What are retention bonuses?

Retaining valuable employees is crucial to the long-term success of a business. During company instability, reorganization, or a competitive labor market, employers must satisfy their top talent so they don’t leave for another opportunity.

One way to keep productivity high and turnover low is by offering retention bonuses. Unlike performance-based bonuses, retention bonuses entice your most experienced and sought-after employees to remain at your company, regardless of performance. While the goal is higher retention rates, these bonuses can also increase engagement and improve morale.

In this blog, we’ll take a deep dive into retention bonuses, including how they work and their advantages. We’ll also explain how offering customized employee benefits can help you retain workers.

What are retention bonuses?

A retention bonus, also called a stay bonus or retention package, is a monetary reward employers give to key employees to entice them to remain at a company. Retention bonuses are temporary payments in addition to an employee’s regular wages. Their intent is to keep an employee at a company for a set amount of time.

The following three examples are common situations in which an employer may offer retention bonuses:

1. Competitive job markets: When the labor market is competitive, top talent may look to outside companies for better opportunities, compensation, or benefits. Retention bonuses may encourage an employee to remain at their current workplace.
2. Company changes: Major organizational transitions, like mergers, acquisitions, or new leadership can trigger vital employees to leave before the change occurs. In these situations, top-level executives may benefit from retention bonuses to help maintain management stability.
3. Special projects: Large-scale projects integral to an organization’s success can hinge on a particular employee’s efforts. Offering a retention bonus to an individual looking to leave the company before the project is complete can help ensure the company meets performance goals.

Because retention bonuses aren’t performance-based, any employee can receive one. However, most companies use strict criteria when determining bonuses and will only target the most valued, skilled, or senior employees.

Bonus amounts vary depending on the company. But most bonuses are between 10%-15% of an employee's regular salary, with more desirable employees receiving larger bonuses of between 20%-30% of their salary.

How do retention bonuses work?

Some employers may worry that an employee will accept a bonus and leave the company anyway. To ensure this doesn’t happen, most employee retention bonuses come with a written contract or agreement outlining the details of receiving the bonus that the individual must sign.

Retention bonus agreements will vary based on the company. But the items below list general items that most contracts will include:

• Financial terms: These include the total amount of the bonus, the frequency of payment (i.e., a one-time payment or small payments distributed over a specific time period), and tax implications. They can also include the employer's criteria that made the employee eligible for the bonus.
• Employment terms: These should outline how long the employee must remain at the company to receive the bonus. The date the employee must remain through, sometimes called a vesting date or retention period, should be specific. Employemnet terms should also include the employee’s job position and any projects they must complete during the timeframe. They should also provide clarification that the contract doesn’t guarantee employment after the period ends.
• Non-disclosure agreement (NDA): Many employers want to keep retention bonus offerings confidential from their competitors. So, some may require their employees to sign an NDA before receiving the bonus.
• Terms of repayment: These should outline employee obligations for reimbursement if they leave the company before the contract period ends and the employee received all or a portion of the bonus.
• Other information: Employers may add further details such as what happens with the contract if the company transitions to a new owner, how or if the bonus amount impacts the employee’s other compensation or benefits, or how the financial health of the company may affect bonus payout.
• Signature: Most agreements will require the employer and employee to sign the contract to be legally binding.

Employees can ask for a retention bonus even if the employer doesn’t offer one. For employers that offer a bonus, eligible employees can negotiate the terms of the agreement, including the bonus amount. Employees can also refuse to accept a retention agreement.

Remember, these bonuses aim to keep the employee at your company. Therefore, negotiation should result in both the employer and employee leaving happy with the outcome.

How are retention bonuses taxed?

The IRS¹ considers employee bonuses taxable supplemental wages. Publication 15 allows employers to calculate the taxes owed using the percentage or aggregate method.

The percentage method separates the bonus from the employee’s salary. The 2023 flat tax rate² for bonuses is 22%. If any bonus amount exceeds $1 million, the excess is subject to a 37% tax. For example, if a senior executive receives a total annual retention bonus of $1.35 million, $1 million is subject to the 22% flat tax rate. The remaining $350,000 gets the 37% tax rate.

The aggregate method combines the bonus with the employee’s regular wage. Suppose a senior executive’s annual salary is $250,000. If they receive a 20% retention bonus of $50,000 for that year, their aggregate wage is $300,000. Employers can then use the standard federal income tax tables to calculate the proper withholding taxes from the $300,000 amount.

