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What is a Retention Bonus? (How It Works, Plus Another Option)

By:
Ryan Shank

A retention bonus is one of the ways in which an employer can retain valuable employees through financial incentives. It can be difficult to find top talent in your industry, and once you do, you want to keep them.

Retention bonuses and employee incentives are great ways to attract and keep quality employees. High employee turnover can impact the morale of the remaining employees, ruin your company's reputation, and the constant training of new staff can become costly.

In this article, we'll discuss how retention bonuses work, the benefits, as well as how profit sharing can be a better option for employee retention.

Key Takeaways:

  • A retention bonus is a financial incentive to retain certain employees in your company.
  • Most retention bonuses have a retention period attached to them, and the employee gets paid when the period has passed.
  • Profit sharing is a good alternative to a retention bonus.
  • Other ways to retain staff include competitive salaries, perks, and flexible working conditions.

What Is A Retention Bonus?

A retention bonus is a financial incentive for employees at a company that offers them additional payment on top of their salary. The goal of employee retention bonuses is to keep employees satisfied so that they stay with the company.

Employers offer a retention bonus on top of an employee's salary to reduce turnover at the company and minimize disruptions due to rehiring new staff. It also serves to prevent staff from being poached by competitor companies.

Retention bonuses are most often offered during critical times when there are significant changes in the company, such as during a merger, acquisition, or an important project.

Employee retention bonus plans are more common in larger companies with thousands of employees, across a variety of industries. These bonuses are typically offered to a top-level or key employee who will be costly to replace.

How Retention Bonuses Work

Now that you know what a retention bonus is, let's discuss how this type of bonus works.

Unlike most employee incentives, retention bonuses are not directly attached to employee performance.

These bonuses are, instead, provided to valued employees to prevent them from leaving should another offer come around.

Common Structures for an Employee Retention Bonus

As a general guideline, companies tend to offer a retention bonus with the value of 10% - 25% of the base salary.

The bonus amount can be paid out as a lump sum payment, or as phased payments over the retention period. Payments can be either cash or as an equity distribution.

In terms of lump sum payments, retention bonuses can be paid at the project completion date (if you wish to only retain the employee for the duration of the payment) or on work anniversaries.

If the company is undergoing change, such as a merger, then the payment can be made at the start of the process.

Key Considerations: Who to Make Eligible and How Much Do You Give?

There's no single rule around who is eligible to receive a retention bonus - it is up to the company to stipulate eligibility criteria

However, there are usually some general conditions that must be met:

  • Employee is employed full-time or works part-time for at least 30 hours a week.
  • Employee has been at the company for several months.
  • Employee has the desired skill level and experience for their role.
  • Employee stays for the specified retention period.

Retention bonuses are most commonly offered to highly skilled or senior employees; however, all levels should be considered - especially if there is growth potential.

A company will usually have a contract in place that regulates the retention bonus. This contract will detail the payment schedule, the amount payable, a non-disclosure agreement, and a clawback clause.

The latter is a clause that states the employee must repay the bonus amount in full, or a pro-rata portion thereof, should they leave the company before the retention period is over.

To calculate the employee retention bonus, you need to consider the following:

  • How much excess cash do you have to spend on financial incentives?
  • Which positions in the company warrant a bonus?
  • How long is the retention period and how will the duration influence the bonus amount?
  • The employee's salary and duration of service to the company.
  • What will it cost to replace the employee should they resign?

Based on these questions, you can calculate the money that can be allocated toward retention bonuses.

Benefits Of Offering Retention Benefits

Retention bonuses are an effective way to reward employees and instill company loyalty. This type of financial incentive holds benefits for both employers and employees.

To the Employer

The single most important benefit of a retention bonus is to retain a key employee. By keeping that specific employee, the company enjoys other benefits:

  • Motivate an employee, resulting in better operational results
  • Retain a project team for the duration of a project, ensuring continuity
  • Deny its competitors the acquisition of a skilled employee
  • Reduced staff turnover which boosts company morale
  • Lower recruitment and training expenses
  • Provide consistency for external stakeholders (especially important during a merger or acquisition)
  • Reward employees with a one-time payment without having to increase salary expenses
  • Safeguards intellectual property

To the Employee

Naturally, an employee will also benefit when they receive retention pay.

The main benefit for employees is the financial benefit of receiving a cash bonus in addition to their salary. A retention bonus can create trust between the employee and the company, making them feel like they are a valued part of the team.

This can make them stay with the company even after the retention period ends.

Pitfalls Of Retention Bonus (What To Look Out For)

Although retention bonuses seem to hold mainly benefits, there are some disadvantages that the company must be aware of.

Cost Implications

A company should only offer retention bonuses when it is in a financial position to do so. However, you'll also have to measure up the cost of offering the retention bonus versus the cost of recruitment and training (not to mention the risks of the project failing), should the employee resign.

Impact on Workplace Dynamics

There's a reason that most retention bonus contracts come with a non-disclosure clause. Should other employees find out that their colleague is being favored and receiving financial incentives and they're not, it can drastically impact team dynamics and decrease morale.

When you open a financial incentive to just one person or a select few employees, you open yourself up to criticism from other staff members.

You also need to understand that a retention bonus can't fix underlying problems. It won't replace fair pay, salary increases, or unsafe working conditions. A retention bonus should only be used to reward and motivate employees, not to make up for other areas where your company is lacking.

