A 12-Step Guide to Running an Annual Compensation Cycle

A compensation strategy can quickly become outdated. The market changes, your business goals pivot, and your workers get itchy feet and want to earn more money at a rival company.

This guide explains how to maintain a fresh approach to pay by conducting an annual compensation review cycle. We’ll discuss the core components of a comp cycle, the 12 steps involved, and the overarching benefits of committing to this process.

Key components of an annual compensation review cycle

A successful compensation review cycle is built on a clear structure and repeatable steps. These four core components provide the foundation for equitable, data-driven pay decisions year after year.

Market benchmarking and salary data analysis

The compensation you offer within your organization is relative to how well the rest of the market pays their staff. Employees are naturally influenced by salaries and may move to another employer if you don’t offer sufficient compensation.

Benchmarking your internal compensation packages according to external market trends enables your company to remain attractive and identify any instances of over- or under-paying employees relative to their peers.

To do this, learn more about how to use salary benchmarking tools in our comprehensive guide.

Performance and merit-based adjustments

Some companies choose to link compensation increases directly with performance evaluations. That way, they can reward high performers while sending a clear message—those who contribute effectively in their roles will receive generous compensation.

A performance-based approach to pay requires careful consideration, as you’ll need to balance compensating the shining stars on your team with internal budget constraints. A merit matrix supports this work by outlining specific performance metrics and corresponding pay increases. HR can use this tool to ensure balanced evaluations across the organization, promoting a culture of transparency and fairness.

Equity and internal pay parity

In 2025, women worldwide earn approximately 77 cents for every dollar earned by their male counterparts. The gap widens for Black, Latina, and Indigenous women, who must work even further into the year before reaching pay parity.

Pay equity audits are essential to any comp cycle, providing a level playing field across roles, levels, genders, and regions. This process strengthens DEI commitments and enables structured pay decisions across managers and departments.

Budget planning and forecasting

Without a clear budget, compensation adjustments can derail business planning or create inequities. Smart forecasting keeps your company competitive and financially disciplined, using modeling to test out different scenarios, such as compensation based on performance tiers.

You’ll partner with finance teams to create a realistic and sustainable plan and allocate salary and bonus budgets by department or team.

Step-by-step guide to running a compensation review cycle

An effective compensation review cycle connects your people strategy to your business goals. This step-by-step guide walks through how to turn your into action, from data collection to communication and continuous improvement.

1. Review your compensation philosophy and strategy

Start by checking that your current approach to compensation is still valid. As a best practice, it’s worth aligning cross-functionally across HR, finance, and diversity teams at this stage. You’ll likely be balancing multiple goals, but work through these questions to check your top priorities:

1. What’s our overall people strategy, and how should compensation support it?
2. Do we want to lead, match, or lag the market?
3. How important is internal equity vs. external competitiveness?
4. Will we tie pay to performance? If so, how?

2. Update your compensation philosophy document

Ideally, your company’s point of view on compensation will already be documented as a clear, written philosophy that includes the following points:

• Pay positioning, for example, "We aim to pay at the 75th percentile of the market."
• Reward criteria, including performance, skills, experience, potential, tenure, etc.
• Pay mix, such as how much of total comp is base vs. bonus vs. equity
• Equity commitments include geographic differences, gender or race, pay equity, etc.

You might use this document as an internal policy or a manager-facing playbook, or you could even publish it online to strengthen your employer brand with your transparent approach to pay. Whatever your approach, use your compensation review to double-check that the document is still valid and make any necessary tweaks.

3. Evaluate your compensation structures

Review the operational translation of your philosophy by defining how you structure pay across your org chart, for example, using:

• Compensation bands (salary ranges) by level and function
• Job architecture or leveling frameworks that define role scope and expectations
• Bonus eligibility criteria as required
• Equity grants for startups

4. Align with finance on budget guardrails

Partner closely with your finance team to understand available budgets and forecasting constraints. Regardless of your approach in past review cycles, you may need to renew your clarification on:

• Overall % of payroll allocated to increases
• Headcount growth plans
• Bonus and equity pools
• Budget allocation methodology by team, level, region, etc.

5. Define the review timeline and responsibilities

A well-defined timeline keeps your compensation review cycle on track, minimizes bottlenecks, and provides clarity for stakeholders so they know when and how to participate. Most cycles take place over several weeks and involve multiple layers of collaboration, especially across HR, finance, and department leadership.

