Employee Retention Bonuses: How-To Guide for Employers

Since the pandemic, the fully remote workforce has started to dwindle. As employers adopt hybrid models or bring their employees in-office five days per week, employees have had to completely readjust their schedules. Or, leave.

That's just one of the numerous changes that could occur. Mergers, acquisitions, growing pains, and company rebranding are all common disruptions that cause employees to have second thoughts about their jobs.

Employee retention bonuses are the perfect way to support your valuable employees through times of change. They're also great for rewarding loyal employees regardless of the circumstances.

What are retention bonuses?

Retention bonuses are financial incentives that encourage employees to stay with the company (and reward them for doing so). Companies typically pay them out in a lump sum or broken up into smaller, periodic payments.

  • Lump sum payments — One-time payments disbursed to employees at the beginning or end of a predefined retention period (typically 26 pay periods, or one year).
  • Smaller, periodic payments — Multiple, smaller payments disbursed throughout the retention period.

The whole point of a retention bonus is to reduce employee turnover within the organization. When an employee quits, it can cost up to 200% of their annual salary to replace them.

And, to be honest, that doesn't even factor in untold costs of lost productivity and the disruption of not having someone in that role.

So, retention bonuses make a lot of sense. It's way less costly to pay that key employee a little extra than it is to watch them go.

How does an employee retention bonus work?

Basically, retention bonuses work according to specific criteria. The employer outlines these criteria in a retention bonus agreement.

General criteria for a retention bonus are as follows:

  • The employee must remain employed with the company until a predetermined date in order to receive the bonus.
  • Or, they must contractually commit to a certain amount of time to receive it upfront.
  • To remain qualified, the employee needs to maintain a certain level of productivity and performance.
  • They must be have full-time employment status, working at least 30 hours per week.
  • The employer and employee must sign a non-compete and/or non-disclosure agreement to receive the retention bonus.

The employer calculates the retention bonus based on the employee's base pay. They disburse the funds through payroll or as a one-time payment using integrated software.

Sign-on bonuses vs. retention bonuses

A sign-on bonus is sometimes confused with a retention bonus because it sometimes requires a new hire to commit to long-term retention.

But telling a new hire, "You have to commit to 2 years with us once we hire you, and we'll give you 10% extra your first year to sweeten the pot," is not the same as offering a retention bonus.

Employers offer sign-on bonuses to new hires and they often come with no strings attached. A well-placed sign-on bonus acts like a low-cost insurance policy against employee churn in an increasingly competitive job market.

Retention bonuses, on the other hand, are for employees who have already proven themselves in the workplace (and continue to do so).

When to offer a retention bonus

Some companies choose to offer everyone a retention bonus. But most find that doesn't make financial sense.

Incentive payments like these are really more for key employees — those who are "irreplaceable" or who would hurt/derail the company if they left.

Examples include:

  • C-suite and senior executives
  • Highly skilled employees and technicians
  • Marketing managers or recruiters
  • High-performing sales professionals
  • Business-critical personnel (e.g., a product team developing a new product with a go-to-market timeline)

Companies usually offer retention bonuses when they are going through a transitional period. This could be a change in leadership, restructuring, or a merger or acquisition.

They were popular incentive programs to motivate employees during challenging times (like a pandemic).

Plenty of employers give retention pay on an ad hoc basis as well. It's a common way to sweeten the deal during the negotiation process for high-level employees.

Calculating your employee retention bonus

The bonus amount is calculated based on the employee's salary or base pay. But there are plenty of other factors that come into play as well.

  • How much can you afford to spend?
  • What positions warrant a financial reward?
  • What are the bonus amounts for each position?
  • Will others think these amounts are fair if word gets out?
  • What is the potential impact if the employee resigns later on?
  • How long is the retention period?

Most retention bonuses fall somewhere in between 10% and 25% of the employee's salary.

Let's take a look at a few brief examples of how that might look with a lump sum payment or ongoing payments.

