Retention Bonus: Why Should You Offer It?

You’ve probably heard of something called “The Great Resignation.” 

It’s a catchy term for the fact that people are leaving their jobs in record numbers. According to the Bureau of Labor Statistics, over 4 million people quit their jobs each month as of November 2021.

While the past two years have no doubt been challenging for companies, the tide is turning. For many, business is picking up again. Yet millions of people continue to leave long-held positions when a new job offer comes along. 

How can you keep your key employees on your team? Well, money talks. That’s why you might want to offer a financial motivator. It’s called a retention bonus.

So, What is a Retention Bonus?

A retention or stay bonus is a sum of money that’s offered in addition to an employee’s base pay and is used to encourage your best workers to stay with the company. These bonuses are not tied in any way to an employee’s work performance. 

Instead, the business can offer retention bonuses that are contingent on employees staying at the company for a fixed amount of time. Because of this time requirement, these bonuses are often paid in installments over the agreed number of years that the employee needs to stay. 

Sound a little confusing? Let’s clear it up. For example, your business could offer a senior manager $50,000 to stay with the company for the next five years. They could then receive $10,000 every year for that time period.

They can be paid out as a lump sum, but if the employee leaves before their contracted term is over, they may have to pay back a portion of their bonus (which is called a “clawback clause”). That would only be the case if you thought ahead and built this into the contract (be aware there’s no legal requirement for the employee to pay back any of this money if it hasn’t been signed off in writing).

How Much is the Typical Retention Bonus?

When we talk about retention bonuses, we usually aren’t talking about a couple hundred bucks. Retention bonuses are often a significant amount of money–usually somewhere between 10 and 20 percent of an employee’s annual salary. 

So, if you have an employee making $75,000 per year, their bonus could be somewhere in the range of $7,500 to $15,000 paid out in a lump sum or in installments. 

Why Should You Offer a Retention Bonus to Employees?

Wait…you need to pay employees even more than you already agreed to pay them? Why would you ever do that?

As companies all over the country fight to avoid the “Great Resignation” and stop competitors from poaching and stealing their staff, benefits like retention pay could be the difference between keeping your best employees and waving goodbye. 

That’s especially true when things already feel rocky. That’s why retention packages are typically offered during big upheavals, like mergers, acquisitions, key production months, or even an overly competitive job market.

Bonuses, in general, come with a number of benefits for employers, particularly for small businesses. They include:

• Boost employee morale: Sure, a pizza party can help bring up spirits. But in reality, nothing makes employees feel more valued more than cash. Retention pay is a way to quite literally put your money where your mouth is and show employees how much you value their hard work. That improves morale and the overall mood at your business. 
  
  
• Up productivity: While retention pay isn’t tied to job performance, financial incentives can motivate employees and increase their commitment to your company. The best news? Engaged employees have been shown to be up to 18% more productive than those who aren’t.
  
  
• Foster loyalty: Even if an employee is contractually obligated to stay at the company under a retention agreement, other employees may not know this. Instead, they’ll see a team member who’s sticking with the business. This can help to inspire loyalty throughout the rest of the organization.
  
  
• Retain knowledge: Employees have a lot of institutionalized knowledge, and it leaves when they do. Using retention bonuses during tough times—like mergers or transitions with new products—helps you keep that knowledge and experience on your staff, at least until the waters calm down a little bit. 

Do Retention Bonuses Work in Every Situation?

You might think that offering some additional cash to your team members is enough to keep them on your side for a few more years. But that’s not always the case. Here are some scenarios where retention bonuses don’t make much of an impact:

1. Retention Bonuses Don’t Make up for Low Pay

With so many companies now offering bonuses to employees, including lucrative sign-on bonuses (which are sometimes used to compensate for the employee’s loss of a retention bonus at their old company), there’s no guarantee that your offer will be enticing enough to stop your staff from jumping ship. This is especially true if a new job is offering a significantly higher salary than what you’re currently paying your employee, even with bonus money included.

In a recent study by Pew Research Center, over 37% of those surveyed said that low pay was the major reason for why they left a job in 2021, with a further 26% saying that it was a factor. That’s 63% of people saying that low wages were a reason for them moving on to a new position. In fact, of all the reasons outlined in the survey, pay topped the list along with a lack of opportunities to advance.

So what can you learn from this? Simply put, your employees want to be fairly compensated for the job they’re doing. And if a competitor can offer them more than you on a steady basis, no bonus amount is going to be enough to sway them.

It’s worth looking at what the market is paying for similar talent and raising employees’ salaries accordingly if you can swing it. If you can’t? Even some extra perks or benefits can help to make up for the shortfall. 

2. Retention Bonuses Aren’t Long-Term Solutions

There’s also the fact that a bonus is a one-time move. It’s not a salary raise or stock option that an employee can continue to build on over the course of their career. 

The bonus may be enough to keep your team member for the amount of time that you’ve specified in their retention agreement. But there’s then nothing stopping them from jumping ship the moment that time has expired. 

Long-term loyalty is never guaranteed, even with a financial incentive. But, ensuring you provide adequate pay and benefits and fostering a culture where people feel valued can go a long way in keeping them around. 

