Key takeaways
What are employee bonuses?
Employee bonuses are financial rewards employees receive in addition to their regular paycheck. Most bonuses fall into one of two categories:
- Discretionary bonuses, which are determined entirely by the employer.
- Non-discretionary bonuses, which are determined by an employee’s compensation package or contract.
In either case, bonuses may be awarded based on individual achievements or company-wide milestones. Similarly, bonuses can be monetary in nature — usually lump sums that are added to an employee’s regular paycheck — or they may be non-monetary rewards such as stock options or extra PTO. The right bonus structure(s) for your company depends on what will be most effective for motivating and rewarding your employees.
10 types of employee bonuses
There are 10 types of employee bonuses you’re most likely to encounter:
| Discretionary | Non-discretionary |
|---|---|
| 1. Performance bonuses | 6. Sign-on bonuses |
| 2. Spot bonuses | 7. Profit-sharing bonuses |
| 3. Non-cash bonuses | 8. Retention bonuses |
| 4. Holiday bonuses | 9. Referral bonuses |
| 5. Annual bonuses | 10. Commission |
Discretionary bonuses
1. 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.
2. Spot bonus
Spot 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.
3. 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.
Flexible working arrangements are another form of non-cash bonus, especially with today’s ever-growing remote workforce. This type of bonus is a common reward in employee-of-the-month programs but may be awarded at other times too.
4. 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.
Some organizations will issue holiday bonuses to the entire organization, while others reserve those end-of-year bonuses for leadership/management-level roles.
5. 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.
An annual bonus that ranges from 5%–10% of an employee’s yearly salary is standard for many industries, but ultimately it will be at the discretion of leadership to decide what’s an appropriate amount based on overall company performance, economic conditions, etc.
Nondiscretionary bonuses
6. Sign-on bonus
Sign-on 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 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. 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.
8. Retention bonus
Retention bonuses are offered to employees to encourage them to stay instead of seeking employment elsewhere. Retention bonuses are normally included in the employee’s contract upon hire, detailing financial incentives for each milestone that they hit with the company—five years, 10 years, etc.
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 duration; they must stay within the company in order to claim it. In this scenario, the bonus could be considered discretionary, as it would likely not have been included in their original 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. Commission
Commissions are payments that employees earn for the sales they close. In certain professions, commissions make up the 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. The most common commission structures include the following:
- Straight Commission: Earnings = Sales x Commission Rate
- Base Salary Plus Commissions: Earnings = Base Pay + (Sales x Commission Rate)
- Residual Commission: Earnings = Customer Payment x Commission Rate
Looking to implement a global benefits program to expand your international operations? Check out our global employer benefits guide for more information.
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 and satisfaction, 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 efforts.
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 and satisfaction
Annual and holiday bonuses recognize the contributions each employee makes to the company’s success and motivate staff to keep up the good work going into the new year. Other types of bonuses, like spot bonuses and non-cash bonuses, encourage employees to be engaged with their work and make them feel both seen and appreciated for a job well done. Bonuses can improve employee morale and lead to higher productivity and greater pride in their contributions to your organization as a whole.
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, especially when it comes to their effectiveness, consistency, and tax implications in some cases.
Ineffectiveness
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, bonus structures that are tied to variable external factors, like annual company profits, tend to yield inconsistent returns for employees. They might get a really big cash bonus one year and no cash bonus the next, which often breeds frustration and resentment.
If bonuses aren’t the right answer, here are some resources that will help you determine what approach is most effective for motivating your team:
- Top 4 Examples of Employee Incentive Programs
- Top Employee Reward Programs & How to Implement Them
- How to Measure Employee Satisfaction: Key Metrics for 2024
Tax implications
Bonuses are considered part of an employee’s income and therefore are subject to special tax withholding requirements that risk significantly reducing the amount of money employees receive. The IRS typically considers bonuses to be “supplemental wages” and therefore 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 implement an employee bonus program
The best way to determine the right bonus structure for your company is to research other employers’ offerings, consider your company values and business goals, and get an understanding of what ultimately motivates your employees to succeed.
See what your competitors are offering
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 ensure 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 make sense to build out a strong commission structure that will 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.
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