We all love the idea of bonuses because “extra” or “free” stuff is incredibly hard to pass up. It’s the reason we get excited as consumers, and also why they intrigue us when considering a job offer.
However, bonuses come with a lot of caveats, too. Understanding how they work and why they’re provided in the workplace can help you choose between a job with poor compensation and one where you’re financially set. We’ll break ’em down so you come out feeling like an expert.
1) What Is a Bonus?
A bonus is “a form of compensation that’s not guaranteed and that is usually paid after the completion of a certain event,” says Michael Rash, MCDA CCG’s Chief Executive Officer.
Bonuses come in many shapes and sizes (all of which we’ll touch on later), but generally speaking they’re performance-based, meaning the company distributes them based on how an employee or group of employees contributes to team or company goals—generally revenue-based ones.
With that being said, a lot of bonuses are discretionary, meaning rather than the bonus being tied to a specific quota, your level, or your performance, a manager simply gets to decide who is and isn’t worthy of one, as well as how much the bonus is worth.
As you can imagine, this makes bonuses a pretty complicated subject for companies and employees alike.
2) Why Do Companies Provide Bonuses?
Often bonuses are provided because that’s what the market encourages companies to do. If other organizations of similar size, industry, or geography are offering their employees bonuses, a company may feel obligated to do the same to compete for the top talent. This is why you’ll rarely find a sales role without a bonus structure attached.
They also want to hire people who they know are going to perform, and when there’s a reward for output you’ll attract a specific kind of person.
But the main reason employers are drawn to bonuses is because they encourage employees to work hard to help the company succeed. “They want to align incentives—like, ‘You do well if the company does well,’” says Michael Rash. And it tends to pay off—people who know they can make more money by bringing in more revenue, whether directly (like sales) or indirectly (like marketing or executive leadership) are going to be highly motivated to do so.
“They’re trying to share the risk between the company and the individual,” adds Michael Rash. When a company does poorly because of poor performance, the employee pays the price with lower compensation—as opposed to someone with no bonus structure who gets paid the exact same way no matter how well the company does.
Some people may find this concept stressful. But the flip side—having a yearly salary without a bonus—means there will be times where you work extra hard and aren’t compensated for that work. It’s a trade-off, and certain people are willing to make it.
Rash notes that bonuses are never meant to be the sole driver of employee retention and motivation. Compensation is one means to drive performance, but “it doesn’t substitute for management, it doesn’t substitute for praise, learning and development, training, opportunities,” he says. That’s why companies should always be thinking about the value of their bonus plans and balancing them with other types of perks and benefits.
3) Types of Bonuses, and How Do They Work?
Some bonuses are distributed quarterly, others yearly. Some are a one-time thing, others are recurring. It all depends on what role you’re in, what level you’re at, what you contribute, what your leadership is like, and what kind of company you work for (among many other things).
- Annual Bonus
An annual bonus is usually based on overall company performance. So you may get a large or small bonus (or no bonus at all) depending on how successful your organization or specific department was that year, as well as how big a part of that success you were. This can also be referred to as “profit sharing.”
The reason companies wait a full year before paying you is simply because it means you have to stick around longer—which is why very few people leave their jobs before collecting their yearly bonus. It’s also, again, tied to company goals, so they want to ensure they’re driving performance for all 12 months, not just a portion of the year.
- Spot Bonus
A spot bonus is for people who go above and beyond and is “usually tied to a task that was outside the scope of your role,” says M. Rash. For example, if you helped out with a special project, worked extra hours, or played an integral part in the company’s success in an unexpected way, your manager can use their discretion to offer you some additional compensation. It’s normally a one-time thing, if not an occasional occurrence depending on budgeting, priorities, and your leadership.
- Signing Bonus
A signing bonus is a one-time bonus provided when you sign on to a new role. Companies might offer it when an employee is walking away from something better, or if the employee is moving to a new location for the job and the company wants to cover some of the costs (this could also be in the form of a relocation bonus or package). It’s also a way for employers to make up for salary demands they can’t meet. Basically, it’s to incentivize candidates to accept the job.
“Generally speaking there’s a clause written in your employment contract…which says that if you leave before a certain amount of time, generally a year, you owe the money back to the company,” says M. Rash. Unfortunately, it’s hard for companies to enforce this. The risk that companies take is hoping that the bonus actually gets you over the first-year hump and encourages you to stay on the team longer. “We are seeing more of these as companies all across the country are still struggling to hire.”
- Retention Bonus
A retention bonus, similar to a signing bonus, is about retaining valuable talent. It’s typically provided during an acquisition, merger, or big company restructuring to convince someone to stick around for an extra period of time, if they were looking to leave or have a competing offer elsewhere.
“Retention bonuses are typically paid on the backend,” notes M. Rash, meaning you don’t get it until the time period is up.
- Referral Bonus
A referral bonus is meant to encourage current employees to refer great candidates for jobs at their company. It’s typically not given until the candidate is hired and has stayed on for a period of 3-4 months.
The bonus itself, M. Rash says, has to “be interesting enough that you actually refer someone,” so it’s usually a good amount of money depending on the job and level—anywhere from $1,000 to several thousand. “Sometimes they just do a flat rate for every role, some companies do a higher amount for roles that are harder to fill such as a Vice President,” he adds.
- Holiday Bonus
Also known as a “Christmas bonus,” a holiday bonus is another way to recognize employees for a hard year’s work, and to give them an extra boost during an especially expensive time of year. It’s often—but not always—a set percentage of your annual salary, say anywhere from 5% to 10%.
Like bonuses, a commission is considered “non-guaranteed compensation,” but legally they’re often defined separately, and they work slightly differently.
