An employee retention bonus is a financial incentive used to retain talent. These bonuses are aimed at keeping employees (particularly executives or those in high-demand roles) from voluntarily leaving an organization.
Retention bonuses are among several creative ways you, as an employer, may choose to attempt to keep employees within your organization. As part of a comprehensive benefits package, bonuses can have a significant impact on retention and continuity.
After reading this article, you will have an understanding of what employee retention bonuses are, how they work, and the pros and cons of using them. Then, you can determine whether this is a compensation strategy that you wish to implement within your organization. For those employers who choose to use employee retention bonuses as an employee retention strategy, it’s important to establish how the bonuses will be calculated—there are multiple factors that must be considered, including tax implications and which types of employees should receive bonuses.
We’ll get into all of that in detail below. Keep reading . . .
What is a retention bonus?
Retention bonus agreements are incentive payments that employers can use to keep the talent of high-level executives or key employees. They are used to retain employees and their experience, expertise, and knowledge.
Often, employers use an employee retention bonus during a merger, acquisition, or period of reorganization. Organizations may use them during a critical time of growth or as a way to hire talented employees in a competitive job market. They are used both to hold on to senior executives and to prevent the poaching of talent by competitors.
Why is retention pay so important? Because employee retention is an important indicator of health at an organization—and it’s a critical way to keep costs down. Financial incentives are powerful motivators to keep employees. Talented employees in particular, may have many career options, and the retention incentive is a great way to keep needed expertise.
A retention bonus, also referred to as a stay bonus, is different from a sign-on bonus. The sign-on bonus is a payment that is paid to incentivize an employee to agree to work for a business. Sign-on bonuses may be paid as a lump sum or in installments. Some people conflate sign-on and retention bonuses, but there are differences.
However, some companies refer to a “sign-on bonus” as installments that require employees to remain for an amount of time. In these cases, the sign-on bonuses are retention bonuses.
How does an employee retention bonus work?
With a retention bonus, the organization and employee agree to specific financial terms. One determinant is the length of time an employee is obligated to remain within the organization.
The retention package will include a pre-determined sum of money, which typically includes 10 percent to 25 percent of the employee’s annual salary. In some cases, compensation also includes equity stakes in the company, where appropriate. The equity stakes may be either fixed or variable.
All of the factors in an employee retention bonus agreement are negotiable. They are usually finalized with a legal agreement signed by all parties. The agreements usually include the following:
· Employment status. This is the date on which an employee must be employed in a specific role on a specific date. This date is often referred to as the vesting date.
· Financial terms. This section determines the financial considerations provided to the employee. These terms may involve a lump-sum payment or valuation amount if equity is involved.
· Organizational financial health. There may be conditions upon which the retention bonus is paid. These are typically tied to the company’s financial health, performance, or solvency. There may also be liquidity considerations that determine if the bonus can be distributed.
· Continued employment. This clause typically indicates that continued employment is not contingent on whether the bonus is earned.
· Assignment. If the company is acquired during the terms of the agreement, then the bonus may be assigned to a different legal entity.
· Repayment agreement. Some agreements pay out the bonus in installments. This clause requires the employee to pay back bonus payments if they leave before the final payment is earned.
· Non-disclosure agreement. Employees often are required to not share details of the agreement with competitors, partners or other employees.
Who is eligible for a retention bonus?
There are no hard and fast rules about eligibility for a retention bonus. Each business will have its own criteria and guidelines for who qualifies and when.
When is a retention bonus paid out?
Each company will pay out retention bonuses on a predetermined schedule. Typically, the payout for bonuses is included in the legal contract between the organization and the employee.
A transitional period may be the end of a fiscal quarter or year. It may be the conclusion of a major project or hitting a key milestone.
For example, a major fundraising campaign may be scheduled to conclude on December 31. The bonus, if all stipulations are met, will be paid by the following February 15.
Is a retention bonus tax-free?
Retention bonuses are considered supplemental income and are, therefore, subject to taxes. The Internal Revenue Service (IRS) considers all bonuses in this way.
Supplemental wages are defined as those that are paid in addition to the regular wages an employee earns.
Retention bonuses may be taxed using one of two methods:
Percentage method
The percentage method is the more commonly desired way to calculate taxes. Employees prefer this method because it allows them to retain a higher portion of the bonus.
The percentage method uses the standardized rate of 25 percent for any bonus amounts below $1 million. For amounts above $1 million, the income tax rate is 39.6 percent.
Aggregate method
The aggregate method adds the retention bonus to the annual salary an employee receives. The new total will be added to an employee’s W-4 form.
This method often leads to a higher overall tax rate for the employee. Consulting a tax professional regarding the tax implications of supplemental income can be helpful.
How are retention bonuses calculated?
Retention bonuses may be paid out all at once or in installments. Let’s assume that the employee has an agreement that pays a 10 percent bonus on annual salary. The employee must stay for four years to earn the bonus.
In our example, the employee’s salary starts out at $200,000 annually. They earn a 5 percent raise each year. Their pay after each year would be the following:
· Year one: $210,000
· Year two: $220,500
· Year three: $231,525
· Year four: $243,101
If the retention bonus is paid after all four years of employment are completed, the bonus would be calculated as follows:
$243,101 x 0.1 = $24,310
If the retention bonus is instead paid out as a 2.5 percent bonus each year, the bonuses would be as follows:
· Year one: $210,000 x 0.025 = $5,250
· Year two: $220,500 x 0.025 = $5,513
· Year three: $231,525 x 0.025 = $5,788
· Year four: $243,101 x 0.025 = $6,077
Over the course of the four years, the total bonuses would be $22,628.
