjustment budget to fix worst cases (more than 15% behind market)
- Medium-term: Larger raises for compressed employees over 2-3 years
- Long-term: Annual market reviews to prevent recurrence
Budget Impact: May need 1-2% of payroll as one-time adjustment
Challenge 3: Limited Budget, High Turnover Risk
Situation: Can't afford market raises, but losing key people.
Solutions:
- Triage approach: Give larger raises to top 20% (stars) and at-risk critical roles
- Accept losses: Budget for higher turnover in lower-priority roles
- Total rewards: Enhance benefits, flexibility, equity to offset lower cash
- Career development: Invest in training, promotion opportunities, growth
Key: Don't spread thin budget evenly—you'll retain no one. Concentrate on highest-value employees.
Challenge 4: Manager Expectations Exceed Budget
Situation: Managers promised raises before budget finalized.
Solutions:
- Prevention: Clear communication before review cycle: "Budget not final, advocate but don't promise"
- Calibration: Cross-manager calibration sessions to align expectations
- Transparency: Share budget constraints and allocation logic
- Manager training: Teach how to deliver below-expectation increases
Best Practice: Managers get targets, not guarantees. Final allocations balance manager requests with budget and equity.
Step 7: Implement and Communicate
Timeline for Annual Compensation Planning
4 months before fiscal year:
- Set compensation philosophy and strategy
- Gather market data and benchmark roles
- Establish initial raise pool target
3 months before fiscal year:
- Complete performance review cycle
- Build budget scenarios and models
- Identify promotions and high-priority adjustments
2 months before fiscal year:
- Finalize budget with CFO/executive team
- Allocate to departments and managers
- Conduct manager calibration sessions
1 month before fiscal year:
- Managers submit individual raise recommendations
- HR reviews for equity and compliance
- Final approvals and adjustments
Start of fiscal year:
- Communicate changes to employees
- Update payroll systems
- Document decisions and rationale
Communicating Compensation Decisions
Manager Training:
- How to explain raise decisions
- Connecting pay to performance
- Addressing disappointment
- Total rewards perspective (not just base salary)
Employee Communication:
- Performance review meeting (separate from raise discussion when possible)
- Written compensation letter showing old/new salary
- Explanation of how decisions were made (company-wide process)
- Context on market positioning
- Total rewards statement (salary + bonus + benefits + equity)
Key Messages:
- Pay is connected to performance and market position
- Budget constraints are real (not unlimited funds)
- Compensation reviewed annually
- Multiple factors considered (performance, market, budget, equity)
Tools and Resources
Compensation Budgeting Template
Download our Salary Planning Template to:
- Plan raises across your department
- Calculate current-year and annual budget impacts
- Track promotions and market adjustments
- Model different allocation scenarios
- Ensure you stay within budget
Features:
- Four Excel tabs including examples
- Percentage or dollar-based planning
- Automatic budget impact calculations
- Built-in formulas for prorating
Salary Survey Resources
Free/Low-Cost:
- Bureau of Labor Statistics (BLS): Government salary data
- Payscale: Basic tier free, detailed reports $200+
- Glassdoor: Free salary data (take with grain of salt)
Paid (Worth the Investment):
- Radford (Aon): Tech/life sciences benchmark
- Mercer: Broad industry coverage
- Culpepper: Startup-focused
- Willis Towers Watson: Executive roles
Compensation Benchmarking Best Practices
- Match jobs accurately: Use responsibilities, not titles
- Adjust for geography: Cost of labor varies 50%+ by location
- Age your data: Surveys are 6-12 months old, add inflation
- Use multiple sources: One survey isn't enough for accuracy
- Document everything: Save match decisions and adjustments for audit trail
Conclusion: Building a Strategic Compensation Budget
Effective compensation budgeting balances competing priorities:
- Fiscal discipline (stay within budget)
- Market competitiveness (attract and retain talent)
- Internal equity (fair and defensible)
- Strategic alignment (reward performance and critical roles)
Your Compensation Budgeting Checklist:
- [ ] Define compensation philosophy (market positioning, differentiation)
- [ ] Determine raise pool (industry benchmark, affordability, competition)
- [ ] Gather market data (surveys, benchmarking, compa-ratios)
- [ ] Build budget model (baseline, raises, new hires, impacts)
- [ ] Create scenarios (conservative, base, aggressive)
- [ ] Address challenges (compression, turnover risk, constraints)
- [ ] Implement and communicate (timeline, manager training, employee messaging)
- [ ] Monitor and adjust (quarterly reviews, market changes, turnover signals)
Download our Salary Planning Template to build your 2025 compensation budget with confidence. Make data-driven decisions that attract and retain top talent while maintaining fiscal responsibility.
Related Resources:
- Salary Planning Template - Complete compensation planning toolkit
- HR Budget Template - Full workforce cost planning
- Performance Review Templates - Link performance to compensation
- Financial Planning Templates - Budget and forecast tools
Build a compensation strategy that drives business results while managing your largest cost category effectively.