Retention bonus: What is it, how does it work, and when should you use this incentive?

Employers worldwide are grappling with a serious talent crisis in the job market thanks to the shake-up of the Great Reshuffle and Great Resignation. 

In 2023, nearly four in five companies worldwide reported skills shortages, the highest figure in 17 years.[1] Rapidly evolving tech areas like machine learning see the highest concentration of these skills.

Employers are pulling out all the stops to keep key employees from leaving, and one of the most popular methods is offering retention bonuses.

According to a World at Work survey, more than 20% of employers were considering retention bonus programs in 2021, doubling the 2016 figure. 

Employers also awarded more employee retention bonuses and bigger payouts.[2]

The question is: Do retention bonuses work to keep top talent, or are they just a band-aid for bigger structural issues?

In this blog, we explore how employee retention bonuses work, the pros and cons of retention bonus schemes, and when you should consider them for your workforce.

What is a retention bonus, and when do companies use it?

An employee retention bonus, sometimes called an “ERB” or a stay bonus, is an additional payment on top of an employee’s usual salary. 

Companies use this payment to incentivize valuable employees who meet eligibility requirements to remain with them for an agreed period.

Businesses also use retention bonuses in difficult moments when turnover rates are likely to spike. Examples include mergers, acquisitions, and organizational restructuring, such as layoffs.

It pays to limit turnover at times like these. Almost three-quarters of workers say that their productivity takes a hit after layoffs, and 69% say that the quality of their company’s output drops, too.

You can also use supplemental wages like retention bonuses to ensure that key employees in high demand stick around to finish important projects and don’t fall prey to poaching by the competition.

Think of it this way: Sign-on and employee referral bonuses exist to incentivize candidates to cross the finish line when hiring – in other words, to fill open roles.

Retention bonuses do the same thing for your existing workers, incentivizing high-performers to cross the finish line in their work, for example, by sticking around to hit a big deadline.

As we discuss below, you should not use them as long-term financial incentives for high-performing employees.

How do employee retention bonuses work?

To award a retention bonus, employers must draw up a legal document between themselves and the employee, setting out the terms and conditions of the bonus, including: 

• How long the employee has to work at the organization to receive it 

• What performance benchmarks they must hit to qualify 

• How much the bonus is 

• How and when the company pays it

When is a retention bonus paid out?

You can either pay retention bonuses as a lump sum payment on completion of the agreed term or in installments leading up to it. 

For example, instead of paying an employee the full bonus as a one-time payment at the end of a year, you can pay them a fraction at the end of each month.

According to the World At Work survey cited above, most employers pay retention bonuses in one lump sum, likely because it ensures that workers work for the full term of the contract.

Retention bonus contracts are open to negotiation, and employees don't have to agree. 

For example, an employee can refuse a retention incentive because of its tax implications on their income tax.

The IRS considers retention bonuses taxable income, like all bonuses, and can tax them in two ways: 

1. The percentage method: A standard rate of 25% for bonuses up to $1m and 39.5% for bonuses of more than $1m

2. The aggregate method, by which they are added to the employee’s annual salary, usually resulting in a higher tax rate 

Which employees qualify for a retention bonus?

In theory, any employee is eligible for a retention package. In practice, it’s only an appropriate strategy to reward and retain groups of employees who bring significant value to your organization or whose absence would incur a great cost. 

The workers who are best suited for retention bonuses usually fulfill one or more of the below criteria:

1. They are full-time employees who put in at least 30 hours per week

2. They have worked for the company for a significant amount of time

3. They are highly skilled in their role, organization, or industry

With this in mind, retention bonuses are most often given to senior employees or high-performers when losing them would harm the success of the company or a particular program. 

An example is a chief operating officer seeing a business through a difficult transition or a senior developer managing a complex project. You don’t want to wait until the employee leaves to provide them with incentive payments.

Research by Panopto found that 42% of valuable company knowledge is unique to the individual employee. 

The more central to a key project an employee is, or the higher up they are in your organization, the more critical the loss is when they walk out of the door.

How do you calculate a retention bonus?

