When the going gets tough, you don’t want your people to get going. During trying or uncertain times, losing your best employees and their hard-to-replace skill sets can be a huge blow to your business. One way to keep these indispensable individuals around? Retention bonuses.
Retention bonuses entice your most invaluable team members to stay at your company while rewarding them handsomely for their loyalty. In this article, we’ll share what retention pay is, how it’s typically calculated and taxed, and how it can benefit both employees and employers. We’ll also explore how to write a retention bonus agreement so you can create your own contracts and start offering retention pay to your employees.
What is a retention bonus?
A retention bonus is a monetary reward provided to employees to encourage them to remain in their current position for a certain amount of time. Retention bonuses are also known as retention pay, stay bonuses, retention packages, or even “golden handcuffs.” Organizations often use these financial incentives during tumultuous times, like a merger or acquisition, when difficult-to-replace employees are at risk of leaving. While retention bonuses are a short-term solution, they can motivate employees to stick around longer in exchange for a monetary reward.
How do retention bonuses work?
There are usually two ways to award retention pay: via a single lump sum payment or incremental payments over time. The former is more common, but your business can pay employees however it sees fit.
Lump sum payment
In a lump sum payment, the company gives an employee their retention bonus in one large payment at the end of the agreed-upon period. The amount may be added to the employee’s normal paycheck or processed as a unique paycheck.
Businesses can also choose to pay employees incrementally throughout the period, dividing the bonus payment across several of the individual's paychecks. While this method is less common than a lump sum payment, it can help improve employee morale throughout the retention period as employees see their reward instantly rather than having to wait until the end of the period to receive their retention pay.
Retention bonuses, like employee wages, are often open to negotiation. Should an employee not approve of the terms or payment schedule outlined in your agreement, they might approach you with a counteroffer. Negotiate with the individual to come to an agreement that works for both of you; after all, the goal of a retention bonus is to make employees feel valued and appreciated.
What is a typical employee retention bonus?
Retention pay is typically determined based on a percentage of an employee's salary, with the average retention bonus falling between 10% and 15% of an individual’s annual base pay. That said, certain external factors could push this number higher, like:
- The current state of the job market
- How likely the individual is to leave
- How difficult it would be to replace the employee
- Your company’s current financial situation
- The existence of any high-importance projects
- The potential impact of the employee’s departure
How are retention bonuses taxed?
However your business chooses to pay employees, remember that in the U.S.A., for example, the IRS will classify these funds as “supplemental wages,” meaning your organization will need to withhold federal taxes on your employees’ behalf. There are two methods a U.S.-based business can use to withhold taxes on a retention bonus: percentage or aggregate.
The percentage method
This method, most commonly used when the bonus is paid via a separate paycheck, involves using a flat percentage to calculate taxes owed. Annual bonuses under $1 million get taxed at a 22% flat rate, while any dollar amount over $1 million is taxed at 37%.
The aggregate method
The aggregate method is often used when employees receive their retention bonus and regular wages in the same paycheck. In this instance, your business will need to withhold taxes on the entire payment at the same rate, determined based on an individual’s filing status and W-4 elections.
Note: Taxation laws vary from country-to-country. Be sure to check out how retention bonuses are taxed in the country or countries your business operates in.
Benefits of retention pay
Retention pay can benefit both businesses and employees. Here’s how:
Retention bonuses encourage loyalty, especially during uncertain times: Money talks. When you need your people most, a cash incentive could be all the motivation they need to stick around. In fact, Keep Financial’s Effective Compensation Survey Report 2023 found that 86% of employees said they would stay at their company for a period of time in exchange for an immediate cash bonus.
Retention pay is a cost-effective way to retain top performers: Your company’s biggest expense is employee wages. Luckily, a retention bonus is often a one-time payment, which makes it a more cost-effective way to reward employees than the ongoing expense of a base pay increase.
It keeps employees’ skills within the company: Employees with highly specialized skills are hard to replace. Your business can use retention pay to keep these skilled specialists around longer so you don’t suffer from a skill gap.
Employees feel valued: Offering your employees more money acknowledges the value they bring to your organization and shows them your business appreciates their commitment and loyalty.
Employees get more money: Higher pay is the top reason employees look for a new role. Retention bonuses give your team members what they want without them having to go to another company to find it.
It improves productivity: Employees who feel they are properly compensated and appreciated in their roles are likely to be more motivated and productive.
Parts of an employee retention bonus agreement
A retention bonus agreement is a formal, legally binding contract explaining the terms of your arrangement. The contract will consist of a few different parts, including:
Bonus agreement terms: First and foremost, spell out the details of your agreement. This includes how much your business will pay the individual and how the calculation was made.
Agreement period: Define the length of the agreement, or how long an employee agrees to stay with your company in order to be eligible to receive the funds.
Payment schedule: Next, outline how the employee will be awarded those funds. Will the payment be delivered as a lump sum or incrementally? Will the employee be paid upfront or at the end of the retention period?
Any productivity requirements: Include any other conditions that an employee must meet in the retention period for the bonus to be delivered, like the completion of a particular project, specific output numbers, etc.
Employment status disclaimer: You may also want to include a contingency plan for what should happen if your business and the employee part ways before the end of the retention period. If the employee voluntarily resigns or is terminated prior to the contract end date, what will happen to payment? Will the retention bonus be prorated and added to the employee’s last paycheck or forfeited?
Confidentiality clause: While optional, you might want to include a confidentiality agreement if you’d like the nature of the retention terms kept secret or if the employee will be privy to confidential information during the retention period.
Reimbursement agreement: Say an employee fails to achieve the productivity requirements laid out in the contract or leaves before the conclusion of the agreement. If the employee was paid upfront or in installments, will they need to give back all or a portion of the funds?
Signatures: Lastly, every formal contract requires a signature from both parties, denoting agreement to the terms outlined in the document. Collect signatures from the employee and a representative of your business.
Of course, you’ll want to consult your legal team to review the agreement and provide any other business-specific wording or additional clauses needed.
Investing in employee retention with Culture Amp
Retention bonuses can help keep employee pay competitive, but don’t rely on them as your only strategy for retaining top talent. Consider investing in other areas to keep employees happy, engaged, and productive. Culture Amp’s employee experience platform can help your business detect the earliest turnover warning signals and take data-driven action to keep your most valuable people.