What is an Employee Retention Bonus? And Do They Still Work in 2022?

September 19, 2021

According to the U.S. Bureau of Statistics, more than 4 million people have quit their jobs every month as of November 2021.

This is an alarming number for business owners, especially with new trends such as Quiet Quitting growing at alarming rates.

Because of that, employers resort to various methods to keep key employees around. One of these methods is providing retention bonuses.

What Is a Retention Bonus?

employee retention bonus for key employees

An employee retention bonus is a financial incentive that offers an extra payment on top of the employee’s salary to keep them satisfied, with the goal of keeping them at the company longer.

Retention bonuses are often given out during difficult transitional times within a business or during internal mobility. The point of employee retention bonuses is to minimize internal damage and reduce the costs of rehiring campaigns.

How Does an Employee Retention Bonus Work?

An ERB aims to retain highly-skilled, valuable employees within the company and prevent them from moving to rival companies with better offers.

The company will offer the target employee a specific bonus if they refrain from leaving the company for a specific time.

How are retention bonuses calculated?

The average retention bonus is calculated based on various factors, some of which include:

  • The current financial situation of the company
  • The extent of the retention period
  • The employee’s base pay and service time
  • The possible impact if the employee resigns from the company

In general, the average financial incentives to keep a key employee range between 10–25%. Here’s an example of how it works:

Retention incentive payment option Retention incentive rate Basic pay earned in installment period Retention incentive installment Total incentive paid after 26 day periods
Biweekly installments (26x per year) 25% $3,633.60

($3,633.60 biweekly rate x 1 pay period)

$908.40 (each)

($3,633.60 basic pay earned x 25%)

$23,618.40

($908.40 x 26 pay periods)

Installment payment provided after 13 and 26 pay periods of service 25%

(Each installment computed at full percentage rate)

$47,236.80

($3,633.60 biweekly rate x 13 pay periods)

$11,809.20 (each)

($47,236.80 basic pay earned x 25%)

$23,618.40

($11,809.20 incentive x 2 installments)

Installment payment provided after 13 and 26 pay periods of service 25%

First installment computed at a reduced percentage rate of 15%

Second installment computed at 25% percentage rate, plus remaining 10% unpaid accrued incentive from first installment period

$47,236.80

($3,633.60 biweekly rate x 13 pay periods)

First: $7,085.52

($47,236.80 basic pay earned x 15%)Second: $16,532.88

($47,236.80 basic pay earned x 25% or $11,809.20,

plus $4,723.68 (remaining 10% unpaid accrued incentive from first installment period)

$23,618.40

(Two installments of $7,085.52 and $16,532.88)

Who is eligible for a retention bonus?

There’s no absolute rule for retention bonus eligibility. Each company has its own policy, but there are some basic conditions that an employee should meet before qualifying for a retention bonus.

The employee must be working full-time for at least 30 hours a week. Additionally, the employee must have spent some time in the business before being eligible.

Furthermore, the role, experience, and skill level also decide who should be offered a retention bonus.

Key employees who deserve the retention bonus the most are typically senior executives and the ones with excessive internal mobility. An employee who is constantly improving is a much better candidate for higher positions than external applicants.

This is especially important if you want to avoid the boomerang employees phenomenon, where employees fail to recognize their future opportunities in the company, leave, and come back later – costing businesses time and money that could have been budgeted elsewhere.

When is a retention bonus paid?

retention package for senior executives to retain workers

The time period for when the retention bonus is paid out varies between companies and their internal policies. However, in most cases, the company pays the retention bonus after the transitional period written in the contract.

A good example of a transitional period is a lengthy project. If the project is expected to last for 8 months, the retention bonus will be paid after 9+ months. This is to ensure that the employee stays until the end of the project.

Is a retention bonus taxable income?

A retention bonus is seen as income by the Internal Revenue Service (IRS) even though they’re supplemental wages and not base salaries.

Because of that, a retention bonus is considered taxable income. There are two ways to apply taxes to retention bonuses:

  1. Percentage method

The percentage method is often favored by most employees as it allows them to retain a more significant chunk of the lump sum.

It uses a standardized 25% tax rate for any amount below $1 million and 39.6% if the bonus amount exceeds 1 million.

  1. Aggregate method

The aggregate method adds the retention bonus to the annual salary. The new annual income for that particular year is the one that should be provided in the W-4 tax form.

Because of that annual addition, the aggregate method often results in a higher tax rate.

Consulting a tax professional before signing the retention bonus agreement in order to understand the full tax implications is recommended. Businesses have different policies, and it’s best to understand the details in depth.

Retention bonuses vs. sign-on bonuses

Unlike retention bonuses, sign-on bonuses aren’t paid to keep an employee at a company. Instead, it’s a financial award as an incentive to join the company.

The sign-on bonus could be a lump sum or a series of installments over an agreed-upon time period. If the employee leaves the company too soon or violates the sign-on bonus terms and conditions, the employee may have to pay back some or all of the bonus.