1. Every 3 months (quarterly)

Payout Schedule: Every 3 months

Bonus Percentage: 15%

Salary in Payout Period: $20,000 ($80,000/4)

Bonus Per Payout: $3,000 (15% of $20,000)

Total Bonus after 26 Periods: $6,000 (2 x $3,000)

2. Twice a year (13 and 26 payment periods)

Payout Schedule: 13 and 26 weeks

Bonus Percentage: 15%

Salary in Payout Period: $40,000 ($80,000/2)

Bonus Per Payout: $6,000 (15% of $40,000)

Total Bonus after 26 Periods: $12,000 (2 x $6,000)

3. Lump sum payment (annually)

Payout Schedule: Annually

Bonus Percentage: 15%

Salary in Payout Period: $80,000

Bonus Per Payout: $12,000 (15% of $80,000)

Total Bonus after 26 Weeks: $12,000

Note: This table assumes the retention incentive rate remains consistent across all payment options. Adjustments would need to be made if the incentive rate varies. These tables provide a basic overview for a salary of $80,000 with a bonus rate of 15%. You will also have to make adjustments based on different rates or specific scenarios.

Tax implications of employee retention bonuses

After you have your retention bonuses calculated, you'll have to worry about taxing them. They're post-tax benefits, meaning the employer withholds tax from the bonus amount.

It's best to do this with the help of a tax professional (and a 100% tax compliant system like Compt). But, believe it or not, the IRS actually makes it pretty easy.

There are two ways to tax your retention bonus package: the percentage method and the aggregate method.

The percentage method

Unter the Internal Revenue Service (IRS), supplemental wages (including retention bonuses) are taxed at a flat rate of 22%. If the bonus is greater than $1 million, it's taxed at 37%.

Pretty straightforward.

The aggregate method

If you use the aggregate method, you'll the retention bonus onto the employee's annual salary. The adjusted annual income for that year appears on the W-4 as if their total comp was (wages + bonus).

The annual addition generally results in a higher tax rate, especially if you're offering retention pay to senior employees.

Benefits of offering retention bonuses

As with all employee perks, the benefits of offering retention bonuses go beyond numbers.

Retention bonus programs can:

  • boost employee morale and foster team loyalty.
  • help retain high-level employees in a competitive job market.
  • increase employee engagement, productivity, and performance.
  • make your company more attractive to potential recruits.
  • keep key staff members on board, especially when the company is going through a transition.
  • incentivize top performers and reward their loyalty.

When an employee leaves a company, it costs the business more than just money. Team dynamics, workflows, and morale of other employees also suffers. This takes months to recover from. And the costs are huge.

Potential drawbacks to be aware of

The success of your retention bonus depends on how effectively you actually implement it. Pay is something many employees are deeply sensitive about. Any time you provide a financial incentive to just one person, you open yourself up to potential criticism, envy, or confusion from the other employees.

Maintaining consistency to outsiders is really important when it comes to how you approach retaining top talent. A non-disclosure clause in retention bonus agreements helps, but the overarching importance here is being fair and equitable.

You should also keep in mind a retention bonus won't fix an underlying issue. It is in no way a substitute for a pay raise or fair treatment of your employees. It's a good idea to evaluate your employee's base salary before designing a retention package for them.

And, a retention bonus isn’t a guaranteed retention strategy. It’s just one component — you still need to focus (heavily) on the employee experience.

Creating and implementing your retention bonus program

Once you've done a cost-benefit analysis and understand the implications, you're ready to offer a retention bonus.

Let's take a closer look at how it's done.

1. Set up software to manage compliance.

Don't offer a retention bonus without employee bonus software. Step one is finding a platform that centralizes everything about your program (we're assuming these aren't the only bonuses you want to offer).

Some bonuses (like retention bonuses) are taxable income. Other kinds of payment are not.

Some employees are eligible for a retention bonus. Others aren't.

When the company pays out bonuses, you need to make sure the payments are compliant with tax regulations and company rules.

Even small numbers make a big difference. Plus, remembering all the eligibility rules and tracking ROI is confusing. So it’s crucial to use software that provides bonus tracking and pays employees correctly.

cough cough like Compt.

2. Determine eligibility.

Retention bonuses aren't for everyone. They're for key employees who have contributed significantly to the company’s success in any given period.

Options for determining eligibility could include:

  • Years of service (such as five or more)
  • Level of decision-making responsibility
  • Size of their team
  • Current projects they're a part of

It's best to give retention bonuses to those who have larger teams or more decision-making ability. Those are the ones who are most responsible for consistency at the lower levels.