Once you’ve identified a candidate for a retention bonus, the next step is deciding how much to offer. Take into account:

• The financial situation of the company

• The period of time you need them for

• The employee's base pay and how long they've worked for you

• The impact of losing the employee

• Current projects (their length and revenue potential)

• Salary benchmark data (if an employee is making a below-average salary, the retention bonus helps make up for it)

• The likelihood that they leave 

That last one is a key point. 

Data from McKinsey suggests that large swathes of the workforce are already considering leaving their jobs, and high performers are particularly prominent among them.

The more ready they are to leave, the greater the incentive must be for them to stay.

So, how much does this work out to?

Generally, a retention bonus is between 10%-25% of an employee’s salary. Here are some retention bonus examples:

The benefits of offering employee retention bonuses

So far, we’ve looked at how an employee retention bonus works and a few retention bonus examples. But to understand if this strategy is right for your business, you need to know the advantages of retention bonus programs.

Here are the benefits of offering employee retention bonuses.

The benefits of offering employee retention bonuses: Summary table

You’re probably in a tough spot if you’re considering retention bonuses. If that’s you, here’s the short version so you can make a quick decision.

It helps retain employees at critical moments for your company 

The most obvious benefit of retention bonuses is that they help retain employees at important moments for your organization. You could be retaining: 

• A project leader until the end of the project

• A pillar of institutional knowledge during a merger or acquisition

• A key member of the executive team during a period of restructuring

Keeping workers with deep knowledge of a product or project on board helps provide continuity to your team and ensures that projects don’t stall. 

You can write retention bonuses into contracts for project-based workers to incentivize them to see the project through to completion.

Minimizing disruptions this way means that employees have the time and opportunity to grow and learn from each other.

It can also be an emergency measure to combat employee churn, for instance, if a central team member has left and you’re concerned about a snowball effect Research from the UK shows that 38% of staff say that open vacancies in their team have made their workloads unmanageable.[3]

In combination with a competitive sign-on bonus amount to help fill vacancies, retention bonuses can steady the ship for under-pressure teams. 

The combination guarantees a minimum number of workers through a phase or project, but it’s not a long-term fix to employee turnover.

It’s cheaper than offering a raise

You may wonder whether offering your employees a raise is easier if you want them to stay. However, this isn’t the best strategic option.

You’re probably already paying more for top talent owing to the abovementioned skills shortages. 

Betterworks research found that roles take longer to fill, and new hires can demand the highest average salaries in a decade.[4]

Adding a raise to this expenditure isn’t a smart decision and can be expensive over the long term, which becomes an issue, particularly if an employee’s most valuable work takes place in the near future.

An example could be a media company switching from a free content model to a subscription model. 

In this case, the manager overseeing this transitional period has a high value in the short term because their institutional knowledge and working relationships help them navigate the complexity of the switch. 

However, the goal is for that complexity to diminish once the system is up and running. A retention bonus could be a better strategic decision because it targets this project.

You maintain a consistent external image 

We all know that a spike in turnover is not a good look for your organization. 

For candidates, high turnover could indicate that your work environment is stressful or that workers are underappreciated or underpaid. 

More than 85% of job seekers say that company culture is important when choosing a new role, so this impression could negatively impact talent acquisition.

For investors and clients, high turnover can be a sign of mismanagement and can make them think twice about working with you.

If high turnover is a long-term issue in your organization, a short-term fix like a retention bonus is not the answer. 

The same issues can reoccur, and you end up spending a large sum of money plugging holes in a sinking ship. The best way to deal with the negative PR is to fix the underlying issue.

However, if you run into a short-term challenge that could cause workers to leave – for instance, a stressful merger – a retention bonus scheme is a good stopgap measure. 

It helps you maintain a positive brand image that attracts top talent and reassures investors.

It avoids spending time and money on hiring

Starting a hiring initiative in the middle of a large project is a burden for your teams and budget.

Calculating the cost of turnover isn’t straightforward, but when a new employee costs roughly $4,700, it’s likely to be significant.[5]

One unexpected dropout could put a team or a project at risk. Numerous walkouts across the business could put you in serious financial difficulty. 

