Your Employee Wants A Raise. Here Are 7 Ways You Can Afford It. Think you can't afford to pay your people more? Think again.

Your employee is asking for a raise. And you can't blame them. Inflation is running between 7-8%, and people need to, at the very least, keep up with the cost of living. This is now the norm in 2023. It's happening everywhere. Payroll company ADP recently reported that employees received 7.3% more pay over the past months — with employees changing jobs seeing more than double that amount. And many experts say that trend will continue through this year.

But giving raises is certainly easier said than done. Big companies may be able to absorb the additional costs. But if you're running a small or even mid-sized business doing so isn't so simple. The good news is that there are options. So before handing out that raise and shouldering that extra expense, here are seven things you can do that may lessen the impact.

Related: 'Ask For a Raise Now': Salaries Aren't Keeping Up With Inflation. Here's What to Do.

1. Tie the increase to performance

Consider a profit a sharing plan for your employees or a bonus tied to achieving agreed-upon goals. When someone asks for a compensation increase, this can be viewed as a mutual opportunity. You can be the one to happily agree to pay that increase — perhaps even more than what's being requested — as long as you receive something in return. People don't have to be in sales to earn a commission. You can set specific job-related goals that either increase revenues and productivity or decrease expenses so that a specific return on investment can be achieved, with added profits shared.

2. Offer more PTO and flexibility

Instead of increasing pay, consider increasing paid time off. Or provide more flexible work hours. Or maybe this is the time to implement a four-day workweek program or expanded work-from-home benefits.

Compensation does not always have to be in cash. People value their time just as much. Flexibility is important, and one of the biggest benefits of working for a small business is the ability to have that flexibility without the bureaucratic oversight experienced by employees at larger companies. Yes, paying someone not to work is still an added cost to you. But if you both agree on job deliverables, you and your employee can together make sure the work gets done on a schedule that suits you both.

Related: Employers Need Workers. Now They're Realizing The Untapped Talent of These People.

3. Pay more for health insurance

Many business owners forget that, in most cases, health insurance payments are both non-taxable to the employee while still being deductible for the employer. If you just give a salary increase, the employee gets taxed, and you have to pay employer payroll taxes. But if instead, you offer to pay more for health insurance, you both save money on taxes, and the employee gets more in their net paycheck. It's a win-win. Of course, talk to your tax accountant to make sure there are no other factors that would impose on this benefit.

4. Pass through the cost to customers

If you increase your employee's pay, you may consider passing that cost increase to your customers in the form of higher prices or fees. But be careful. You don't have to pass on the full amount of a pay increase if you can find savings elsewhere. And if you spread the cost across your entire overhead so that it's fully absorbed, you may find it easier to spread the price increase across many customers and products and therefore cushioning the impact.

5. Offer a long-term employment contract

When an employee asks for more compensation, you can also ask for something in return: a longer-term commitment. Although most employer/employee relationships are "at-will" which means that both can end things whenever they want, by entering into a longer-term contract you can not only set goals and include future benefits that can be earned, but also agree on a fixed compensation increase over the term of that contract that will enable you to better budget your future costs.

6. Do a 401(k) match

Instead of a salary increase, you can offer to increase your 401(k) retirement plan match for that employee. Not only does that employee receive that money on a pre-tax basis (which means that you can pay a lower amount to the employee). It also means more money in your employee's 401(k) account, which they can put away for retirement. You also don't fail any of the required "discrimination tests," which limits your contributions as a higher-paid employee or owner. Also, thanks to the recently passed Secure 2.0 retirement legislation, some businesses will soon receive a tax credit of up to $1,000 per employee every year for five years when they contribute to a 401(k) plan. This means you can give your employee added compensation and the government will pay for it!

7. Finally, consider an ESOP

Thanks to an aging population, there has been a significant increase in interest in employee stock ownership plans or ESOPS. So rather than dolling out increased compensation to your existing workers, you can create an ESOP where you get paid for a portion of your equity that you sell to an entity owned by your employees, and then you receive significant future tax benefits on both your payback to the bank for financing the transaction and for the income allocated to that ESOP. A great resource to figure out whether an ESOP is right for your business is here.

You're going to have to pay your employees more this year. That's a given. But just because your employees request (and need) a raise doesn't mean you have to bear the entire cost burden. There are options.