In this example, the employee would earn slightly more in bonuses when paid at the end of the four-year retention period.
Typically, retention bonuses are calculated solely on base salary. Other bonuses or compensation earned are not factored into the retention bonus calculation.
Benefits of employee retention bonuses
Retention bonuses offer benefits to both employers and employees. Whether it’s increased loyalty, better morale, or higher productivity, there are major internal benefits. In addition, you’ll see more reliable work due to strategic investments in key staff and positive ROI. Your company will be more consistent with stakeholders, yield better results and retain more employees.
Here are some of the core benefits of using a retention bonus program.
Increased company loyalty
Offering retention bonuses can instill loyalty on the part of employees. The bonus shows that the company values the contributions an individual makes to the organization. Employees who receive these bonuses are unlikely to leave before the bonus is paid.
Improved morale
Employees who feel appreciated and valued are likely to feel better about working for the organization. High levels of morale can also have a ripple effect throughout the company, affecting how other employees feel as well. Morale increases can affect the retention of all employees, not just those with retention bonus deals.
Higher productivity
Most employee retention bonuses are not tied to performance or organizational productivity. However, the bonuses may have an impact on how hard employees work and their output. This factor is especially true if the employee can be terminated for performance during the terms of the bonus deal.
Reliability
Many times, employers choose to offer retention bonuses during challenging times. By having core, talented employees committed to the company or project, there’s a reliability factor at play. Teams remain stable and consistent while the retention bonuses are at play.
Strategic investment
A key component of a retention bonus program is identifying the people and roles that are most critical to the organization’s success. This work helps your business pinpoint where investment is necessary and what the impact of a bonus program will be.
Return on investment
Companies invest lots of time and money in their employees. Training programs, continuing education, and skill-building all provide employees with valuable abilities. Retaining those employees means employers will not have to invest in new hires when an employee leaves.
Consistency to outsiders
Investors and customers want to see stability and consistency in your staff. A high employee retention rate ensures that the same key leaders are available, engaged, and connected to key stakeholders.
Better results
When you’ve invested in highly talented people, it’s likely you’ll see an impact on the bottom line. By inspiring financially motivated employees to be successful, there’s a correlated improvement in profits, revenue and growth strategies.
Retention
While it may seem obvious, one of the main reasons to offer these bonuses is to keep employees with the company. Retention is important to continuity, growth, and profits. By incentivizing staying, companies are able to provide consistent staffing and stronger teams.
Cons of employee retention bonuses
There are potential downsides to using a retention bonus strategy. They can be perceived as a way to buy loyalty while not addressing root causes of poor retention. They can create workplace conflict and hurt your recruitment efforts and reputation.
In addition, bonus programs will not safeguard against employees who are performing with mediocrity (or poorly). Employees may develop an entitled attitude or bide their time until receiving the bonus. And in the end, despite your best efforts, employees who receive a bonus may choose to leave shortly after.
Here’s a look at some of the drawbacks to retention bonus programs.
Does not address the root cause of employee turnover
Retention bonuses may prevent some departures but do not address the fundamental issues at play in an organization. Some may perceive the move as “throwing money” at a problem without understanding the main reasons people are leaving.
In addition, bonus structures are typically only paid to high-level or highly skilled employees. They are not designed to solve retention issues among low-level employees.
The best move is to implement a bonus program while also addressing core issues in the company culture that are driving retention problems.
Potential to create workplace conflict
The bonus program is sure to show some employees why they are valued by the organization. However, employees ineligible for the program may feel slighted and undervalued, leading to worsening retention issues.
Detrimental impact on recruitment
While retention bonuses can be a powerful motivator, they can also have the reverse effect. Competitors and applicants may wonder why you need such programs and why it’s hard to keep employees. Having clear reasons and talking points around the program is critical to controlling the narrative.
Bonuses may not shape job experiences
Employees leave jobs for many reasons. If the job an employee has is affecting their well-being, bonuses may not be enough to compel them to stick it out.
It’s important to look at the jobs, the role, and the work before offering a new employee (or existing employee) a retention bonus. By working with human resources to fix a job, you’re more likely to get the desired results from your bonus program.
Entitled employees
Some employees who receive bonuses may develop an entitled attitude. They know they are valued and that you want to keep them around. Security may breed cockiness or a similar attitude that can have a detrimental effect on overall morale.
Looking for a new job
Employees who are nearing the end of the retention bonus timeframe may use their time to look for their next opportunity. If they’ve already concluded they will leave when the bonus is paid, you may see a loss in productivity and morale, and they try to find a different role.
Employees may still leave
Despite the best intentions of bonus programs, employees still may leave. Other factors can lead to employees choosing to leave before a bonus is paid or soon thereafter. There are ways to structure bonuses so that leaving right after the period is over, but employees can walk away.
The budgets for these programs are not infinite, and paying employees with continual retention bonuses can be costly in the long run.
There are many good reasons for creating an employee retention bonus program. With the right approach, organizations can leverage the program to attract and keep valuable employees to address critical needs or projects.
