Retention bonus | Definition, benefits & the do’s and don’ts

Compensation can be a powerful tool for companies that want to hold onto their best performers, especially as the current external talent pool shrinks. (1) However, pay is also a balancing act as decision-makers have to work within budgetary constraints, especially in a tricky economic landscape. 

Despite the fact that more employees are staying put, the reality is that inadequate pay is still the number one reason global professionals seek other opportunities, (2) which puts companies with limited financial resources in a difficult position.

The retention bonus might be the answer to this problem. As a negotiable, short-term monetary incentive, a retention bonus can help you remain competitive, reduce churn, and stay within your payroll budget.

Retention bonuses and other similar incentives can have a positive effect on turnover and engagement as long as you implement them in alignment with your business and operational goals. That’s why we discuss:

• How retention bonuses work
• Factors to consider before offering a retention bonus
• Alternatives to retention bonuses

1. U.S. Bureau of Labor Statistics, 2023

2. Boston Consulting Group, 2023

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What is a retention bonus?

A retention bonus — sometimes called a ‘stay’ bonus — is a type of temporary supplemental pay offered to an employee in addition to their regular salary. Its purpose is to motivate employees to stay in their current position. 

Employers typically offer team members a retention payment when:

• The job market is thriving, as a way to stay competitive and hold on to their best talent.
• The company is experiencing a disruption or transitional period like a merger, acquisition, or organizational restructuring.
• Management suspects a vital employee is about to leave and wants to motivate them to stay.

⭐ Leadership and staff alike should know that employees can always ask for a retention bonus — they don’t have to wait for their employer to offer one. If an individual requests a retention bonus, schedule a one-on-one meeting to discuss their proposal and explore their options.

How the retention bonus works

To protect themselves from employees simply taking their reward and leaving, most companies make written agreements or contracts part of a retention bonus.

A retention bonus agreement may specify how long the employee has to stay with the company. For example, if an employer offers a retention bonus package to a lead project manager during a vital initiative, they may stipulate in the retention bonus agreement that the employee has to stay until the project is completed to receive the payment.

While a company might offer a retention bonus as a lump sum payment, they can also spread the reward out in installments. Using a payment schedule may help retain employee motivation throughout the contractually agreed-upon period. 

Remember — retention bonus contracts are open to negotiation, and employees don’t have to accept them if they aren’t reasonable or fair. 

US employers should also note that retention bonuses count as taxable income. The IRS treats bonuses as supplemental wages and taxes them at a flat rate of 22%. However, companies can also add bonuses to regular employee salaries, which may put them in a higher tax bracket. 

⭐ Looking to create a retention bonus agreement?

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For employees: Can I negotiate my retention bonus?

Yes, employees can negotiate their retention bonus. When entering a negotiation discussion, make sure you can point to business-critical projects or initiatives you’re leading or have led, leverage previous performance data, and come armed with current industry pay and benefits benchmarks to make a strong case in your favor.

It’s also important to be aware of company policies that may standardize bonus amounts, as that may affect how much you can ask for. 
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Factors to consider when deciding on a retention bonus

Retention bonus rates typically range between 10% and 15% of an employee’s base pay, and companies often offer them as a lump sum or in biweekly or biannual installments. They’re powerful retention tools as long as business and employee needs align. Before making your bonus offer, consider the following: 

• The state of the job market — In a turbulent or competitive job market, awarding substantial retention bonuses can motivate your best people to stay with your organization. Retention bonuses aren’t directly tied to performance, but they’re still a great way to reward hard working employees for their dedication and loyalty.
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• Time with the company — The employee’s current seniority level and tenure should determine whether their retention bonus falls at the higher or lower end of the percentage range.
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• The potential impact of losing the employee — The average cost of replacing an employee can be as high as three to four times their salary. So, if you’re paying your employee a salary of US$50,000 a year, it could cost up to US$200,000 to find someone to fill their role and onboard the new hire. Taking that and your current salary structure into account, a retention bonus of 15% of their salary could translate to a significant cost reduction for your organization.
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• The company’s financial stability and budget — Retention bonuses can be cost-effective when compared to the price of losing an employee. However, if your resources are limited, they may not be feasible if you want to offer them to a significant portion of your workforce.
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• Previous performance review data — This information could also help you determine whether a retention bonus is the best tactic for motivating your employee to stay. A performance bonus, merit increase, or promotion may be a better option.
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• Current projects — If you suspect an employee is about to leave in the middle of a crucial project, offering a bonus may be a good strategy to ensure they see the project through. While this doesn’t ensure they’ll stay with your organization long-term, it can reduce bottlenecks in the near future.
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• Salary benchmark data — If the employee’s salary currently sits below the industry average, an above-average retention bonus may help to make up for the disparity between their base pay and that of their industry counterparts. Compensation software like Leapsome can help with this. For instance, Leapsome teamed up with Mercer, integrating their data into our platform to help users undertake more precise external benchmarking processes.

“Retention bonuses can be costly, so it’s important to consider the financial impact before deciding on a bonus. They may also create discord among employees if they are perceived as being unfair or unequally distributed.”

‍— Linda Shaffer, Operations expert and former Chief People Operations Officer at Checkr

Benefits of a retention payment

Times of difficulty and transition can put a strain on the employer-employee relationship. However, financial incentives like the retention bonus can provide some certainty and improve outcomes for individuals and businesses in several ways.