When Should You Offer a Retention Bonus?

As an employer or a company owner, you should offer a retention bonus in the following scenarios:

  • When there’s a key employee that you intend to keep from leaving
  • When you want to reduce employee turnover
  • When you need to guarantee a minimum number of employees through a certain phase or project

It’s important to offer the retention bonus to the right employees at the right time. Retention bonuses have pros and cons and can backfire if misapplied.

Pros of Retention Incentives

Here’s how retention incentives can work to your advantage:

Higher productivity

Although it’s not guaranteed, a retention bonus package will likely result in higher productivity and company loyalty than usual, especially if they’re targeting the right people.

A highly-skilled or critical employee is much more likely to increase productivity as an appreciation gesture for the bonus than an average employee.

Targeted in nature

Retention incentives aren’t for everyone. They’re targeted toward a specific group of employees.

It means that the company has already identified its most valuable assets and are ready to do what they need to keep them.

Consistency to outsiders

Retaining vital employees for extended periods of time is a good sign for external investors and stakeholders.

It shows that the organization has a low turnover rate and high job satisfaction at the company, which appeals to investors and potential new hires.

It is a morale booster

We mentioned earlier that employees can feel it when the business is going through difficult times. That can negatively affect morale and, in turn, reduce overall productivity.

Performance bonuses can significantly affect work morale and give employees a sense of appreciation.

One-time payment

Because it is a one-time payment, retention incentives are great win-win deals that make everyone happy.

For the employer, it’s a one-time expense with a high ROI, if done right. And for employees, who doesn’t want to feel appreciated for either their hard work or their potential?

Knowing that the company cares can spread the benefits of a one-time payment across many months – even years!

Cons of retention pay

Retention pay bonuses can still adversely affect employees. In fact, a retention bonus may sometimes have the opposite effect as is intended. Here’s how:

Attempt to buy loyalty

Some employees might view the retention bonus as a last-minute resort to save a sinking ship. After all, employers had the chance to reward employees long before a retention bonus came into play.

Instead of seeing it as an incentive bonus, the employees might think that their employer is trying to buy their loyalty by handing out some money.

In return, they might insist on handing in their resignation even more.

Doesn’t address the root cause

When a business or company has an ongoing problem that increases employee turnover rate, retention payments may prevent some employees from leaving.

However, such payment may only delay the inevitable as the origin of the problem is still present. The best strategy at this point is to give out those incentive bonuses while still tackling the high turnover problem – which likely stems from not feeling appreciated or supported by employers.

Rather than pay a bonus out as a last-ditch effort, spreading that over the course of year keeps employees feeling good for longer.

Conflict in the workplace

We’ve mentioned earlier that incentive payments can show some employees that they’re appreciated.

On the other hand, those who don’t get the bonus will feel the opposite. If other employees find out that some of their peers are more favored than others, it could create a disruptive period and workplace conflict.

Retention incentives: The employee’s side

On a very general level, there are three types of employees within a particular workplace: those who are happy with their career choice, those who aren’t, and those who are unsure.

Unfortunately, employees who love their career choice and their position aren’t the most common.. However, these are the ones that are most likely to give the most favorable response to retention incentives, especially during tougher times.

Employees who are just in it for a stable income – or Quiet Quitters – may not be the best choice for retention bonuses. Unfortunately, these are often more abundant in numbers than satisfied employees.

Hesitant employees form the largest chunk of the workforce, and with the right motivation, can push the business in the right direction. They often give mixed responses toward incentive bonuses, but the responses are mostly favorable.

How to Improve Retention and Sustain High Rates Long-Term

A retention bonus is an excellent way to keep employees from leaving. However, it’s only one of the various methods that can be used to improve retention.

Here are some recommendations on other possible ways to sustain high rates:

  1. Employee Surveys

Information is key to the success of any institute or firm. Surveying your employees and hearing their feedback will provide great insight into what is really going on in the workplace.

Keeping these surveys anonymous is an excellent way to hear even more honest answers. The answers may be brutally honest, but they’ll help to improve the work environment in the long term.

  1. Aim for the cause, not the effect

Any attempt to keep the employees around without tackling the actual problem is just a temporary solution – and not a very good one at that.

No organization is devoid of problems. A good employer should use some temporary solutions to minimize the damage as they work through a company transition or on identifying the root of the problem.

  1. Hire the right people from the start

There’s a strong connection between employee turnover and employee engagement.

Hiring people who feel connected to the company’s missions and goals from the start and constantly engaging them provides a much better retention rate.

Employees need to feel like they are partners in success instead of just ‘working for someone.’ That all comes down to hiring the right people and giving them support through feedback, check-ins, and engagement surveys.

Final Words

Retention bonuses aren’t just a business tactic to keep people from leaving; with the proper application, they make the workplace more wholesome and productive.

The moment you make all your employees feel like partners instead of workers is when the business will thrive. Retention bonuses are an excellent method to achieve such a goal.