Q: What Does Compensation Mean?

When you think about the word “compensation,” you might think it starts and stops at each employee’s paycheck

But the compensation definition goes beyond just salary. It includes all of the expenses you pay for each employee, like health insurance, commissions, travel allowances, and any other non-cash benefits. 

What is compensation?

An employee’s total compensation is everything they earn while working at your business. 

The main benefits of having a thoughtful compensation package can include:

  • Being able to make competitive job offers, therefore attracting (and keeping) top talent
  • More satisfied, loyal, and motivated employees, which increases productivity and retention
  • Ensured compliance with state and federal laws

When building a compensation package, you’ll want to consider everything you may want (or be required) to offer your team. 

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In addition to hourly or salaried wages, types of compensation include things like: 

  • Commissions earned on a sale
  • Tips, such as for restaurant workers
  • Insurance plans, such as medical, dental, and disability
  • Retirement plans, such as 401k plans
  • Bonuses given for performance or at year-end
  • Overtime pay
  • Monetary achievement awards or merit pay
  • Profit-sharing and stock options
  • Travel allowances
  • Dependant care and tuition assistance
  • Employee assistance programs, like providing personal or work-related counseling
  • Any other non-cash benefits

What’s the difference between base pay and total compensation?

Your employee’s base pay is their wages—the amount they receive on each paycheck for the time that they worked, regardless of whether they’re paid hourly or by salary. It’s the minimum they are paid each pay cycle. 

But “base pay” doesn’t include the types of compensation mentioned above, which combine to create a total compensation package. 

For instance, employee bonuses and overtime pay may add to that base pay each paycheck. And any amount you pay for your employees’ health insurance counts as compensation, too. 

The total compensation package is the full amount of money and benefits each employee receives for working at your business.

What is a compensation philosophy? 

When you start hiring employees, it’s a good idea to decide how you want to approach compensation. 

  • What base pay will you offer for different positions and tiers? 
  • What percentage of each employee’s health insurance will you cover?
  • Do you want to offer additional non-cash benefits, like gym memberships? 

By thinking through how you plan to compensate your employees, you can develop a compensation philosophy, which will guide you as you grow your business and make additional job offers. 

Here are some questions to ask yourself while you develop your compensation philosophy.

  • How will I reward employees for a job well done? Will I offer merit pay or an awards program?
  • How do my competitors reward their employees? Can I improve my compensation package to attract more employees?
  • How will I ensure equal pay across the business, even though employees are performing different duties and may not be in the same managerial tier?
  • If I can’t offer higher salaries, can I offer other benefits that might make up the difference, like transit reimbursement, better health insurance, or gym memberships?

What should I be aware of when planning my company’s compensation package?

Deciding on a new employee’s salary can be difficult. (Use this salary formula as a starting point.) 

With so many variables to consider, planning a compensation package can be even more stressful. However, there are a few things to be aware of before you settle on a plan.

  • Federal, state, and local laws: Some states dictate which benefits you have to offer. The Affordable Care Act (ACA), for instance, requires employers with 50 or more full-time employees to offer health insurance. San Francisco requires six weeks of paid parental leave (which increases to eight weeks in July 2020). And California, Hawaii, New Jersey, New York, and Rhode Island require short-term disability insurance. Check federal, state, and local statutes for any laws that may influence the benefits you need to offer.
  • Taxes: The benefits you offer will affect your company’s payroll—and your employees’ taxes. Certain fringe benefits are taxable, and you’ll need to make sure you’re withholding the right amount of taxes on any tips, bonuses, or overtime wages.
  • Minimum wage: An important note: Just because your employees are salaried doesn’t mean you don’t need to pay attention to minimum wage. Knowing the difference between exempt and nonexempt employees is essential for developing a compensation philosophy—otherwise, your carefully laid plans may be thrown off-kilter when you unexpectedly have to calculate and pay overtime. 
  • Industry or regional expectations: Don’t forget that potential employees may be considering other job offers, and their decision may come down to the compensation package. Pay attention to regional or industry trends in compensation. For example, if it’s commonplace to offer 401(k) matching in your line of business, consider providing those same benefits. Otherwise, you may lose potential employees to your competitors.

A well-thought-out compensation package can attract better employees and ensure they stick around for longer. Think beyond the base salary—health insurance, paid time off, and fringe benefits are other factors to consider when creating a competitive compensation package. 

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