7 main types of employee compensation

Compensation is what employees earn in exchange for their contributions to your business. A total compensation package typically includes the employee’s base salary, as well as various other forms of direct and indirect compensation.

Direct compensation is a cash payment, so it might include commissions, bonuses or tips. Indirect compensation has financial value, but it doesn’t come in the form of an immediate cash payment. One example is paid time off.

These are seven of the most common types of employee compensation. While reviewing them, think about how each one can help your company attract and retain talent.

1. Base pay

Base pay is the regular salary or wage an employee receives for doing their job, before you add bonuses, tips or other forms of compensation. It’s typically expressed as an hourly rate or an annual salary, although some employers use weekly or biweekly rates.

An employee’s base pay depends on several factors:

• Job title
• Geographic location
• Industry standards
• Skill level

Companies typically use salary scales to document the minimum and maximum salaries paid for each role. These scales may also have salary bands to help HR professionals set compensation based on a new hire’s background.

2. Commissions

Commissions are a form of compensation based on job performance. They’re often used to reward sales professionals for reaching their goals. Some companies offer a base salary plus commissions, which may give Salespeople some stability while also encouraging them to improve their performance.

Other companies use a 100% sales commission structure. In this type of environment, sales professionals earn based solely on what they sell. They don’t receive a base salary, but they can increase their compensation by selling more units.

If you have a dedicated sales team, you might also want to consider tiered commissions or gross margin commissions. In a tiered commission structure, Sales Representatives generally receive a certain commission percentage at each sales tier. For example, your sales team might receive a 5% commission after hitting $20,000, 7% after hitting $50,000 and 10% after hitting $100,000. You can have as many tiers as you’d like.

Gross margin commission is a percentage of your profit on each item. For example, if you make a $30 profit on an item that sells for $75, you’d pay a percentage of the $30 profit, not the $75 sale price.

3. Bonuses

In addition to guaranteed salary or wages, some compensation packages include employee bonuses that are paid if the company reaches certain milestones. For instance, you might give employees a $1,000 bonus if you exceed your quarterly revenue goal.

4. Overtime

Overtime pay is compensation that some employees receive for working beyond their regular hours. For example, you might pay team members one and a half times their normal hourly rate if they work more than 40 hours in a week.

5. Insurance benefits

Some companies offer several types of insurance, increasing each employee’s total compensation. These are some common examples:

• Health insurance: Health insurance covers some of an employee’s medical expenses, such as doctor visits and medications. If you offer health insurance, you might pay a portion of the monthly premium or contribute to a flexible spending account, increasing each team member’s compensation.
• Vision insurance: Vision insurance covers expenses related to eye care, such as exams and contact lenses.
• Dental insurance: Dental insurance covers routine cleanings, X-rays and other expenses related to the teeth and gums.

6. Retirement plans

Some companies offer 401(k) plans, while others have Simple IRAs or 403(b) plans. These are called defined-contribution plans because the total amount available at retirement depends on your company’s contributions, the employee’s contributions and how well the plan’s investments perform.

Although pensions are less common than defined-contribution plans, some companies still offer them. A pension is considered a defined-benefit plan, as employees receive a guaranteed payout when they retire. Pension payments depend on salary, years of service and age.

7. Paid time off (PTO)

PTO is a benefit that compensates employees when they’re not at work. Setting up a PTO plan is an alternative to offering separate vacation, sick or personal days. Some companies also include family leave, bereavement leave and paid holidays in their PTO plans.

It’s common for companies to offer PTO on an accrual basis. This means that an employee earns PTO hours every pay period instead of receiving them all at once. You may also want to give additional PTO days based on years of service. For example, you could provide five days of PTO to employees with one to five years at your company, and 10 days to those with over five years.

What to consider when creating an employee compensation package

When creating an employee compensation package, consider the following factors:

• The local market: Determine the value other companies in your area place on certain roles to evaluate how much your potential hire could earn elsewhere.
• Individual assessment: Consider adjusting compensation to match each employee’s experience and skills.
• Company finances: Maintain a responsible budget by factoring in the financial impact of any compensation package.
• Previous and coworker salaries: Assess how much employees earned in their previous roles and how much your current employees are making.

FAQs about employee compensation

Why is it important to have a clear compensation strategy?

A clear compensation strategy supports fairness and ensures that all employees understand what to expect. You can also incorporate a clear compensation strategy into recruiting materials, which might make your company more attractive to quality candidates.

What role does compensation play in attracting quality candidates?

Your compensation plan helps candidates understand how you value employees’ contributions. When you’re clear about direct and indirect compensation, candidates can easily compare offers and choose the one that best meets their needs.

What are some forms of nonmonetary compensation?

Common forms of nonmonetary compensation include wellness benefits, recognition programs, professional development opportunities and workplace perks. For example, you might provide snacks for employees who work third shift or reimburse team members for their monthly gym memberships. Nonmonetary compensation has value, but it doesn’t increase an employee’s salary or wages.

How does compensation affect budget planning?

When you create a business budget, you have to account for direct and indirect compensation, as they’re some of your most significant expenses. Careful planning helps ensure that your compensation strategy matches your company’s financial performance.