Here’s a typical timeline and breakdown of responsibilities:

6. Gather compensation and performance data

Before you can make informed, equitable compensation decisions, you need a complete and up-to-date view of both compensation and performance data. This step forms the entire review cycle’s foundation, so adjustments are based on facts rather than gut instinct or guesswork.

You’ll want to centralize all relevant data sources into a single system or dashboard, making it easy to review and reference during the calibration and approval stages.

Types of compensation data to collect

• Total compensation package: Base salary, variable pay (bonuses, incentives), equity grants, benefits, and any non-monetary perks
• Current compensation bands: Where each employee currently sits within their salary range by role, level, and location
• Salary history: Past increases, promotions, and bonus payments to identify trends or red flags
• Job level and role classification: To ensure accurate benchmarking and objective comparisons across peers

Types of performance data to collect

• Most recent performance ratings or evaluations: Pull from your latest review cycle (or multiple cycles if using a rolling review model)
• Manager feedback and 360 reviews: Qualitative input to complement numerical ratings, especially for team dynamics or leadership potential
• Goal attainment or KPIs: Where applicable, objective metrics tied to individual or team performance
• Promotion or role change history: To contextualize recent performance or scope increases

Best practices for data handling

• Maintain data integrity: Work with HR ops or people analytics to clean up any errors, duplicates, or missing records before the compensation cycle starts
• Keep data centralized and secure: Use a trusted HRIS or compensation platform, like Deel Compensation, to minimize the risks of working across spreadsheets
• Normalize ratings across teams: If using performance scores, ensure calibration is applied across departments to prevent rating inflation or anomalies.

7. Benchmark against market salary trends

Market benchmarking compares internal compensation data to external market rates to check your pay remains competitive and aligned with industry standards. Salaries shift quickly in the talent market, making this a critical step in a compensation review cycle.

There are three main ways to gather benchmark data: software platforms, third-party services, and manual research. The right option depends on your company’s size, complexity, and available resources.

Manual benchmarking

Best for: Startups and small HR teams seeking quick insights without the overhead of formal tools

This approach involves scanning job boards, open-source salary tools, or industry forums to get a directional sense of market pay. It’s a free but laborious approach that can detract from more value-adding work.

Third-party benchmarking services

Best for: Large or scaling companies that need strategic support, deep analysis, or formal comp design

Consultants and compensation survey providers deliver validated, high-integrity market data, often tailored to your industry or company stage. These services can be expensive but may suit organizations building or auditing comp structures.

Benchmarking software

Best for: Mid-sized to enterprise companies looking for scale, speed, and self-service insights

These platform-based tools offer dynamic, real-time access to salary benchmarks across roles, levels, and locations. Many integrate directly with your HRIS or payroll data, making it easy to visualize gaps and align pay with the market.

8. Establish pay adjustment guidelines considering available budgets

Once your compensation strategy and market benchmarks are in place, the next step is to apply the “rules” from your compensation philosophy to shape practical, scenario-based guidelines your managers can follow during the cycle. These guidelines directly inform your calibration sessions and final decisions.

Clarify which types of compensation changes are eligible during this cycle. Common examples include:

• Merit increases tied to performance ratings
• Market adjustments to bring pay in line with external benchmarks
• Cost-of-living adjustments (COLA) for inflation or location-based discrepancies
• Promotions reflecting expanded scope or new titles
• Equity refreshers to reward retention or recognize critical talent

Also, clarify timing rules. For example, some companies handle promotions and equity off-cycle, while addressing merit and market adjustments during the annual review. Others combine everything into one consolidated review cycle. Either way, setting expectations upfront achieves balance and avoids confusion during approvals.

9. Conduct manager calibration meetings

Calibration meetings are a critical step to keep compensation decisions structured across teams. They identify disparities, eliminate bias, and check all managers apply performance ratings and pay recommendations equitably.

HR leads these sessions as facilitators so the process runs smoothly and in sync with your compensation philosophy, budget constraints, and internal equity goals. Manager training beforehand sets the stage for a productive, data-informed discussion.

10. Finalize pay adjustments and gain leadership approval

Once you’ve completed the calibration, compile all recommended changes and conduct a final review with senior leadership. This step synchronizes overall budget targets, business goals, and any last-mile equity checks. Leadership approval also creates accountability and reinforces balance before moving into employee communication.