3. Retention Bonuses Can Cause Resentment If Employees Compare What They're Given 

You also need to think carefully about how you roll out any kind of retention bonuses. Naturally, you’ll likely give the most money to your highest value individuals. But when groups of employees get together and share the details of their own retention bonuses, it could quickly become apparent that some have received more than others. 

Not only can a situation like this tank employee morale overall, but it could also mean that you lose other key members of the team. If staff feel they’re not as well-respected or valued thanks to a lower bonus, or even no bonus at all, they could soon be looking for a new position somewhere else.

This isn’t to say that retention bonuses don't work at all. In many cases, they’re a great stepping stone to bridge the gap of a chaotic time. But being aware of the potential downsides is important before you rush into handing out extra money to different members of your team.

What Should You Require from an Employee in Return?

Before you can make any offers to your team members, you need to decide what your bonus agreement will look like. 

You should work with your human resource management team (if you have one) to iron out the FAQs that your employees will have about retention bonuses. This could include topics like: 

• How long the employee must stay with the company
• The amount of money in their bonus
• How the employee will receive their money, i.e., a lump sum or in installments and when those payments will be made
• Any potential consequences or requirements if the employee leaves before the end of their contracted time
• What your business is on the hook for if the employee is fired before the end of their contracted retention period (for example, do you still need to pay the full bonus?)
• The tax implications (bonuses are taxed differently than normal income!) that will impact the employee as a result of the bonus

There are no legal requirements when it comes to the eligibility of employees for a retention bonus. Who receives a bonus is entirely up to you. If you decide on a standardized eligibility structure (e.g., employees are only able to get retention bonuses after their 90-day probation), you should also include this in your documentation with HR—like your employee manuals and benefits paperwork.

What Are the Legal Logistics of Offering a Retention Bonus?

The IRS determines that any kind of bonus is considered supplemental wages, so it must still be reported as part of an employee’s total gross income on their annual taxes.

You may choose to work with a tax professional to account for these funds on your employees’ W-2 forms come tax time. There are two ways to do this—the aggregate method or the percentage method: 

• Aggregate method: Combines their retention bonus with their yearly salary to make one total for the employee’s gross income. The income tax rate is then determined based on this total.
  
  
• Percentage method: Uses a flat rate of 22 percent for the amount of their bonus. For any bonuses over $1 million, the tax rate is 37 percent for the portion over $1 million. For instance, a retention bonus of $1.5 million would be assessed at 22% for the first $1 million, then $500,000 would be at the 37% rate.

Retention Bonus Letter Templates

Whenever you’re changing the terms of a team member’s payment and employment, you need to have an in-person conversation with them and your head of HR. 

Once that chat is over? Follow up with a formal letter that addresses everything you discussed (so you have the right documentation if you need it). Here’s a sample letter to get you started:

Dear [employee name],

As we discussed during our conversation on [date], we would like to offer you a bonus to continue your employment with [company] [you can include any extra information here, e.g., “as a result of our upcoming acquisition/merger with [new company].”]

Under this agreement, you agree to remain with the company for a period of [time the employee has to stay for], beginning on the date of signature below. Your position will not be impacted by this bonus and you will continue to perform the duties of your job description and report to [manager].

Your annual salary will remain at [amount of base pay] and this will continue to be paid according to our normal payroll schedule, as outlined in the employee handbook. Salary adjustments may occur during your retention period and are not subject to any of the agreements made here. 

Your retention bonus of [amount] will be paid in [quarterly/annual/etc.] installments, with the first [amount] paid by [date]. The subsequent installments will be made by December 31 for the next [time] calendar months/years. 

If [company] terminates your employment before the end of your retention period, we will only be obligated to pay you the retention bonus amount up until this point in time. If you choose to leave your employment voluntarily before the end of the retention period without good reason, you will be obligated to repay any part of your retention bonus earned so far within 60 days. 

If you have any questions or concerns, please let me know.

Regards,

[Head of HR]

What Other Kind of Employee Bonuses Are There?

A retention bonus is focused on keeping an employee around. But, there are other types of bonus payments you could dish out to employees.

You can offer employees a fixed sum of money at the end of the year to recognize and reward excellent employee performance. You could also offer a lump sum payment in response to a big accomplishment at any point in the year. This is a great way for employers to boost a team member’s confidence and show appreciation for their hard work.

Similarly, a sign-on bonus is fairly common, where a new employee receives either a one-time payment or a series of installments toward a fixed amount when they begin work at a new company. This is separate from the employee’s salary and is used as a financial incentive to convince a candidate to join a particular business when they’re choosing between several competitive job offers.

Investing in Your Team for a More Successful Future

It’s a challenging time to head up a company, but using your time and resources wisely to invest in your team can really pay off. 

There will always be circumstances outside of your control when it comes to keeping your staff. Maybe they’re relocating due to their partner’s job or to be closer to a sick loved one. Or perhaps another company made them an offer that they absolutely couldn’t refuse. 

But when you can, put some money behind your team members and show them how much you value and respect them. You never know—you just might be able to persuade them to stay.