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What Is a Retention Bonus? Meaning & Examples

Last updated 03/15/2024 by

Emily Africa

Edited by

Fact checked by

Summary:
The United States job market can be ruthless. When a company finds good employees, it wants to keep them. Retention bonuses are one means companies use to do this. These bonuses provide an incentive for employees to stay and keep working hard at the company. By the end of this article, you will understand how retention bonuses work.
Every company goes through stressful or challenging times. Hard-working, loyal employees are what bring success through these times. If company executives are concerned about losing key employees, they may offer a retention package. A retention bonus package is a lump-sum financial incentive paid to an employee. It encourages the employee to stay at the company. Keep reading if you think you deserve a retention bonus, have already received one, or are a company leader considering giving out a retention bonus.

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What is a retention bonus?

Retention bonuses are financial incentives given to valuable employees in exchange for company loyalty. Other terms for retention bonus include retention pay and retention package.
A company may offer retention bonuses to key employees during a merger, acquisition, or particularly crucial part of the business cycle. Typically, companies with 20,000 or more employees offer retention bonuses. Retention bonuses can secure quality employees and prevent them from transitioning to other companies.
The goal of an employee retention bonus is to satisfy key employees so that they will both stay at a company and want to give it their best work. A monetary incentive can be the best way to accomplish this.

How do retention bonuses work?

An employer may offer a monetary incentive in the form of a retention bonus package. The average retention bonus is 10–15% of an employee’s regular salary. A retention package usually comes with a lump-sum, one-time payment. The key employee may agree to stay with the company for a certain amount of time in exchange for this package. Employers still risk losing the employee after paying a retention bonus — successful retention is not guaranteed.
Retention bonuses are typically based on the following factors:

Key retention bonus considerations

  • Reason: A company must consider the reasoning behind giving a retention bonus. Common reasons include a company transition or an employee with specialized skills.
  • Competitors: Employees may seek to move to a competing company for a variety of reasons. If this is the case, a company should try to understand appealing factors in competitors. This should include looking at competitors’ salaries to make sure a retention bonus is appropriate and persuasive.
  • Company finances: Companies must consider if they can afford retention bonuses. They should weigh the costs and benefits of keeping key employees before offering retention bonuses.
  • Employee performance: Before offering retention bonuses, companies will consider employees’ performances. What value does an employee add to the company qualitatively and quantitatively? Has an employee worked extra hours to complete a high-value project? Once a company has considered all relevant aspects of an employee’s performance, it will decide on what compensation is appropriate. Employees who receive bonuses should feel adequately valued to continue their quality performance and morale.

Putting your retention bonus to good use

Many people who get retention bonuses may decide to splurge on an extra vacation, superior home theater system, or other luxuries. But unexpected extra income can present a great opportunity to invest in your future. If you’re of the more prudent and practical sort and want to put your money to good use, now may be a good time to consider consulting an investment advisor.

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Retention bonus examples

Employers offer financial incentives for many reasons. A retention bonus can reward strong employee performance during a crucial production period. It is also a strategy to keep a key employee who threatens to quit.
The bottom line is that employers use retention bonuses to retain employees. Here are some real-world examples of retention bonuses:

Retention bonuses in action

  • A company is being acquired by a larger firm. To get ahead of apprehensions surrounding the upcoming merger, company executives offer retention bonuses to the most valuable employees. They will need these employees around for a smooth transition.
  • Instead of a salary increase, a company offers a retention bonus. Executives do not believe they can afford an increase in the employee’s salary costs, but they want to offer some financial reward. A targeted payment can incentivize employees to keep up the great work.
  • A business is changing its organizational structure to better allocate its resources. Some employees may be on new teams with new managers. The company wants to assure its valued employees that they won’t be laid off during this reorganization. The employer also wants to compensate employees for any restructuring challenges.
  • A key employee has received a job offer from a competitor and notified a supervisor. The current employer does not want to lose this employee. Management researches the competitor and offers the employee a retention bonus package that outweighs the competitor’s benefits.

Tax implications of retention bonuses

A retention bonus doesn’t come tax-free. Retention bonuses are considered supplemental wages by the IRS (Internal Revenue Service). Supplemental wages are any form of compensation on top of an employee’s regular salary.

Bonus income means supplemental wages

Supplemental wages must be reported on your yearly taxes as part of your total gross pay. This means that employees have to pay taxes on their retention bonuses. Taxes on a retention bonus can include Federal Income Taxes (FIT) and state taxes.
Payroll taxes are different than income taxes. It is helpful to understand the difference between the two when doing your yearly taxes.

Determining the income tax for your bonus

Employees can calculate how much taxes they owe on their retention bonuses using the aggregate method or percentage method. With the aggregate method, employees combine their salaries with their retention bonuses. They calculate their tax rates based upon that aggregate amount using their W-4 forms.
With the percentage method, employees separate their retention bonuses from their base pay. The tax rate on the bonus income depends on the amount of the supplemental wages. If supplemental wages are greater than $1 million, the employee owes 37% in taxes. The employee owes 22% for supplemental wages less than $1 million.

Make sure you’re ready for tax season

Taxes can be complicated. You can start learning more about taxes and your paycheck from SuperMoney. Speak to a tax professional to determine the best way to handle your retention bonus.
Pro tip — Usually, the aggregate method results in a higher tax rate than the percentage method. Keep this in mind as you analyze your unique situation with a trusted tax professional.

SuperMoney may receive compensation from some or all of the companies featured, and the order of results are influenced by advertising bids, with exception for mortgage and home lending related products. Learn more

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Pros and cons of retention bonuses

Retention bonuses can be beneficial for both the employee and employer. It is good to understand both the advantages and disadvantages of retention bonuses.
WEIGH THE RISKS AND BENEFITS
For your consideration, here is a list of the advantages and disadvantages of retention bonuses.
Advantages
  • Employee loyalty
  • Improved morale
  • One-time payment
  • Increased productivity
  • Retaining highly skilled and trained employees
Disadvantages
  • Extra costs for the company
  • Supplemental wage taxes
  • No guarantees of improved or sustained employee performance or morale
  • Buying versus earning loyalty

Key takeaways

  • Retention bonuses are a financial incentive offered to key employees to encourage their loyalty. Employers often offer retention bonuses during challenging times or when a valued employee threatens to leave.
  • A retention bonus is usually a one-time, lump-sum payment. The average bonus is 10–25% of an employee’s salary. It depends on employee performance, company finances, and competitors.
  • Employees must pay taxes on retention bonuses. They can calculate their supplemental wage tax rate based upon the aggregate method or percentage method. Consult a trusted tax professional for guidance.
  • Retention bonuses can increase morale and productivity for valued employees. However, when a company buys instead of earns loyalty, this does not guarantee a happy, long-term employee.

FAQ

What is a typical retention bonus?

A typical retention bonus is a one-time payment of 10–25% of an employee’s regular salary offered as motivation to stay hard working at the company.

Is a retention bonus a good thing?

Retention bonuses can be beneficial for both businesses and their employees. If you are offered a retention bonus, it means that you are a valued employee.

Why did I get a retention bonus?

You likely received a retention bonus because you are valuable to your company. Company executives may see a crucial production period coming up and want to make sure they compensate you appropriately.

Who is eligible for a retention bonus?

Any employee is eligible for a retention bonus. It is up to the discretion of company executives. Check this article out if you are curious about what jobs make the most money.

SuperMoney may receive compensation from some or all of the companies featured, and the order of results are influenced by advertising bids, with exception for mortgage and home lending related products. Learn more

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