For added insight, overlay this data with employee performance metrics, engagement, and turnover rate.
Related Learning
Talent Management
Should You Offer a Retention Bonus? What HR Leaders Need to Know
Throwing money at a problem doesn’t always work. But when it comes to keeping your best employees from jumping ship, a retention bonus might just do the trick.
Employee retention is the stable bedrock of successful organizations. But it’s not just about stopping people from leaving — it’s about engaging and inspiring them to stay. And when your best employees have one foot out of the door, how can you ensure they have a good reason to stick around?
Retention bonuses can be an effective way of meeting this challenge. When implemented as part of a strong retention strategy, they can help organizations navigate difficult transitions, retain skilled talent, and reward top performers for their loyalty.
In this article, we’ll explain how retention bonuses work, how they’re calculated, and four best practices for crafting a compelling offer.
Key Takeaways
- A retention bonus can be a helpful HR strategy that keeps employee engagement and performance high during organizational change.
- Retention pay works best when it forms part of a broader retention strategy focused on nurturing employee engagement and development.
- Building a great package hinges on using data to design an offer that is competitive, fair, and aligned with market benchmarks.
What is a Retention Bonus?
A retention bonus — also known as a stay bonus — is a financial incentive offered to employees to encourage them to stay at their organization for an agreed-upon period.
Think of it as a reward for loyalty, especially during a period of organizational change, such as a merger, acquisition, or restructuring. Organizations might also offer a retention bonus in a competitive talent market, where employees with key skills are in short supply.
When offered in the right context, a retention bonus can actually save your organization money.
The cost of turnover varies, but estimates put it between 50% and 200% of an employee’s annual salary. The cost of hiring, training, and ramping a new employee is one thing — but organizations also must understand how declining performance, engagement, and productivity hit their bottom line.
If employees start leaving en masse, those costs can quickly stack up. Offering a retention bonus can help maintain workforce stability and performance during critical transition points. It’s a way of telling your workforce that you value their contributions and commitment.
Learn More: How to Calculate (and Analyze) Employee Turnover Rate
How do Retention Bonuses Work?
As the name suggests, retention bonuses are designed to help organizations keep their best talent and skills and stop employees from having their heads turned by another role. When used as part of a long-term retention strategy, they can effectively minimize attrition.
Retention bonuses are usually awarded in one of two ways:
- Lump sum payment: Employees receive their payment in one lump sum at the end of the period set out in the contract. This approach offers a strong incentive for employees to go the distance and complete their entire retention period.
- Incremental payments: Employees receive regular, smaller installments throughout their retention period. This drip-feed approach could increase employee motivation, as employees receive instant loyalty rewards.
In either case, enticing your employees to stay is all in how you calculate the offer. Building a great retention bonus package will help employees feel fairly rewarded for their commitment and increase the likelihood that they’ll stay engaged.
How to Calculate Retention Pay
Retention bonuses are usually calculated based on a percentage of an employee’s base pay, with most offers falling between 10% and 15%. However, there are a few factors that can change this rate:
- Knowledge and skills: Organizations may need to offer higher payouts to keep specialist knowledge, organizational expertise, and in-demand or mission-critical skills in-house.
- Turnover likelihood: Employees at higher flight risk, either due to disengagement, competing offers, or other factors, may need a larger bonus offer to guarantee retention.
- Turnover impact: How an employee departure may impact the broader team.
- Length of retention: Longer retention periods may demand a higher payout to reflect the commitment length required.
Understanding how these multipliers can enhance your offer means you have a better chance at putting together a great retention pay package for key talent.
Are Retention Bonuses Taxable?
In the United States, retention pay is considered taxable income, as it falls under the category of “supplemental wages.” Supplemental income is any compensation employees receive in addition to their regular salary, including overtime, bonuses, and commission.
Retention bonuses are subject to tax withholding, which can be calculated in one of two ways:
- Percentage: This involves using a flat percentage to calculate taxes owed. Bonuses under $1 million are taxed at a flat rate of 22%, while any dollar amount over this sum is taxed at 37%. The percentage method works well for larger bonuses, one-time lump sum payments, or employees in higher income tax brackets.
- Aggregate: The bonus is added to your employee’s regular paycheck and taxed based on their income tax bracket. The aggregate method works well for smaller bonuses and organizations that have chosen to pay out bonuses on an incremental basis.
In international workforces, HR leaders must follow local laws and tax conventions to ensure retention bonuses are taxed correctly.
Learn More: A U.S. Employer’s Guide to Paying International Employees
What is a Retention Bonus Agreement?
Without a contract, nothing stops an employee from cashing in and heading for the exit the moment their bonus hits.
This is why many organizations use a retention bonus agreement - a formal contract between an employer and an employee that outlines the terms and conditions of a retention bonus. This agreement usually outlines:
- Bonus amount
- Payment structure (e.g., lump sum vs. incremental
- Tax implications
- Duration of the retention period
- Other conditions specific to the role (e.g., completion of a project, non-disclosure agreement, non-compete agreement)
- Clawback provisions, in case the employee departs before the terms are met
By setting clear expectations, a retention bonus agreement ensures transparency and protects the employer’s investment and the employee’s interests.
Benefits and Drawbacks of Retention Bonuses
Deciding whether to offer retention pay isn’t just a simple financial calculation — it’s a strategic choice that hinges on your workforce dynamics, current financial situation, market conditions, and organizational priorities.