11. Communicate salary adjustments to employees

How you communicate compensation outcomes delivers as much impact as the adjustments themselves. Even when increases are modest or not applied, a clear communication plan builds trust, reinforces fairness, and reduces confusion or speculation. A strong communication plan includes:

• An executive announcement or all-hands update explaining the compensation review process and timeline
• Email or intranet content that reaffirms your compensation philosophy and explains the types of adjustments that may occur
• FAQs or help guides for employees outlining how compensation decisions are made and where to go with questions

Managers play a central role in compensation conversations. Equip them with the tools and talking points they need to explain outcomes clearly, accurately, and with empathy. Miscommunication or uncertainty at this stage can erode trust, even if the comp decision itself was fair. Provide managers with:

• Individualized compensation change summaries
• Conversation guides or scripts
• Guidance on handling difficult conversations, such as no-raise situations
• Answers to common employee questions

We recommend holding comp conversations 1:1 and framed within the broader context of performance, development, and future opportunities. Each discussion can cover:

• The specific adjustment (or lack thereof)
• The rationale behind the decision, based on performance, market data, or role changes
• How the employee fits within their compensation band or market positioning
• Reaffirmation of their value and future development opportunities

12. Document and analyze the process for continuous improvement

The compensation review cycle doesn’t end once salary adjustments are communicated. To improve outcomes year over year, it’s essential to reflect on what worked, what didn’t, and how employees perceived the process.

Start by documenting each phase of the cycle, including data collection, calibration, approvals, and communications. Capture lessons learned from HR, finance, and managers while the experience is still fresh. Note any pain points, time sinks, or inconsistencies to improve on next time.

Then, close the loop with your people. Use surveys to understand how compensation decisions were received, whether communications felt clear and fair, and how employees feel about pay transparency and equity overall.

Why annual compensation reviews matter

Compensation reviews certainly require some prep work and an investment of resources. But they’re worth it for the following reasons:

Boosting performance

Regularly evaluating compensation and keeping it unbiased for all workers can boost your team members to excel in their roles. This is especially true if you link performance metrics to compensation increases.

For this reason, 90% of sales reps and 92% of sales managers cite clear visibility into compensation as a key driver of performance. The more they understand how pay is calculated, the more they want to achieve.

Raising retention and staff satisfaction rates

Money matters. 64% of employees are open to seeking new job opportunities, with better compensation cited as the top reason to move on from their current employer. This drive is unsurprising, given that 34% of employees struggle to pay their bills each month, according to the Achievers Engagement and Retention Report.

You can offer a broad selection of perks, benefits, and professional development opportunities, but base pay will always be the priority if your workers can’t afford their mortgage. Bringing your compensation packages in line with market value will alleviate their financial concerns and retain your top talent.

Achieving compliance with pay transparency and equity regulations

Global momentum around pay transparency and equity is reshaping how companies handle compensation. An annual compensation review cycle is a natural opportunity to align with these evolving requirements and reduce risk. Some of the key regulations to watch include:

• EU Pay Transparency Directive: Requires salary range disclosure in job postings, gender pay gap reporting, and employee access to pay data across all EU member states
• California Pay Data Reporting (SB 973): Requires employers with 100+ employees to report pay by job category, gender, and race to the state annually. Employers must also include salary ranges in job ads
• New York State Pay Transparency Law: This law requires employers to include minimum and maximum salary ranges in all job postings and internal promotions. Failure to comply will result in penalties
• Colorado Equal Pay for Equal Work Act: This is one of the most comprehensive U.S. laws, requiring salary ranges, benefits details, and promotional opportunities in all job postings
• Washington State Pay Transparency Law: Similar to NY and CA, this law requires employers to include salary ranges and general benefits in job listings; it also applies to remote roles if the company has WA employees
• UK Gender Pay Gap Reporting: This law requires companies with 250+ employees to report annual gender pay gaps; expansions to race and disability gap reporting are expected in 2025

Streamline compensation management with Deel Compensation

Running an annual compensation review cycle requires precision, cross-functional alignment, and a strong foundation of data and strategy. Deel Compensation is a purpose-built compensation management software that helps HR and finance teams manage compensation cycles with greater speed, accuracy, and transparency.

Whether building compensation bands, managing approvals, or ensuring pay equity, the platform centralizes every step of the process so you can move from spreadsheets to strategy. With Deel Compensation, you can:

• Automate data collection and benchmarking across global roles and regions
• Align pay decisions with performance data and compensation policies
• Run calibration sessions with built-in guardrails and equity insights
• Equip managers with the tools they need for confident pay conversations
• Stay compliant with evolving pay transparency regulations around the world

Ready to simplify your next compensation review cycle? Request a free Deel product demo today.