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Retention Bonus: What Is It And How Does It Work? Pros and Cons

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Employee retention bonus

You have heard a lot about the performance bonus, but nowadays, the retention bonus is quite common as well.

Employees are the heart and soul of any organization. All the goals and objectives that any firm wants to accomplish boil down to people management. So, it is essential that they retain talented, experienced, and driven employees.

However, there are times when there is an unprecedented demand for talent and resources across all industries. This is when it is common to notice people switching jobs in lieu of better compensation, titles, and other benefits.

This has given rise to a practice where firms pay some of their existing top employees a retention bonus to make them stay.

Also, it helps firms maintain an edge in the war for talent. This phenomenon of a retention bonus is exactly what we are going to discuss in this article.

What Is a Retention Bonus?

Retention bonus agreement
Retention bonus agreement

While running a business, firms often need a tool or an incentive that can convince key employees to stay with the company. One such incentive is the Retention incentive. This retention bonus is typically offered when firms are undergoing a transition period.

Examples of such periods are a merger or an acquisition. A retention bonus is usually a one-time lump sum payment. However, it can also be paid in parts over a given period.

The retention bonus is in the form of a contract. This contract usually details how long the employee must stay with the company in exchange for the promised sum of money. Generally, retention bonuses are a significant amount. Usually, they can range anywhere from 10-25% of your base pay but sometimes even more.

How Do Retention Bonuses Work?

A retention bonus is unrelated to your performance at the workplace or in a particular role. This bonus is not meant to retain people over an indefinite period.

A firm must decide on its reasons for giving an employee a retention bonus. This can also help determine the amount that the firm must pay. If the sole purpose of the retention bonus is to prevent people from switching to the competition, then the bonus must match the competing offer.

However, there may be a situation where the employer wants to stop its key team members from leaving before they complete a project. In such a scenario, the employer will have to consider various factors such as :

  • The length of the project
  • The value or the revenue of the project
  • The time the retained employee has to give to the project
  • The budgets available with the concerned department
  • Employees' period of service in the firm
  • Financial stability of the company
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Retention bonuses are pretty common in large firms with more than 20,000 employees. These big companies usually have the resources to retain critical employees.

Is Retention Bonus Classified as Income?

Retention bonus as income
Is retention bonus part of income?

The IRS considers all forms of bonuses, including retention bonuses as supplemental income. Now, the supplemental wage is basically compensation in addition to an employee’s regular wages.

The taxation, in this case, usually takes place in one of two ways – the aggregate method or the percentage method.

Any retention bonus is a part of one’s gross pay and must be reported for tax purposes. In most cases, the aggregate tax method leads to more tax because the aggregate tax adds the retention bonus to the yearly salary.

The final tax is then calculated on this salary. A W-4 form is used to calculate the tax rate. However, the exact tax depends on the actual bonus.

A flat rate of 25% applies to the bonus in the percentage tax method. However, if the bonus is in excess of a million dollars, then the taxation rate for the amount above million dollars is 39.6%.

For instance, if a person receives a bonus of 1.5 million dollars, then 1 million dollars would be taxed at 25%, and 500,000 dollars would be taxed at 39.6%

How to Decide if One Should Accept a Retention Bonus?

When a company has offered an individual a retention bonus, it means that the firm values his contribution. Now the person must decide whether he wants to accept the bonus or not.

This depends on various factors that are detailed below:

The reasons a firm offers a bonus.

A firm might extend a retention bonus for several reasons. They would like to ensure stability as the firm goes through leadership or structural changes. Or, they might not want to lose quality talent to the competition.

However, one has to use his discretion and conclude whether they agree with the company’s rationale.

A person’s experience at the firm.

The individual has to assess whether the work he is doing currently motivates him or not. Also, he has to see if his career progression aligns with his overall goals. Moreover, there is the question of cultural fit. Is his overall personality more in line with the current organization or the new one? Collaborative work culture is a crucial driver of job performance.

The current job market and industry scenario.

Based on skillsets, a person should study the current demand in the industry. He can gauge how easy or difficult it would be to find a suitable job role. This clarity will go a long way in helping a person decide whether to accept a bonus or not.

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Taxes

We have already discussed the taxation structure for bonuses. Ultimately, it is upon the person to decide whether a retention bonus would be beneficial to him. One can reach out to a tax consultant to discuss this issue. Based on the feedback, he can decide whether to opt for a bonus or ask for a raise.

Pros of Retention Bonus

There are several pros of giving a retention bonus to employees. We will explore them in detail here.

Retention bonus pros
Pros of Retention bonus

Higher productivity

Even though retention bonuses are not connected to an employee's performance, they still add to the feel-good factor and encourage employees to work harder.

Targeted in nature

A retention bonus is only for specific individuals, meaning that the company has already identified a select group as valuable assets. This, in turn, increases the motivation to work harder. This is because the company has rewarded its unique contributions.

Consistency to outsiders

Retaining top-level executives and other key employees during a transition period is a sign of strength. Also, it signals to the investors and other stakeholders that things are moving smoothly, which helps maintain the investors' confidence in the company.

It is a morale booster

There could be times when the industry or the firm is going through a crisis. Financial rewards are one of the best ways to show appreciation. A retention bonus is a great way to show that the firm values its employees. Also, it will motivate employees to upskill themselves further.

One-time payment

From the employer’s point of view, a retention bonus is a one-time payment to a select few. This helps him keep the costs under control compared to a pay raise. Also, the team performance improves. Thus, it is a win-win situation.

Cons of Retention Bonus

Despite all the plus points, there are downsides to a retention bonus. We shall look at those disadvantages here:

Retention bonus cons
Cons of Retention bonus

Attempt to buy loyalty

Some employees might feel that they are valued only when they handed in their resignation. Also, the employees can view it as a last-minute rescue effort to steady a sinking ship. A retention bonus could then have the opposite effect and cause more people to leave the team.

Does not address the root cause

There might be issues such as toxic work culture or unresponsive management. A retention bonus is a quick fix that might reduce the discontent temporarily. However, it does not solve the issues of employee dissatisfaction.

Conflict in the workplace

The fact that some people have received a bonus and others have not will make its way through the grapevine. This will then create discontentment amongst the staff. The result of this exercise will be a toxic office environment with a demotivated workforce.

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In Conclusion

The final decision to accept or reject a retention bonus lies with the employee. However, it is essential to know that a retention bonus is not a silver bullet that will resolve all the concerns that employees have.

This decision to move on or stay in an organization or a role is entirely dependent on several factors. There may be an interesting situation where several employees look for more fulfilling roles rather than a larger pay packet. This is when even a retention bonus might not help the employer in retaining the talent.

Also, one must not forget the employer’s thought process on this. He has to choose between infusing young blood and fresh thoughts and keeping seasoned people on board.

The fact of the matter is that every employee, whether seasoned or new has to stay relevant at all times, in order to receive such incentives.

If the employees are insistent on leaving the organization, then an employer has to think hard about whether a retention bonus is a worthwhile investment or not.

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