Financial issues apply even to rehiring human resources who have previously worked with you, often known as “boomerang employees.”

Research into the boomerang employee phenomenon shows that a quarter of returning workers were previous high performers. Their return represents lost profits from their departure and additional resources spent on rehiring them.

Rehiring former employees also incurs extra costs because they earn an average of 25% higher pay than before leaving and gain a boost in responsibility in many cases.[6]

The good news is that rehiring employees is a sign you’re doing something right regarding your culture. The bad news is that the rehiring process is often even more expensive than the hiring process. 

Retention bonuses could be a way of avoiding it.

It improves employee engagement and performance

High turnover has a proven link to low engagement. 

Low-engagement teams have as much as 43% higher turnover than those with high engagement.[7]

High turnover has knock-on effects on business success. Organizations in the top 25% of companies for employee engagement are 23% more profitable than those in the bottom quartile.

Although causation is hard to find here, it’s safe to assume that there’s a mutual relationship.

A lack of engagement causes team members to seek opportunities elsewhere, and constant churn deters employees from engaging in their work.

As mentioned, retention bonuses are not a silver bullet for deep-rooted issues in your team or company culture. You need strong supportive strategies to address team engagement (more about these below).

However, by averting a spike in turnover, you can avoid a drop in engagement and break this cycle. 

Avoiding disengagement is particularly effective when you include a performance requirement for retention bonuses because this motivates the employee to remain engaged.

Research supports this: Motivation and productivity improve when retention bonuses are present.[8]

Other workers may even perform better to enter a retention bonus agreement. 

Without the right supportive strategies, managing employees’ performance could be more difficult as they “wait out the clock.”

How to prevent employees from leaving after collecting a bonus

You could be wondering: If I incentivize an employee to stay with money, what’s stopping them from quitting after receiving the bonus payments?

That’s a good question. Retention pay sends a message: “You can’t leave during this period,” which carries the implicit counter-message that employees can leave once that retention period is over.

Retention bonuses are not a long-term fix to employee turnover because they put an end date on an employee’s value to a company.

Some employers make workers repay their retention bonus payout after resignation if they leave too soon, but this can project a lack of trust and further push away employees.

Realistically, you should chiefly use retention bonuses for workers you expect to leave soon. They’re an effective tool to manage the transition and make time for succession planning. 

You can also use them to show extra appreciation for a team member’s work on a specific project. However, a performance bonus is less risky if this employee is already motivated and engaged.

The best way to ensure that employees don’t leave your organization after you invest in them is to build a solid company culture that employees won’t want to leave in the first place.

A strategic retention bonus scheme combined with a strong company culture is a powerful tool for an engaged workforce.

When retention bonuses aren’t the answer: 3 scenarios when you shouldn’t choose this incentive

We’ve discussed the scenarios in which retention bonuses are a good incentive to offer workers, and we’ve also mentioned that they are not always the right answer. 

Here are three scenarios in which you should avoid offering retention bonuses – and alternative strategies you can use instead.

1. To nurture long-term retention 

Retention bonuses are for short-term retention and usually focus on overcoming a specific challenge. A retention bonus does not replace fair compensation and a good culture. 

Ultimately, if an employee can find a significantly better salary and satisfaction with a competitor, they are likely to choose that over a short-term payout. 

Most employers deploy retention bonuses through management discretion rather than a blanket policy – for example, only workers above a certain pay grade or tenure are eligible.

A blanket policy could incentivize workers to work until their retention payout and then move on, merely slowing employee churn.

An alternative retention strategy is to use skills-based compensation to motivate employees and skills-based learning to develop their skills.

Skills-based compensation determines employees’ salaries according to the value of their skills to the organization rather than experience or rank. 

Combined with skills-based learning, which focuses on the hands-on application of skills, this fosters a learning mindset in workers and gives them clear routes to advancement.

Skills-based compensation and learning have a positive effect on retention. 

The McKinsey data cited above shows that lack of career development and advancement opportunities and inadequate compensation were the top two reasons for people quitting their jobs in 2022.