For businesses

Here are a few benefits of the retention bonus for businesses dealing with higher employee churn.
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Boost employee morale

Many companies experience dramatic internal shifts due to restructuring or merging. Team leads and their direct reports often bear the brunt of these transitions and may want to leave their positions if their work environment becomes too unpredictable. Providing a retention payment to employees in leadership roles and encouraging them to stay through a difficult period can provide more stability for the teams they support.
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Facilitate a smooth handover between departing & incoming employees 

Some team members will want to leave their jobs for reasons beyond your control, and you can’t motivate them to stay indefinitely. However, you can offer key employees retention bonuses with the expectation that they stay around long enough to train their replacement. 
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Weather short-term storms

While uncomfortable, challenging economic situations or transitional periods are often temporary. Retention bonuses — in addition to longer-term investments in employee development and engagement — can help you hold on to your people during critical periods before things return to normal.

For employees

The retention bonus can also be an attractive incentive for employees, especially when considering the following benefits.
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Provides room for negotiation

If your compensation or retention policy incorporates retention bonuses as an initiative, you let employees know how to negotiate a bonus before they consider leaving the company due to inadequate compensation. It also empowers them to request other incentives, such as a raise, a promotion, or access to development opportunities. 
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Makes team members feel valued

Showing appreciation can make the difference between an engaged and disengaged workforce. What’s more, a retention payment might be the answer to show a dissatisfied employee that you recognize their efforts and see them as an irreplaceable part of the team. If they’re undecided about quitting, doing so might make them reconsider.
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Gives staff a competitive edge in their professional futures

A retention bonus shows employees how essential they are to a company in times of uncertainty. Knowing their value gives them leverage when seeking a promotion or new role in the future, especially when applying internally.

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When not to choose a retention bonus

Done right, employee retention bonuses can be an excellent strategy for holding on to your best talent. Still, relying on them too heavily — or using them as a quick-fix solution every time you experience increased turnover — may work against your business and reputation. Here are some caveats to consider regarding retention bonuses:

• They may not prevent employees from leaving — If you make the language of your retention bonus too vague or don’t give people enough room to negotiate, it may drive them to apply for positions elsewhere. Make sure your bonus agreement outlines clearly defined criteria that the staff member must meet and stipulates how long they must stay to receive the bonus, but also consider leaving the exact bonus amount open to negotiation.
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• They’re not a standalone solution for long-term retention — Companies typically rely on retention bonuses during short-term transitional periods. They don’t expect them to fix underlying issues like low engagement and high dissatisfaction.
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• They might create tension if offered to some and not others — Employees talk to each other, and those who don’t receive bonuses may feel overlooked or undervalued. For this reason, some employers ask bonus recipients to sign a non-disclosure agreement, even though doing so may work against your company’s commitment to transparency. That’s why it’s essential to be strategic about who you offer bonuses to and why. 

“Employee retention bonuses are not the solution to all potential problems. A toxic climate will emerge in the workplace if management offers retention bonuses without investigating the reasons why employees wish to quit the organization.” 

— Leo Ye, Co-founder and CEO of Cubo

Alternatives for improving employee retention

If you’ve decided against implementing a retention payment, you’ve got other options. It isn’t the only strategy that can help you strengthen your company in times of high turnover — nor is it the only possible monetary incentive. Other ways to retain a key employee include:

• Performance bonuses — A performance bonus is a type of supplemental pay that companies award to individuals when they meet specific objectives or goals. Think of the annual bonus given at the end of the fiscal year to reward an employee for their contributions. You may have also implemented task bonuses in the past, which you pay team members after they complete a particular project.
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• Merit increases — Not to be confused with pay raises, a merit increase is a strictly performance-based financial incentive that boosts an employee’s overall salary. While merit increases depend on performance criteria alone, employers award pay raises based on factors like tenure, promotion, seniority, or changes in an employee’s cost of living.
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• Variable pay — Variable pay includes compensation models like commission, management by objectives (MBOs), and even bonuses. Employers that implement variable pay offer their employees a percentage of their salary on top of their base salary. However, this percentage can change monthly based on their performance and productivity.
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• Employee promotion — When a team member receives a promotion, it typically means moving up to a more senior position or laterally to a more specialized role. They also usually involve a pay raise, a change of title, and more responsibilities. This option may be a better alternative to the retention bonus if your employee has met particular performance or tenure milestones.
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• Training and development — Unlike the other options, development opportunities can help reduce churn without changing employee compensation. To expand your training and development options, start by creating a competency framework that details the skills an individual needs at every level to advance in your organization. Then, survey your employees to see what relevant training they’d like to receive to grow professionally.
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Engage & retain your people with Leapsome

The retention bonus is a great solution for companies that want to overcome a temporary hurdle and keep their best talent around. Still, the most important and effective way to retain your workforce is by engaging them, empowering them, and showing them how valuable they are to your organization.

Without the right tools in your tech stack to create streamlined workflows for making employees feel appreciated, it can be hard to develop repeatable engagement processes at scale. 

Leapsome helps companies create resilient teams that know their value. With integrated insights from performance reviews, competency frameworks, and OKRs, our Compensation module helps you create transparent and equitable compensation structures that boost retention across your organization. Moreover, it integrates Mercer data, which means users have detailed, up-to-date external benchmark figures to inform their internal pay and benefits packages and keep their pay schemes competitive and compliant with pay equity and transparency laws.

As a holistic people enablement platform, Leapsome supports organizations with their compensation, performance, and engagement processes, allowing them to stay resilient in times of change.

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