June 2, 2023

Employee Bonuses 101: Everything You Need to Know

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Key takeaways:

  • There are numerous types of compensation bonuses companies can give to staff.
  • Bonuses can incentivize financially-motivated employees but can also foster competition and resentment.
  • Bonuses are subject to tax withholding rules that can significantly reduce the financial payout.

Explore solutions that can help you manage your total compensation strategy in our payroll, performance management, and employee engagement software guides.

What are the types of employee bonuses?

There are several types of bonus structures that benefit and motivate employees in different ways:

  1. Non-discretionary bonus
  2. Performance bonus
  3. Profit-sharing bonus
  4. Spot bonus
  5. Non-cash bonus
  6. Sign-on bonus
  7. Annual bonus
  8. Retention bonus
  9. Referral bonus
  10. Holiday bonus
  11. Commission

1. Non-discretionary bonus

Non-discretionary bonuses are outlined in the employment contract; as long as the employee meets the stipulated requirements, the employer must pay them the bonus. Sometimes the amount or percentage of the bonus will be outlined in the contract, but some contracts may only list the prerequisites.

2. Performance bonus

Employers award performance bonuses based on tangible KPIs and overall goal progress. Most performance bonuses are awarded on an individual basis, but some highly collaborative companies prefer to award bonuses based on team performance instead. For team distributions, the bonus amount is split equally among all employees in the group to avoid bias.

3. Profit-sharing bonus

With profit-sharing plans, the employer distributes a certain percentage of quarterly or annual profits to eligible employees. The payouts may come in the form of cash or be funneled directly into the employee’s retirement savings account.

4. Spot bonus

Spot bonuses, also called discretionary bonuses, are given “on the spot” to employees who exceed their employers’ expectations — they are not based on any concrete metric or timeframe. These bonuses typically have a lower cash value than other types of bonuses and are sometimes awarded in the form of gift cards.

5. Non-cash bonus

Non-cash bonuses are any bonuses that don’t come in the form of money. Common non-cash bonuses include extra paid time off and dedicated employee parking spots. This type of bonus is a common reward in employee-of-the-month programs but may be awarded at other times too.

6. Sign-on bonus

Signing bonuses are given to employees when starting a new job and are often used as a recruiting tool. They may be paid out in one lump sum at the beginning, or the bonus payments may be spread out over the employee’s first year in addition to their regular pay. Employees who receive a sign-on bonus are often contractually obligated to stay with the company for a certain amount of time or else refund the bonus.

7. Annual bonus

Annual bonuses are given to employees at the end of a fiscal year when the company has performed well. These year-end bonuses may only be distributed if the company had a very successful year, or they may be guaranteed at the end of every year with the bonus amount varying based on annual profits.

8. Retention bonus

Retention bonuses are offered to employees to encourage them to stay instead of seeking employment elsewhere. Employers might also offer retention bonuses during mergers, acquisitions, and other major organizational changes to incentivize staff to stay. Like sign-on bonuses, this type of bonus often comes with a minimum employment contract.

9. Referral bonus

Employees can earn referral bonuses when the company hires someone they recommended for an open position. The bonus may be a flat rate, or it may vary depending on what role the person was hired to fill. Hiring managers and relatives are often excluded from receiving referral bonuses for conflict of interest reasons, and they are usually distributed after the new hire’s onboarding period has ended.

10. Holiday bonus

Holiday bonuses may be given at the end of the year and are often calculated as a percentage of each employee’s annual pay. Holiday bonus pay typically isn’t tied to either individual or business performance and is instead viewed as a “thank you” gift for the employees’ hard work that year.

11. Commission

Commissions are payments that employees earn for the sales they close. In certain professions, commissions make up a majority of the compensation package in addition to employee benefits. Workers may make a flat rate per deal or the commission may be a percentage of the overall sale. The more the employee sells, the more they make in commission.

Benefits of employee bonuses

Employee bonus programs offer unique benefits for both employees and companies. Specifically, a bonus program can improve:

  • Pay equity.
  • Employee engagement.
  • Recruitment and retention.

Pay equity

Non-discretionary and performance bonuses allow companies to reward employees based on merit, so the highest-performing employees are compensated for their effort. This creates a more equitable compensation structure and minimizes the risk of paying low-performance employees for work they aren’t doing.

Similarly, commission and profit-sharing incentives tie monetary rewards to overall company success and profits, so employees benefit if the organization does well.

Employee engagement

Annual and holiday bonuses recognize the contributions each employee makes to the company’s success and motivates staff to keep up the good work going into the new year. Other types of bonuses, like discretionary bonuses and non-cash bonuses, promote good employee behavior and make them feel seen and appreciated for a job well done.

Recruitment and retention

Bonuses act as a recruiting tool to attract top talent, and depending on the industry, some potential hires may expect a hefty bonus as part of their total compensation. Bonuses also act as a retention tool to entice employees to stay with the company and keep turnover and attrition at bay. A robust bonus program can support your talent management strategy and help your company stay competitive.

Challenges of employee bonuses

Employee bonus plans also come with certain drawbacks as well:

  • Ineffectiveness
  • Inconsistency
  • Tax complications

Ineffectiveness

For one, money may not be a strong motivator for all employees. If an employee is more motivated by team engagement or leadership opportunities than cash, then a large bonus may not be the best incentive.

Furthermore, employee incentive programs can foster competition rather than collaboration. This is especially true if an individual is given a bonus based on the whole team’s performance.

Inconsistency

Some bonus structures, especially those tied to variable external factors like annual company profits, can yield inconsistent returns for employees. They might get a really big cash bonus one year and no cash bonus the next, which can be very frustrating and breed resentment.

On the recruiting front, most potential employees focus on regular wages rather than bonuses when deciding between job offers, so a low salary combined with high potential bonuses might not be enough to sway them.

Tax complications

Bonuses also are subject to special tax withholding requirements that can significantly reduce the amount of money employees receive.

The IRS typically considers bonuses to be “supplemental wages” and subjects them to a 22% withholding rate regardless of the recipient’s tax bracket. There might be additional tax liabilities on the bonus as well.

In these situations, some employees may feel their total take-home compensation isn’t commensurate with their contributions.

How to determine employee bonuses

The best way to determine the right bonus structure for your company is to research other employers’ offerings, center your company values and business goals, and understand what motivates your employees.

See what your competitors are doing

Bonuses can be an important part of the overall compensation package, especially when it comes to sign-on bonuses, retention bonuses, and profit-sharing. To ensure your jobs stand out in a competitive labor market, research the kinds of bonuses other employers in your industry are offering, review your overall compensation package (including bonuses), and make adjustments accordingly.

Center company values and business goals

You should make sure that your employee bonus program supports your overall company values and business objectives. For instance, if your company values high collaboration, then team bonuses may be more appropriate than individual bonuses. On the other hand, if you are trying to increase sales, then it might sense to tie the bonuses to that goal.

Learn what motivates your employees

Ultimately, a bonus structure is only effective if it drives performance and motivates employees to succeed. To understand what types of incentives your staff would find most motivating, conduct a survey that gauges how they value various compensation elements. For example, if more employees prioritize flexible PTO or team bonding over direct financial compensation, a non-cash bonus program would likely be a better fit than a profit-sharing program.

Some employee engagement apps like Lattice and Leapsome offer tools that combine data from company surveys, performance reviews, and compensation reports. In turn, this information can help you create a total compensation strategy — including incentives — that makes the most sense for your business.

Explore these software guides to strategize, launch, and manage your business’s bonus program:


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