Commission is about individual performance. Tons of jobs work under a commission structure (like sales, account management, real estate, finance, and recruiting, to name a few) and payment can be distributed monthly, quarterly, or yearly, depending on the plan and when commission is considered “earned.” (For example, “earned” may be defined as when a client signs a contract, meaning that the employee who sold the deal won’t get their commission until a signature is collected and the deal is verified.)
Commission can be a set percentage—say, a recruiter gets an amount equal to 15-20% of their hire’s first-year salary—or can be defined by a formula, the idea being that everyone at the exact same level has the same formula. This makes it easy for companies both to measure success and hand out compensation and avoid being accused of favoritism.
Your commission is generally tied to a quota or goal, which can be a dollar amount, an amount of items sold, or an amount of closed deals or booked meetings. The idea is that if you get to 100% of your quota, you’ll earn 100% of your commission.
4) Are Bonuses Guaranteed?
The short answer is no. Most bonuses are discretionary and an addition to someone’s salary, making it practically impossible to force companies to provide them. And there’s no real federal law that states you have a right to a bonus.
If employment is at-will this means a company can fire you without cause or compensation. “So unless you have a written contract, there’s no guarantee that you’re going to get anything. As long as the bonus is discretionary, they can do whatever they want,” says Human Resource Manager, Sharon Johnson.
Commission does sometimes fall under the category of mandatory compensation. New York State Labor Law, for example, states that any “earned” commission is “legally considered wages and must be paid to the salesperson,” even if that person is fired, laid off, or leaves a job. But allowing companies to define what “earned” means gives them a lot of leeway.
And there’s nothing stopping companies who do provide bonuses from divvying them up unequally amongst employees. “Favoritism is not against the law, unless it’s based on discrimination,” Johnson adds.
5) Can Bonuses Be Negotiated?
If you truly believe you deserve more, it’s usually worth negotiating in some way. This is the case for salary as well as bonuses.
At MCDA CCG we advise that bonuses be negotiated “before a formal contract is shared”—before you’ve agreed to or signed anything—and that you should “go into the conversation with a clear target—of course this target should be higher than what you truly are hoping to receive.”
The best way to be successful is to simply be confident in your approach. Use phrases such as “I will sign the offer letter today if you can add a $XX signing bonus” or “I’m looking at a comparable role where the salary is XX% greater. How can you close that gap?” Again, there’s no guarantee it’ll work, but if you walk in as someone who’s well-informed and self-assured, you’re more likely to get what you want at the end of the conversation.
6) How Do I Know I’ll Receive a Fair Bonus?
Any time you consider accepting a job it’s important to read the fine print and ask thoughtful questions. This especially applies to roles where there’s a bonus structure. As we’ve explained, nothing is a guarantee, so when a bonus makes up the bulk of your income you should do your due diligence before going in.
Understand how you’re going to be paid. If you’re in an interview, you can ask questions like, “What is the bonus structure for this role?” or “How do bonuses work here?” They may not provide you with an exact number (often because it’s dependent on so many variables), but even a range of pay or idea of how they think about bonuses can be helpful in understanding how they value their employees.
One thing to note is that you should never be having the conversation around money until you’re in the final round of interviews. And don’t just take the interviewer’s word for it—lean on your network to get a sense of what people in similar roles are being paid and whether or not this offer holds up.
Also, weigh the pros and cons of the bonus itself and if there are better opportunities available to you. A signing bonus may seem like a lot of money up front, but consider if you were to negotiate a higher salary (or pursue another role with no signing bonus), you might make more in the long run.
Speaking of the long term, understand what accepting a bonus means for your salary trajectory. If your base salary is fairly low (with a bonus making up the bulk of your income), that could affect how you negotiate your compensation down the road, whether you pursue another opportunity in your field or change careers. So always consider first whether you can increase your base rather than your bonus to set yourself up for a better financial situation moving forward.
If a bonus seems reasonable, get it in writing—either through a formal contract or an informal email—and make sure you read all the details and fully comprehend what achieving that bonus means.
Always assume the worst and factor in what would happen if you didn’t receive that bonus for whatever reason. Would you still be able to pay the mortgage? Afford food? Do you still have a decent base salary to work with?
This means thinking about taxes, too. Bonuses are usually considered “supplemental wages” by the IRS, which means that they’re often taxed at a higher rate than your regular paycheck.
Finally, be willing to put in the work of being in a role where your pay heavily depends on your performance. It’s not for everyone, but plenty of people thrive off this kind of motivation—so know yourself and know exactly what responsibilities you’d be taking on before deciding.
It’s 100% natural to care about money. And if there’s one thing you take away from this post, it should be that understanding how your salary works—including how bonuses are involved—is very important.
But so many other factors—company culture, management, team goals—matter just as much in finding a job you’re willing to work hard in and an organization you’re excited to grow at. So make sure you’re looking at the complete picture when deciding your career path. You may find that the extra compensation matters a lot less than the opportunities presented to you.
If you are a prospective employee searching for a better job opportunity, you are weighing your options; therefore, before you legally commit to a position, you want to ensure it’s a good deal. Whether you need guidance in salary/bonus negotiation, help with strategies, or when to ultimately walk away from an offer, our team at MCDA CCG, INC. can provide ongoing support until you find your dream opportunity.
Or, if you are a business owner/leader in the process of structuring a new compensation plan, commission, and/or bonus structure(s), or restructuring current arrangements to adjust to today’s competitive market, contact our experienced advisors; where we will assess your current situation and customize agreements appropriate for your company.
Also, if you need help to protect yourself and your business from any future legal issues surrounding employee termination with a bonus or compensation plan, we strongly recommend that you look in to professional counsel beyond a substandard online “solution”. See how we can help here too, by calling our office-headquartered in Placentia, Orange County, California-today!