Most Common Types of Bonuses and How They Work
Bonuses are a payment or incentivized reward added to an employee’s compensation package. In addition to wages or salaries, some companies provide regular bonuses to their employees. Each company’s bonus structure depends on the size and net worth of its business.
In this article, we take a comprehensive look at how bonuses work by defining what they are and listing 12 of the most common types of bonuses.
Bonuses are a payment or incentivized reward added to an employee’s compensation package.
There are two ways to categorize most bonuses: discretionary (not guaranteed) or nondiscretionary (guaranteed as shown in your employment contract).
Companies often use bonuses as a way to increase productivity, improve employee retention, thank employees for their efforts and create a positive work environment.
What are bonuses?
Bonuses are a type of compensation paid to an eligible employee in addition to a previously set hourly wage, contract amount or annual salary. While many companies provide bonuses in the form of cash, a bonus can take any form as long as it provides value to employees as well as the organization.
Bonuses can be built into a company's budget in a discretionary fund, or they can be determined by the overall success of the company. Some bonus structures have multiple criteria including the company’s financial success, the performance of your team and your individual evaluation results.
Related: How To Calculate Employee Bonuses By Type
Discretionary vs nondiscretionary bonuses
In many cases, a bonus will either be discretionary or nondiscretionary, as follows:
Discretionary: These bonuses are awarded at the discretion of the employer, meaning they are not stipulated in your employment contract and are not guaranteed. For example, milestone bonuses are awarded at the discretion of your employer.
Nondiscretionary: Theseincentive-based bonuses are outlined in your employment contract and vary by employer. As long as you meet the requirements detailed in your contract, the bonus is required as part of your compensation package. Signing bonuses and retention bonuses are examples of nondiscretionary bonuses.
Some types of bonuses are guaranteed while others are not. It's important to remember, too, that while the action of providing the bonus may be guaranteed, the amount of a bonus may not. Look closely at your employment contract to see if you should receive any guaranteed bonuses. You can also speak with a human resources representative to find out whether your company pays out a percentage of your salary or a flat rate when they calculate bonuses.
Read more: Discretionary vs. Nondiscretionary Bonus: Everything You Need To Know
Types of bonuses
Bonuses can take many forms but the most common types of bonus payments you might receive from your employer include the following:
One type of bonus some companies use is a profit-sharing plan. Employers often implement these plans because they want to give their employees a sense of ownership in the company. With profit-sharing, the company distributes a certain percentage of the company's quarterly or annual profits to employees, usually based on each employee's annual salary. Some companies provide the shares of profit as cash payouts, while others contribute the bonus payout to a 401(k) or another retirement plan on behalf of their employees.
Companies give spot bonuses to employees for a variety of reasons. Usually, managers or supervisors are authorized to provide these relatively low costs—usually around $50 or $100—bonuses to employees who demonstrate a specific company value.
A noncash bonus is any award or prize that isn't of monetary value. An example might be an extra day of paid time off or a coveted parking spot in the employee lot. Usually, noncash bonuses are tied to programs like employee of the month, and companies regularly award them to employees for meeting certain criteria.
A sign-on bonus is a payout agreed upon when starting a new job. Companies often use this nondiscretionary bonus when trying to recruit highly qualified staff, to fill a role that has a high turnover rate or when a new employee is leaving a considerable amount of money behind at their past job—either through a salary cut or loss of guaranteed bonuses—to accept a new position.
Some companies pay signing bonuses in one lump sum, while others might spread the payments out over a year as a way to retain the employee in the role for a certain amount of time. Be sure to clarify the terms of your employment contract so that you understand any stipulations, especially for this type of bonus. For example, your contract might specify a conditional sign-on bonus that must be repaid if you leave the company before 12 months of employment.
Milestone bonuses—also known as task bonuses or mission bonuses—are directly tied to your work performance. Companies give milestone bonuses for reaching certain metrics or goals. The company decides the milestone in advance so a team or individual has a goal to work toward to earn the bonus payment.
Companies usually give annual bonuses when the organization has a successful year. For some companies, annual bonuses are a guarantee, though the amount may differ from year to year depending on the company's profits. Other companies only distribute annual bonuses after a particularly successful year.
Some companies provide retention bonuses to current employees to entice them to stay with the organization. Often, the company presents these in advance so employees know they're entitled to a certain amount of money if they stay with the company for a definite amount of time. Companies might also offer retention bonuses during a merger, acquisition or other major organizational change to keep staff numbers up through the transition.
Another type of bonus is the referral bonus. This payment is given to employees who recruit talent to join the organization. Referral programs can vary from company to company, with some giving a flat payout rate regardless of the position, while others pay their employees more for finding candidates for hard-to-fill or executive-level roles.
Related: What Are Fringe Benefits and How Do They Work?
Some companies provide a holiday bonus around the end of the year to all their employees. Usually, the value of this bonus is a percentage of each employee's annual pay. This practice is more common outside of the United States, but there are some companies in the U.S. that give holiday gifts not specifically tied to business profits or work performance but as a gesture of gratitude for employees’ efforts.
Stock options allow employees to have ownership in the company. In this case, you'd be able to purchase shares at a fixed rate and gain money (in stock value) as the company succeeds. Instead of giving away shares directly, employers give their employees the option to acquire a certain number of shares at a discounted rate. While stock options don’t have a straightforward value like a signing bonus, they can still be a valuable asset to your finances.
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