An employee’s drive to succeed is steered by two factors: intrinsic and extrinsic.
Intrinsic factors are traits that are found in an individual such as curiosity or the drive to learn and are not influenced by external factors. For instance, an employee stays longer with an organization because the work environment is welcoming and conducive to learning.
On the other hand, another employee stays for a longer duration because they are motivated by the salary and additional benefits that their employer provides. The latter is described as extrinsic motivation whereby the employee is motivated by external rewards.
A pat on the back or a good evaluation will definitely cheer up your employees but it is the bonus that is likely to improve their performance, morale, and productivity.
In this article, you will learn about the types of bonuses, how they are calculated and taxed, and their benefits to employers and employees.
What Is an Employee Bonus?
An employee bonus is anything that you pay to your employees apart from their base salary. It is usually given for a specific purpose.
A common misconception is that bonuses are only given when an employee fulfills a certain task or performs exceptionally. That is certainly not the case.
Different types of bonuses have different purposes which you will explore later in this article.
Regardless of the type, all bonuses should be given with an intention of:
- Achieving organizational goals
- Improving an employee’s commitment to the organization
- Boosting employee’s morale, productivity, and performance
- Increasing an employee’s motivation to perform better
- Retaining top performers
- Attracting employees with extraordinary potential
When Do Companies Give out an Employee Bonus?
The time when an employee bonus is rolled out depends on the type of bonus. So, let’s say, if you are giving an annual bonus, it will usually be paid at a fixed time during a particular year.
However, a year-end bonus is generally paid within the first few months of the new year. Similarly, some employee bonuses are paid on the spot when an employee performs remarkably well on a certain task or project.
Benefits of Employee Bonus
Bonuses for employees are meant to benefit both employers and employees. A bonus, no matter how big or small can do wonders for your organization.
An employee bonus has the ability to transform your workplace and workforce tremendously. Wonder how? Let’s find out.
Benefits for Employees
To desire praise and recognition is part of a human’s nature. You and everyone in your surroundings look forward to verbal as well as non-verbal appreciation. A pat on the back, a recognition, reward, or praise in front of others has a significant impact on an employee’s mood and morale.
When an employee knows that going an extra mile will reap benefits in the form of a bonus, they are more likely to go above and beyond.
A bonus encourages employees to work harder. Irrespective of the type, a bonus has the power of motivating employees and boosting their morale.
But how will a motivated employee benefit an organization? Is high morale directly proportional to improved performance?
Benefits for Employers
A satisfied employee means success for the company. How well your business performs depends on your investment in your employees’ motivation. It is a domino effect.
Increased Revenue
The more you reward their hard work with bonuses, the more the chances of them fulfilling your organizational goals.
An employee bonus is an incentive. This incentive pushes employees to bring in more revenue thereby increasing a business’s top line.
Employee Retention
Apart from meeting business goals, an employee bonus helps in retaining top performers. As an HR professional, you may be well aware of the time, money, and effort a company puts in hiring and training its employees. So why lose them to competitors?
A bonus, whichever it may be, will encourage employees to stay loyal to their company. As a result, the turnover rate will decrease, generating monetary benefits for the employer.
Reduced Cost of Hiring Replacements
A loyal employee eliminates the need for a business to look for new employees. Of course, the business will hire new talent as and when needed, but the general idea is to cut down on costs wherever possible.
Turnover costs vary by role and wage of an employee. According to a CAP study, the average costs to replace an employee are:
- 16 percent of the annual salary of a low paying job
- 20 percent of the annual salary of mid-level positions
- Around 213 percent of the annual salary of executive-level positions
An employee who works for several years in a company accumulates a wealth of knowledge about the company, its products, and its strategies. Moreover, the experience gained over the years is tremendously valuable to the company.
So when an employee leaves a company, they take with them the bulk of knowledge and experience. Research shows that 42% of the knowledge required for a certain position will only be available to the person in that position. So when they leave the company, 42% of their work will suffer as other workers will not have that knowledge.
Eventually, the company will hire someone else but they will have to learn that 42% from scratch.
No company would want to lose such an employee to its competitors. Because by doing so, it will lose customers and a great chunk of revenue to them.
Internal Talent Mobility
Another point to consider is that such employees can be promoted to C-Suite roles. It reduces the burden on the employer to hunt for external talent for as important positions as these. It saves time, energy, and money.
Although bonus programs are known to engage and inspire employees to perform better, you should always be mindful of the reasons for which you give out bonuses.
As a best practice, try to align your bonus goals with that of your business. If you are giving out bonuses, make sure you are giving them out for reasons relevant to the purpose and goals of your business.
Types of Employee Bonus
Christmas Bonus
The name is pretty self-explanatory. A bonus paid to employees on Christmas is called a Christmas bonus. Employers give out Christmas bonuses at their own discretion. However, they are mandated to pay in the following situations:
- When it is mentioned in an employee’s contract
- It is deemed necessary through custom
There is no fixed time to give Christmas bonuses but they are usually paid 4 to 5 days before Christmas.
How much should a Christmas bonus be?
In order to calculate a Christmas bonus, you need to ensure that an employee has worked for at least a year in the company. You can do so using the 2 methods below:
Annual Accrual
Christmas Bonus= (Monthly Salary)/Average Days in a Year x Days Worked in the Company
Biannual Accrual
This method of calculating Christmas bonuses is beneficial for employees who have been working in a company for a short period of time.