You should also consider retaining employees who are essential to certain projects, such as a lead engineer or product developer. If they left, it could seriously derail your plans to launch.

3. Calculate the amount and retention pay timeline.

You have a few options when it comes to calculating the exact bonus amount:

  • A percentage of salary or compensation for roles with similar responsibilities
  • A fixed dollar amount based on performance or years of service
  • A mix of both methods, depending on how much

It's generally seen as more fair to use a percentage because it recognizes the value of every employee's work, regardless of pay.

When it comes to timing, you have two choices:

  • Pay out bonuses all at once (this is the more popular option).
  • Distribute them in parts over a period of time.

It's a lot easier to account for a one-time payment, and it helps your retained employe see the light at the end of the tunnel. But some companies have more success offering payments as a motivator throughout the year.

4. Create retention bonus contracts

If retention bonuses are part of your strategy, you have to create a retention bonus agreement that standardizes the process.

It should include the following details:

  • Description of the bonus (including amount and payment timeline)
  • Conditions under which the bonus can be kept or taken away
  • Any required training, certifications, etc., needed to keep the bonus
  • Tax implications for both you and the employee
  • Nondisclosure clause

It's better to create one templatized contract with blank spaces. Then, you can just plug in the details for each employee.

5. Track ROI over time.

After you launch your retention bonus program, make sure to track the changes in employee engagement and productivity after bonuses are paid out. This will help inform future decisions around how often you offer them, what amount of money you should pay out, and which key employees respond well to them.

The best way to do this is to track metrics like:

  • Average time spent on tasks.
  • Employee feedback surveys/reviews.
  • Employee turnover rate before and after the bonus program launch.

Of course, it goes without saying that financial incentives are always less costly than replacing an employee who leaves. Taking the time to optimize your program will help you stretch those benefits further.

Other strategies for improving employee retention

Employee retention is important, but a retention bonus is just a tiny piece of the puzzle. You have to do a lot more for your employees than offer the most important ones a bonus for staying.

To really improve your employee retention rate, you should focus on creating a positive work environment that celebrates success and rewards loyalty for everyone.

Here are a few places to start:

Employee surveys

The best way to know what's going on in your employees' heads is to talk to them. A confidential employee benefits survey is the best way to see what they'd like to have more of without feeling threatened.

You can measure employee satisfaction with things like salary, benefits, work conditions, and other important criteria to figure out what might be more motivating for them.

Incentives for others

Spot awards, recognition programs, and company-wide incentives are great ways for everyone to get in on the fun.

For example, you could run a month-long challenge with the sales team to reach a certain number of deals, and reward the whole team with a day out if they make it.

On the individual level, you could award the three highest performers a spiff.

Health and wellness programs

Employees care about more than supplemental wages. Employee wellbeing is, in many cases, more important.

That's why offering health and wellness benefits (such as gym memberships, fitness classes, mental health services, or nutritional education) can do wonders for employee engagement and retention.

And if you offer a health and wellness stipend? Even better.

Remote and flexible working options

Remote work isn't always a possibility, but you can still support your employees' work-life balance by offering flexible working hours, generous vacation policies, and a hybrid (in-office/from home) arrangement.

Hiring the right people from the beginning

Employee turnover and engagement are, in some ways, interrelated. When a key employee leaves, others become disengaged (particularly when that employee had a "reason" to).

Hiring valuable employees who align with your company's goals and mission will do a lot more for your retention and engagement rates than a retention bonus ever could.

This ultimately boils down your recruitment process. Ask the right questions, be clear with your requirements for the position, and set reasonable expectations for your employees.

When people leave, find out why

How employees feel when they decide to leave your organization can be more telling than a retained employee.

Exit interviews are useful for discovering the underlying causes of why people decide to leave. Ask every employee who resigns what could have made them stay. You may be surprised by the answers you get.

Compt gets your employee retention bonus paid (without the hassle)

Is a retention bonus taxable income?

Who's eligible?

Oh, shoot! I forgot to expense this 3 months ago!

We can think of a million administrative issues that come up

Our platform helps companies automate their retention bonus process, end-to-end:

  • Set up a budget and approve bonuses in minutes
  • Manage payment schedules and track bonus payments in one place
  • Leverage our robust security measures to keep data safe
  • Set rules and stay IRS-compliant

See how it works.

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