What is a retention bonus? A guide with do’s and don’ts

What is a retention bonus?

A retention bonus is a financial incentive employers pay to workers who remain with the company for a set period of time. It’s common for companies to implement retention bonuses during periods of change, such as mergers or internal restructuring, but you can use them anytime. Retention bonuses are especially useful for keeping key employees from leaving the organization when those exits would be very disruptive.

People sometimes say stay bonus vs. retention bonus, but they are the same thing. Whatever the term, the goal is getting key employees to stay in your workforce as part of your strategic HRM (human resource management). Companies can offer flat-rate retention bonuses, but more commonly, they are a percentage of the qualifying employee’s salary.

Benefits of retention bonuses

Most companies already have other bonus structures in place, so why add the expense of paying employee retention bonuses? Retention bonuses don’t just make workers happy — they can benefit your organization in several different ways.

Reducing turnover

Employee turnover is defined as the number of people who leave a company over a given time period. It’s a key HR metric. Generally, higher turnover hurts your workplace. When workers leave more frequently, you may experience workflow disruptions, decreased productivity, and lower morale among the remaining staff. Plus, you incur higher recruitment costs to replace the staff you lost.

One of the top benefits of offering retention bonuses is reducing your organization’s turnover rate. Because employees have the opportunity to earn a financial bonus for staying, they’re less likely to leave your company for other employment.

Cost savings

Somewhat counterintuitively, paying retention bonuses can also save your company money. Even though you’ll temporarily have higher payroll costs, the retention bonuses can bring down turnover rates by cutting expenditures related to recruiting and training new employees.

On average, companies spend around $4,700 to hire each new employee. These costs can be much higher in specialized fields or when the job market is tight for employers. Paying out a retention bonus can be the less expensive option that helps you keep key employees. It can make good business sense to consider it an investment in your workforce.

Preserving knowledge

Employees who work for your business for a long time build up knowledge of your company culture, how you do things, and best practices within your organization. They take that knowledge with them when they leave. Even if you bring in a highly skilled, experienced professional, it will still take that person time to reach the level of knowledge the previous employee had.

Using retention bonuses to encourage your employees to remain with the business helps to ensure that their knowledge also stays in house. You get to keep that institutional knowledge. As a result, you may notice better productivity levels and final work products.

Enhancing employee morale

Employee turnover is bad for workplace morale. When workers leave, the remaining staff must pick up the slack until reinforcements arrive. They can start to feel stressed and disengaged, which hurts the overall environment, especially if you have a clan culture.

Getting employees to stick around with retention bonuses cuts down this problem. Also consider conducting stay interviews with some of your top staff to learn what they like best about working for your business. Then you can emphasize or even enhance those workplace qualities to further boost employee morale.

Recognition and reward

Providing a retention incentive payment is also a way of recognizing and rewarding employees for their loyalty. When you award a retention bonus, you’re showing that employee that you notice their commitment to your business and want to acknowledge it.

Workers who receive recognition and rewards from their employers are more likely to feel valued, engaged, and productive. Recognition can be especially impactful in workplaces with a hierarchy culture, but when implemented correctly, it’s effective anywhere.

Designing an effective retention bonus program

When you’re creating a retention bonus program, there are a few key decisions you have to make. Consider questions like:

• Determining eligibility criteria: What do employees need to do to qualify for the retention bonus package? How long is the retention period?
• Tax withholding structures — percentage vs. aggregate: When withholding taxes from the retention bonuses, will you use the percentage or aggregate method?
• Establishing clear communication strategies: How will you make sure that all the employees understand the retention bonus contract? With a meeting? Email?
• Aligning with long-term organizational goals: What are your long-term business goals, and how does the retention bonus help you reach those goals?
• Integrating into broader recognition systems: How will you use the retention bonus alongside other methods for recognizing and rewarding your employees’ good work?

Retention bonus calculation methods

You can either calculate the retention bonus as a flate-rate bonus or a percentage of each employee’s base pay. With a flat-rate bonus, employees would get a set amount of money, such as $5,000, for staying with the company through the retention period.

Otherwise, establish a retention bonus percentage of the qualifying employees’ base salaries and individually calculate each bonus. The average retention bonus falls between 10% and 25% of the employee’s base pay. So, for an employee making $50,000, you would likely pay somewhere between $5,000 and $12,500.

Retention bonus timing and frequency of payments

Generally, retention bonuses are one-time payments when employees reach the end of the retention period. A key detail to include in your contracts is when employees can expect to receive their retention bonuses if they qualify. If you choose to pay the bonus in installments rather than a lump sum, clarify how often those installments will be disbursed. 

Retention bonus tax implications

Retention bonuses are treated as supplemental wages, so you must withhold taxes from them. To comply with tax regulations, follow IRS guidelines for tax withholdings. You can either use the percentage method, which involves withholding a flat 22% for bonuses less than $1 million, or the aggregate method. In the latter, you add the bonus amount to the employee’s other wages and withhold the appropriate amount for the tax bracket the employee falls into. 

Legal and compliance considerations

While implementing a new program like a retention strategy, it’s important to make sure that you comply with applicable labor and tax laws. When you’re drafting your retention incentives into employee contracts, make sure that the offers are clear and fair. Outline how much the bonus will be, what employees need to do to earn it, and when they will receive their qualified payment. Have legal counsel review your retention agreements to ensure that you’re fully compliant with applicable laws.