If an organization pays two bonuses per year to its employees, the amount for the next bonus is calculated for the day the last bonus payment was rolled out. The formula is the same as the annual accrual with a slight change:
Christmas bonus= (Monthly Salary)/ Days since Last Bonus was Paid x Days Worked in the Company
So for instance, if an employee has a monthly salary of $2000 and received their last payment 140 days ago then the calculation will be:
2000/140 x 28 = $400
Holiday Bonus
A holiday bonus is a gift to employees. Unlike other bonuses, a holiday bonus is not given to express appreciation for an employee’s performance or achievement of a goal. In fact, a holiday bonus is mostly given to make employees feel that they are valued.
A holiday bonus can be given as cash, a gift, or in the form of leaves. You don’t necessarily have to pay a holiday bonus in cash to make your employees feel appreciated. Giving some extra leaves can do wonders for an employee who will feel motivated to return back to work.
Another factor that sets a holiday bonus apart from other bonuses is that it is distributed equally among employees and rightly so.
A few points that you should keep in mind when paying a holiday bonus:
- If you are giving out holiday bonuses in monetary terms, then make sure you pay them all equally regardless of seniority.
- Try to maintain transparency about the bonus program. Keep your employees informed of the bonus and how it is calculated. This will make employees feel valued.
- If for some reason you are unable to give a bonus, inform your employees well in advance with the reason so that employees aren’t blindsided.
It is important to bear in mind that all holiday bonuses take into account the Christmas holidays as well. But a Christmas bonus does not consider other holiday bonuses.
Spot Bonus
As the name suggests, a spot bonus is one that is given to employees on the spot for completing a task that deserves recognition.. Spot bonuses are usually in the form of cash and generally start from $50.
A spot is approximately 1% of the base salary and can result in improved performance.
Retention Bonus
Retaining employees is an issue that many organizations face owing to increased competition and changing market conditions. Apart from improving their work culture, employers can develop a retention bonus program whereby the employees will be rewarded with a bonus for spending a particular number of years in a company.
With such programs, employees feel motivated to work and stay with the organization. A retention bonus is a gesture of gratitude from the employer, thanking the employees for staying loyal and true to the company.
A retention bonus need not always be given in monetary terms and can be given as paid leaves.
The end result is a decreased turnover rate and a pool of top talent.
Annual Bonus
An annual bonus also known as a year-end bonus is given once in a calendar year. Annual bonuses are tied to the goals or tasks set for an entire department or a company as a whole.
An annual bonus is a token of appreciation for employees’ consistent effort and contribution that contributed to the company’s profitability. An annual bonus is also known as profit-sharing because it is only given when a company makes a profit during the year and decides to share it with employees in the form of a bonus.
Some companies pay an annual bonus to all the employees while some only pay to those who have substantially contributed to the company’s success.
There are two ways of paying an annual bonus. It can be either given as a percentage of the base salary or a predetermined amount.
Performance Bonus
Performance bonuses are paid when an employee meets the target or surpasses expectations. It may sound similar to a spot bonus but it is not. Although both are paid as a recognition of an employee’s brilliant performance, a performance bonus is given annually or semi-annually.
A performance bonus is given as an incentive for employees to continue surpassing expectations. It is also encouraged so that a company retains top performers and keeps them satisfied.
Discretionary Bonus
A discretionary bonus is a bonus that an employee has no expectations or anticipations about. It is usually given when an employee goes above and beyond to fulfill their duty. It is at the employer’s discretion to give this bonus as it is not mentioned in an employee’s contract.
Bonus Structure Template
With so many types of bonuses, it might get a little difficult for a company to keep track unless they are all documented.
It is recommended that an employer creates a bonus plan which contains all the relevant details of the bonus program such as
- The objective of the bonus
- Eligibility criteria
- Approximate amount
- When it will be paid
How Is an Employee Bonus Taxed?
Just like an employer deducts taxes from an employee’s salary, a certain amount is also withheld from a bonus. The withheld amount then goes to the IRS on an employee’s behalf.
There are two ways of calculating the tax on employee bonus:
Percentage Method
The percentage method, also known as a flat rate method is the easiest to calculate whereby a bonus is taxed using a certain percentage. Since bonuses are considered supplemental wages, they are taxed by 22%.
Aggregate Method
An aggregate method is calculated based on an employee’s annual salary. For example, if an employee is earning $5000 per month, their annual salary would amount to $60,000.
If an employer gives a bonus of $10, 000 in a certain month, the monthly salary in that particular year will amount to $15,000.
The employer will now calculate the annual salary as $180,000, pushing the employee into the tax bracket of $32. The tax amount will now be calculated based on 32%.
How to Avoid Taxes on Bonus Checks?
A bonus is a supplemental income and is taxable. Although there might not be a method of completely getting rid of bonus taxes, there are strategies that will help minimize bonus taxes.
Employee Benefits are Employer’s Benefits
A bonus is an effective way of encouraging employees to work at their potential. An employee bonus is an incentive for employees to contribute tirelessly to an organization’s success.
As an HR professional, you know that a company’s performance is a reflection of employees’ performance.
Through bonuses, employees feel valued and appreciated. They know that regardless of the workload and challenges, their effort, determination, and hard work will always be recognized.
Such employees feel motivated to stay with the organization as they have earned the company’s trust and loyalty.
Therefore, employers should try to create simple but transparent bonus programs. It is one of the best ways of retaining top performers and getting success.