It could even attract new workers: 48% of American workers would switch to a new job if offered skills training opportunities.

2. To counteract a toxic culture 

You could be considering a retention bonus to halt the churn in a troubled team or because you suspect some of your employees of “quiet quitting” owing to a toxic culture in your organization.

In cases like these, retention bonuses should not be your only strategy. 

Instead, consider investing in skills-based hiring to hire workers who share core values and motivation to ensure that a common purpose unites workers with diverse skills and mindsets.

The benefits are widespread. Deloitte found that skills-based organizations were almost twice as likely to retain high performers and more than twice as likely to innovate.

3. To make up for a conflict 

On a related note, you should not use a retention bonus to compensate for a team conflict or smooth over resentments that have not yet escalated to an open conflict.

For example, retention bonuses cannot fix a team in which a heated disagreement leads to one or more employees threatening to leave.

Using a retention bonus here could breed more ill will because employees could feel you favor one employee over another. 

It also fails to address the core of the issue. 

Essentially, you’re trapping workers in a working situation that has broken down.

In cases like these, use nonviolent communication to resolve the core dispute and apply strategies to promote psychological safety at work. 

For instance, you could design a specific process to deal with toxic behaviors, including:

1. Discussing toxic behaviors during 1:1 meetings

2. Implementing coaching and mentoring

3. Designing courses on workplace behavior

4. Encouraging employees to report toxic behavior

Use skills testing to hire teams you won’t need a retention bonus to keep around

Ultimately, retention bonuses are most effective as a last resort. 

When you’re in the triage stage of an organizational crisis or fighting to break a churn cycle in a troubled team, a retention bonus can show your existing employees you value them and want them to stick around.

For longer-term issues, you need a broader policy. 

To get an overview of the options available, read our blog about the 12 retention strategies you need.

To deal with a retention crisis, check out our recommendation of 6 ways to reduce employee turnover.

If you’re in the middle of a hiring spree and need to find candidates that share your vision for your organization, use our Motivation test to hire the best.

Sources

1. “2023 Global Talent Shortage”. (2023). ManpowerGroup. Retrieved July 26, 2023. https://go.manpowergroup.com/hubfs/MPG_TS_2023_Infographic_FINAL.pd “Bonus Programs and Practices”. (2021). World At Work. Retrieved July 21, 2023. https://worldatwork.org/media/CDN/dist/CDN2/documents/pdf/resources/research/WAW1021_Survey_KF_Bonus-Programs-and-Practices_FNL.pdf 

2. Roberts, Cherilyn. (April 21, 2022). “Hiring Trends Index: a look at the recruitment landscape of Q1 2022”. TotalJobs. Retrieved July 21, 2023. https://www.totaljobs.com/recruiter-advice/hiring-trends-index-a-look-at-the-recruitment-landscape-of-q1-2022 

3. “9 Talent Management Statistics That Might Surprise You”. (July 19, 2019). JobHoller. Retrieved July 21, 2023. https://jobholler.com/employee-engagement/9-talent-management-statistics-that-might-surprise-you/ 

4. Navarra, Katie. (April 11, 2022). “The Real Costs of Recruitment”. Society for Human Resurce Management. Retrieved July 21, 2023. https://www.shrm.org/resourcesandtools/hr-topics/talent-acquisition/pages/the-real-costs-of-recruitment.aspx 

5. Sherman, Lee. (2022). “Boomerang Employees Return to Work—On Their Own Terms”. Visier. Retrieved July 21, 2023. https://www.visier.com/blog/boomerang-employees/ 

6. “The Benefits of Employee Engagement”. (January 7, 2023). Gallup. Retrieved July 21, 2023. https://www.gallup.com/workplace/236927/employee-engagement-drives-growth.aspx 

7. Frankort, Hans.; Avgoustaki, Argyro. (2022). “Beyond Reward Expectancy: How Do Periodic Incentive Payments Influence the Temporal Dynamics of Performance?”. Journal of Management. Retrieved July 21, 2023. https://journals.sagepub.com/doi/10.1177/01492063211016032