The aggregate method can push the employee into a higher tax bracket, meaning they may pay more income taxes. The percentage method is easier to calculate, but you can only use the aggregate method if you combine the bonus with the employee’s salary. To determine the best option for you, work with a tax professional or financial advisor.

No matter which option you use, bonuses are subject to Social Security, Medicare, and FUTA taxes.

What are the benefits of offering a retention bonus?

You may think offering a retention bonus only benefits the employee who receives one. However, there are several advantages of providing financial incentives that benefit the employer.

The following are a few advantages of retention bonuses:

1. They improve morale: When employees experience burnout, it can drain them mentally and physically. This will often lead them to explore new opportunities. Financial rewards and bonuses are a great way to boost morale, strengthen your employees’ financial situation, and keep your staff happy.
2. They increase stability during transitional periods: If your company is going through a reorganization, the change in course can be frustrating for some individuals. While you won’t be able to keep every employee from leaving, a bonus may convince some to stay and help you complete essential projects, train new team members, and stabilize the company during challenging times.
3. They help attract job seekers: One way to become an employer of choice is by offering unique benefits. If you’re comfortable highlighting retention bonuses in your job description, you may see an increase in applications from talented candidates and gain an edge over your competitors.
4. They boost productivity: Only some workers will receive a retention bonus. But while they’re not performance-based, employees may see retention bonuses as a result of being more effective and productive at their jobs. Because skilled employees are more likely to receive a retention bonus, employees might seek professional development opportunities to grow their skills to advance within the organization.
5. They create brand ambassadors: Employees who agree to a retention bonus contract tend to have a strong employer-employee relationship. Bonuses show your staff that they’re valued and important to the company. So when these employees finally leave the organization, they’re more likely to depart on good terms and become ambassadors for your company’s brand, send referrals, and stay business contacts.
6. They instill trust: Even though retention bonuses are financial incentives, they showcase your trust in an employee’s ability to do their job—which is why you want them to stay. This can increase a worker’s confidence, efficiency, and company loyalty.

How can employers offer a retention bonus?

Most retention bonuses are single lump sum payments. In some cases, the employer will split the total payment into smaller portions and distribute them monthly or biannually. Paying bonuses in installments is an effective way to keep employees motivated and productive.

But in either case, employees typically must pay back a portion of their payment amount if they leave the company early.

How having a comprehensive employee benefits package can boost retention

Bonuses can go a long way toward retaining your talented employees. But if you want to get ahead of potential turnover, offering a benefits package that goes beyond salary and mandatory perks can help.

Your retention strategy should cover every stage of the employee life cylce, starting from the point when a job seeker explores your job description. In fact, a recent PeopleKeep benefits survey found that 82% of employees say that a company’s benefits package is an important factor in whether or not applicants accept a job. Another recent survey³ found that 66% of current employees wait to review their company’s new benefit offerings before deciding whether or not they’ll stay.

To entice job seekers and retain highly skilled employees and entice, you need a robust benefits package that supports their unique needs.

A diverse employee benefits package may include:

• Health benefits
  • Outside of traditional health insurance plans, you can consider more flexible benefits like health reimbursement arrangements (HRAs), health savings accounts (HSAs), flexible spending accounts (FSA), or health stipends.
• Life insurance
• Paid time off (PTO)
• Flexible work schedules
• Profit sharing, stock options, and opportunities for bonuses
• Retirement benefits
• Lifestyle spending accounts (LSAs)
• Professional development benefits
• Technology benefits
• Fertility benefits
• Meal allowances
• Pet insurance

Luckily, you have options when managing your employee benefits. At PeopleKeep, our HRA administration software makes offering personalized health benefits for companies of all sizes quick and easy.

Conclusion

Retention bonuses are excellent tools that encourage your talented employees to stay on at your organization. Whether it’s for the completion of a project, restructuring of a team, or preparing for a merger, offering retention incentives shows your workforce that their efforts are integral to the success of your business.

In addition to bonuses, having a benefits package filled with unique perks can attract qualified job seekers. At PeopleKeep, our HRA software solutions can help you administer customized employee health benefits to help you engage and retain your employees. Schedule a call with us today, and we’ll help you get started.

1. https://www.irs.gov/publications/p15
2. https://www.empower.com/the-currency/work/bonus-tax-rate
3. https://www.workhuman.com/blog/human-workplace-index-the-future-of-employee-benefits/