What is a retention bonus? How worker incentives work

Businesses need an innovative strategy to secure their most valuable asset: talented employees. If workers seem poised to leave for greener pastures, a retention bonus may convince them to stay.

Beyond showing appreciation for a job well done, retention bonuses maintain internal stability, fortify operations during mergers or acquisitions, and signal strength to stakeholders and the broader industry.

What is a retention bonus?

A retention bonus is a type of financial incentive employers give to encourage long-term employee loyalty, especially during crunch time. Unlike performance bonuses, retention bonuses are typically offered during organizational shifts, such as mergers, acquisitions, or restructuring.

Retention bonuses can reduce turnover, maintain stability, and ensure continuity within the company. They’re often reserved for employees with specialized skills, knowledge, or experience that would be hard to find among prospective new hires. Eligibility for retention packages varies by company, but they’re generally given to senior employees in pivotal roles since they’re meant to retain top talent who can guide the company through transitional phases.

How does a retention bonus work?

Retention bonuses are usually lump-sum payments offered to employees who agree to stay with a company for a specified period. Contracts typically outline the terms and conditions, including the duration of the commitment, the payment schedule, and when a retention bonus is paid—often at the end of the period or disbursed in installments throughout the term.

How to determine the size of a retention bonus

A retention bonus sum may vary, but it’s typically 10–20% of an employee’s annual base pay (not including benefits that add to their total compensation package). Ultimately, it must be enough to entice the employee to stay with the company instead of seeking external opportunities.

Several factors can impact the size of a retention bonus. Examples include:

• Company’s financial situation: The company’s budget may influence the size of the bonus.
• Length of retention period: Longer retention periods typically merit higher bonuses.
• Employee’s base pay and service time: A higher base salary or lengthier history with the company may justify a more significant bonus.
• Impact of employee departure: Employees whose departure could significantly disrupt operations are often offered higher bonuses.

Terms of a retention bonus agreement

The terms of a retention bonus should promote clarity and mutual understanding between employer and employee. Here are several essential elements of an agreement:

Financial terms

This section outlines the total amount of the retention bonus, the payment schedule, and any tax implications. It also indicates whether the bonus is a lump-sum payment or disbursed in installments over a specified period.

Employment terms

Employment terms define the duration the employee must stay with the company to receive the bonus, also called the vesting period. This part of the retention bonus agreement also includes the employee’s job position and any specific projects or responsibilities they must fulfill during the retention period. It may clarify that the agreement only guarantees employment within the vesting period.

Non-disclosure agreement (NDA)

An NDA protects sensitive information. An employer may include this clause to ensure the employee doesn’t disclose proprietary information or details about the retention bonus to competitors or external parties. Confidentiality is vital, especially as a company undergoes organizational changes or risky projects.

Bonus assignment

This clause addresses the possibility that the company is acquired or undergoes a merger. It facilitates the transfer of the retention bonus agreement to a new legal entity. This provides greater security to the employee, ensuring they can count on the agreed-upon bonus if new ownership takes charge.

Reimbursement agreement

If the retention bonus is paid in installments, this section outlines the terms for reimbursement should the employee leave the company before the vesting period ends.

Signature

The employer and employee must sign the document to formalize the agreement. As with all conventional workplace agreements, the signature makes the contract legally binding and indicates that both parties understand the terms.

Are retention bonuses taxable?

In the United States, the Internal Revenue Service (IRS) considers bonuses supplemental wages, meaning a retention bonus is taxed like any other income. As such, it isn’t exempt from federal, state, or local taxes and must be reported on the employee’s W-2 form as part of their total earnings.

Retention bonuses may be paid in installments or as a lump sum, but the entire amount is subject to taxation in the year it’s paid. For lump sum payments, tax is withheld at the time of payment. For installments, taxes are withheld with each disbursed payment.

Employers typically apply one of two methods when withholding taxes on these bonuses: the percentage method or the aggregate method.

Percentage method

This method stipulates a flat tax rate of 22% on the retention bonus if it totals less than $1 million. For bonuses above $1 million, the excess amount is taxed at the highest income tax rate—37% as of 2024. This method is more common due to its simplicity.

Aggregate method

The aggregate method involves adding the retention bonus to the employee’s regular paycheck and then calculating the tax based on the total amount. This can temporarily push the employee into a higher tax bracket, leading to a higher withholding rate.

Benefits of retention bonuses

Retention bonuses offer substantial value for employees and employers. Here are some of the mutual benefits:

Improve employee engagement

Retention bonuses may significantly boost employee engagement. When companies offer financial incentives to employees, they demonstrate their appreciation for their workforce, increasing motivation and commitment to the company.

Engaged employees are more likely to approach their work with creativity and efficacy. They contribute to their company’s goals with a positive, optimistic attitude.

Attract talent

In a highly competitive job market, retention bonuses are a simple way to enhance a company’s prestige and PR. They show that the company offers employees competitive salaries and real financial incentives. Such measures signal to prospective employees that the company truly values and invests in its workforce.

Boost productivity

Retention bonuses can promote a company-wide increase in productivity. Financial rewards incentivize employees to focus on their roles and exceed expectations. Additional financial security—linked directly to their loyalty—increases employees’ sense of security, leading to higher morale. Employees will feel less inclined to seek employment elsewhere and dedicate their undivided attention to company initiatives and internal advancement.

Show consistency to stakeholders

Retention bonuses will lead stakeholders (including investors and clients) to perceive the company as stable and appreciative of employees. High retention rates denote a healthy work environment and strong leadership. This reassures stakeholders that the company is reliable and dedicated to maintaining its talent, which may enhance its credibility and reputation.

When should you offer a retention bonus?

Retention bonuses are most common when a company is in dire financial straits or undergoing a merger, but various other situations may warrant employee retention bonuses.

• When key employees leave the company, the company’s performance may suffer. Vital skill sets and institutional knowledge are costly to replace.
• Reducing turnover is greatly facilitated by retention bonuses. Retention pay may slow the disruption of operations, maintain worker morale, and reduce recruitment and training costs.
• Boosting engagement is also possible via retention bonuses. They remind employees that the company values them and their contributions. However, bonuses must reflect employees’ salaries and expectations—a low amount could backfire.
• When the company is about to undergo a change, retention bonuses can provide preemptive reassurance to employees. They provide a light at the end of the tunnel, encouraging an organization’s workforce to stick out a rocky transition.

Implement a benefits strategy to boost retention

Retention bonuses are one of many ways to promote loyalty and make employees feel more secure in their roles. Are you looking for a way to reward your globally distributed team? Oyster can help.

Oyster recognizes the value of retaining top talent with its Total Rewards program. We help you offer competitive pay and attractive benefits packages while ensuring compliance with taxes and regulations. Explore how Oyster can support your global team today with customized retention strategies tailored to your unique needs.

About Oyster‍

Oyster is a global employment platform designed to enable visionary HR leaders to find, engage, pay, manage, develop, and take care of a thriving distributed workforce. Oyster lets growing companies give valued international team members the experience they deserve, without the usual headaches and expense.

Oyster enables hiring anywhere in the world—with reliable, compliant payroll, and great local benefits and perks.