But when done well, it can offer some compelling benefits — both for employers and employees:
- Increase short-term performance: The jury’s still out on how money influences long-term job satisfaction — but it can have a shorter-term impact on employee performance. One 2023 study assessing the impact of pay-for-performance, for example, found a positive link in employees’ task performance — a strategy that HR leaders can leverage to boost focus during the retention period and beyond.
- Retain hard-to-replace skills and knowledge: In the current talent market, specialized knowledge and skills are often expensive and time-consuming to replace. Plus, long-tenured employees have expertise in how your organization works, which is hard to ramp up quickly with new hires. Retention bonuses may help keep key hires motivated and signal that their contributions are valued.
- Maintain continuity and productivity: Periods of high change can disrupt workflows and teams, often leading to a dip in productivity. Increasing retention maintains team continuity, helping employees complete mission-critical projects and product launches.
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Avoid the turnover “snowball”: Employee departures impact the whole organization. If one decides to leave, others may follow, causing a huge loss of morale. Retention pay can help stabilize this potential mass exodus, giving HR more time to build out succession and hiring plans.
Retention pay is not a one-size-fits-all process and can lead to challenges if not implemented carefully. The financial outlay may strain organizations going through change, particularly those with larger workforces.
Retention bonuses also have a short-term focus that may feel transactional to your workforce if not paired with broader retention strategies to retain and engage employees. In the long term, this may just delay the inevitable, resulting in a wave of quits as the retention period ends and the payout lands in employees’ bank accounts.
4 Retention Bonus Best Practices
Unlocking the benefits of retention pay hinges on aligning it with your entire employee lifecycle. Broadly speaking, you’ll need to consider how and where retention bonuses fit into your employee engagement, growth, and compensation strategy.
This will help you maximize its near-term impact alongside your organization’s long-term goals and priorities.
Here are four best practices to follow.
1. Use Data to Inform Your Offer
Crafting a compelling retention bonus starts with data. In a competitive talent market, your offer needs to reflect the employee's value and the realities of broader industry and macroeconomic trends. Taking a data-driven approach is essential if you want your retention pay offers to land.
Compensation management tools make it easy to pull real-time market data, identify compensation trends, and see how your offer stacks up. Run reports on internal salary trends to see how your retention bonus aligns with your existing pay structures, and then compare this number to market benchmarks to assess its competitiveness.
2. Communicate the Terms Clearly and Transparently
Retention bonuses are, first and foremost, a contract. This means that employees need to have a full understanding of what they’re agreeing to so that they can evaluate their offer properly.
Clear, proactive communication that addresses the “what” and “why” is essential. You’ll also need to provide a simple calculation that breaks down how you landed on their offer. A total rewards statement can also help illustrate the bonus in the context of an employee’s entire compensation package.
If retention bonuses are only being offered to a select few, you’ll also want to get ahead of brewing misunderstanding and resentment. Create an explainer that addresses the eligibility criteria, and provide opportunities — such as segments all-hands meetings or office hours — for employees to ask questions directly.
3. Align Bonuses with your Long-term Retention Strategy
Retention bonuses are a one-time boost, but they’re hardly the basis of a long-term strategy. That means that what you do after the bonus period ends really matters. Building initiatives that engage and develop your workforce is essential to show them you value their contributions and commitment.
Try the strategies below as a starting point:
- Develop clear career pathing, compensation policies, and opportunities for internal mobility.
- Provide ample opportunities for growth that nurture upskilling and new skills development.
- Run regular engagement surveys to evaluate what motivates your workforce, identify employees at risk of departure, identify root causes of attrition, and proactively address feedback.
- Build out regular performance cycles to identify promotion opportunities and reward top performers.
4. Get Ahead on Headcount Planning
As the retention period ends, some employees may choose to stay — but others may choose to take their money and run. Get the jump on this potential turnover risk by conducting scenario planning to gauge how this will impact your workforce in the future.
Analyze hiring data, historical turnover, engagement, and performance to identify any patterns (for example, cyclical seasonal trends), and identify your mission-critical employees. Use this data to understand the impact of any potential departures.
Use the following questions as a guide:
- Which roles are critical to keeping our organization running?
- Which other key departures may impact employee morale or productivity?
- Do we have succession plans for potential executive or leader departures?
- What is our strategy to re-engage employees who choose to stay?
Addressing these questions will help you plan for worst-case scenarios and prepare the organization for a smooth transition.
Turning Short-term Incentives into Long-term Success
Retention bonuses can be a powerful tool for addressing near-term workforce challenges, offering both organizations and employees a sense of stability and mutual commitment during tough times. Crafting a great offer hinges on taking a data-driven approach, aligning employee needs with compensation trends and market benchmarks.
Paylocity’s all-in-one HR and payroll software provides real-time compensation and headcount data that help your team:
- Make Data-Driven Decisions. Use dashboards to see performance and compensation history. Unlock detailed spend analytics, attrition analysis, and forecasting to help you make smarter headcount decisions.
- Understand Salary Expectations. Browse market data like salaries and highest-demand locations to help define roles and compensation.
- Show Employees Your Investment. Easily create and distribute a view of total compensation to provide employees with an overview of their pay and additional benefits.
Want to learn more? Request a Paylocity demo today!
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