Legal and Tax Implications

It would be beneficial to consult the advice of a tax professional when it comes to retention bonuses and tax.

The IRS treats retention bonuses as supplemental wages - an amount paid in addition to an employee's base pay. Taxes can be added to the retention bonus using two methods.

  1. Percentage method: The retention bonus paid is separate from the salary, and taxed at a 22% flat rate. If the bonus pay is more than $1 million, it's taxed at 37% (data provided for 2024).
  2. Aggregate method: This method is applied when the employer withholds tax. The retention bonus and salary are combined in a single payment. You can use tax form W-4 to figure withholding.

Retain Employees A Better Way: Profit Sharing

Profit sharing is another financial incentive that employers can offer their employees.

With a profit sharing bonus, employees receive a portion of the company's profits, depending on the profitability of the company and the profit sharing calculation used.

This cash benefit is also paid in addition to the employee's salary, and can take the place of a retention bonus, as it has many of the same benefits:

  • It boosts employee motivation, encouraging staff to contribute to the company.
  • Companies with a profit sharing plan will attract top talent.
  • Easily retain skilled employees as they benefit when the company is successful.
  • Profit sharing contributions are tax deductible for employers.
  • Motivated employees tend to work harder, helping the company grow.

Setting up a profit sharing plan

  1. Determine your profit sharing calculation and what portion of the profits you wish to share. We can help you determine how to calculate profit sharing bonuses.
  2. Determine eligibility criteria. This can relate to job performance, time with the company, hours worked, or certain positions.
  3. State when profit sharing payments will be made - annually, quarterly, etc.
  4. Create a clear and transparent guidance document so that everyone is aware of how profit sharing works and how to become eligible.
  5. File Form 5500 with the IRS.
  6. Constantly track company performance as well as the profit sharing document to see whether the current scheme is working.

To help you get started, you should download ShareWillow's free Profit Sharing Plan Template. This spreadsheet template and guide will give you everything you need to set up your own profit sharing scheme.

Other Ways To Retain Employees

Although a retention bonus is one of the most common methods in which companies retain employees, as discussed above, it is not the only way, with profit sharing another great alternative.

Below are some other employee incentive ideas an employer can adopt to retain staff.

1. Competitive Base Salaries

Bonuses will only get you so far - you also need to offer a competitive and fair base salary. A proper compensation plan will let your employees know you value their time.

Employees should receive a salary or wage that covers the basic cost of living and is adjusted for inflation.

You should also research what salaries your competitors are offering their staff to ensure you're offering competitive wages. If your base salary range is less than that of your competitors, you're likely to lose staff to them.

2. Flexible Work Arrangements

Whether you opt for flexible hours or a hybrid work arrangement, employees value flexibility so that they can find hours or settings where they can be most productive.

Remote work is no longer a foreign concept, and many employees find they are more productive working from home than in a stiff office setting.

By allowing employees to set their own schedule (both in terms of the hours of work and the location), you're more likely to retain happy team members.

3. Recognize Hard Work

The two best ways in which to recognize hard work is through financial rewards such as a performance bonus and social recognition (e.g. an employee of the month program).

Perks for hard work can include public recognition, additional time off, cash, or gift cards. These simple gestures will not only motivate employees to work harder but also make them feel like valuable members of the team.

4. Comprehensive Benefit Packages

Perks do not only have to include cash. You can offer employees a comprehensive benefits package that includes healthcare, a retirement plan, car rentals, WiFi or cell phone payments (if working remotely), and covering the cost of the commute to the office.

5. Professional and Personal Development

Training is essential to not only upskilling your workforce but also showing you care about their development.

A company with a low employee turnover will continuously invest in training within their field. This will not only make employees more adept at their jobs but also show them you have a vested interest in their growth.

Retention Bonus Examples

Let's look at how companies in different industries use retention bonuses to retain staff. Unfortunately, companies do not freely disclose their retention strategies, so the examples below are industry and situation-specific, not company-specific.

1. Healthcare

During the recent COVID-19 pandemic, a lot of pressure was placed on the healthcare system.

Healthcare facilities and departments quickly started offering a retention bonus to their staff. Here are some examples:

2. Technology

2023 was a hectic year for those in the tech industry. The release of OpenAI's ChatGPT3 in March 2023 caused what can only be described as an "AI boom".

Many companies quickly started offering retention bonuses to their developers and software engineers.

This is not the first time this has happened in the IT industry. In 2019 there was a short supply of IT experts, with tech companies offering elaborate retention bonuses and other incentives to retain staff.

3. Finance

The finance sector is highly competitive, with companies constantly vying for top talent. Private equity firms and investment banks frequently offer retention bonuses to incentivize financial analysts to stay at the firm or bank.

Retain Top Talent With Profit Sharing With Our Free Profit Sharing Template

If you're interested in retaining employees, consider implementing a profit sharing plan. This benefit will not only satisfy employees with a once-off bonus - instead, employees will feel valued every day as they share in the company's profits.

Our free profit sharing template is a good place to start or check out the many solutions we have available for companies interested in profit sharing. We have plenty of resources, including guides and case studies, to help you manage a profitable company with a low staff turnover.

ABOUT THE AUTHOR

Ryan is the founder of ShareWillow. He's passionate about helping businesses create incentive plans that motivate and reward employees. He previously built and sold PhoneWagon.

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