What is a retention bonus? Complete guide for employers

If you’re running a business or leading an HR department, it’ll come as no surprise that the competition for top talent is fierce. Regardless of industry, there’s a heavy demand for the best people. Why? Because to build a winning team, you need great players.

But how do you attract and then keep the people who produce results, inspire others, and move your business forward? Employee incentive programs can boost engagement and morale while motivating employees to stick around, especially during periods of uncertainty or changes in the business climate.

Retention bonuses are one of the most effective ways to encourage people to stay. Not only do they help you retain top employees, but they also save you money. According to The Society for Human Resource Management (SHRM), the total cost of hiring a new employee can be as much as four times the salary of a departing employee. That’s not insignificant.

In this article, we’ll cover what you need to know about retention bonuses, including:

• What is retention pay (and is it the same as a retention bonus)?

• How does a retention bonus work?

• How much should a retention bonus be?

We’ll also discuss when and why you should use one, as well as how to set up an effective program within your organization.

What is a job retention bonus?

A retention bonus (sometimes called a stay bonus) is an incentive offered to key employees to encourage them to remain with a company for a specific period. While you can offer a retention bonus at any time, they are typically used at critical times, such as mergers, changes in leadership, or key product launches. They can also be part of your organization’s overall compensation philosophy. From an HR and organizational perspective, a retention bonus is a strategic way to keep your most important people in place.

Businesses can offer retention bonuses as a flat rate or a percentage of an employee’s pay—in either case, the amount is taxable.

Is a retention bonus the same as retention pay?

Retention bonuses and retention pay are not quite the same thing. A retention bonus is commonly paid as a lump sum, whereas retention pay is usually a structured incentive that’s paid out in installments. Retention bonuses also differ from performance bonuses, which are based on meeting specific goals.

Benefits of offering a retention bonus

While the primary purpose of retention bonuses is to retain top talent, they come with these additional benefits:

Maintains project momentum and internal expertise

If you’re in the middle of a big project, the last thing you need is to lose critical talent before completion. A well-timed retention bonus can keep key employees and their expertise around until the project wraps and hopefully even longer.

Reduces turnover during transitions

Losing staff during transitions can have a significant impact on productivity and morale. For companies undergoing mergers and other major changes, offering retention bonuses can help retain employees during these transitions.

Encourages long-term commitment in key roles

They’re called key roles for a reason. Employees in these positions have a significant impact on your organization, and maintaining consistency is crucial. Retention bonuses can go a long way in keeping your top talent in place.

Signals employee value and building trust

By recognizing key employees with a retention bonus, you’re showing that you value their contributions. This leads to increased trust, which is another reason employees tend to stay.

Lowers costs compared to turnover and rehiring

Finding the right person, bringing them on board, training them, and waiting for them to gel with your team is costly and time-consuming. And, after all that, what happens if they’re not a good fit? Instead of reinventing the wheel, a well-timed retention bonus is a far more efficient use of your company's resources to retain your best people.

How retention bonuses work

Retention bonuses can help keep valuable employees from leaving your company, especially at critical times. You identify the employee you want to retain and offer them a payment to remain with your company for a set period.

For example, after identifying a key employee you want to retain, you offer them a financial incentive, such as $10,000, to stay with your company for an additional year. If the employee accepts the offer, they will sign an agreement and be contractually obligated to remain with your organization until the end of the agreed-upon date. If they leave before the contract expires, they’re usually responsible for paying back the bonus, sometimes with interest.

The structure and mechanics of retention bonuses typically follow a similar blueprint. After you identify the key employee, determine the amount of the bonus based on these factors:

• Employee’s salary

• Importance of their position

• Cost to replace them

You can offer the employee the payment in one of these ways:

• Lump sum payment at the start of the agreement

• Installments paid throughout the agreement’s timeframe

• Lump sum payment at the end of the agreement

Each payment method has its own benefits. For instance, an upfront payment gives the employee an immediate financial incentive, whereas a back-loaded payment is an effective motivator. Some employees may prefer to receive their bonus in installments, combined with their paychecks.

In most cases, companies formalize the terms of retention bonuses in a detailed written agreement. Specific terms ensure that everyone is on the same page and legally bound to uphold their end of the agreement. Typical contracts spell out:

• Bonus amount

• Payment structure and schedule

• Duration of the agreement

• Consequences and penalties for the employee breaching the agreement

• Implications of the employer terminating the agreement

• Impact of changing business conditions

Retention bonus timelines aren’t open-ended. Typical agreements range from 12 to 36 months, which is usually enough time for organizations to manage challenging business situations, replace top talent, or complete important projects. A well-thought-out timeline will provide enough time to accomplish your goals without feeling too restrictive for the employee.

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When should employers offer a retention bonus?

Keeping your top talent is far less costly than replacing them, and there are several situations where a retention bonus can head off poorly timed departures that could negatively impact your business. You should use retention bonuses strategically and proactively rather than as a last-minute fix. Here are six common scenarios when you should consider offering a retention bonus:

Mergers and acquisitions

The mere possibility of a merger or acquisition can create a climate of uncertainty and concern within your organization. In the case of actual M&A activity, your best employees may seek out other opportunities, and competitors may start poaching anxious talent. A well-structured retention bonus keeps critical employees in their roles during significant changes. This helps smooth the transition, protects company knowledge, and retains consistency with important business partners and other stakeholders.

Critical project completion

When’s the worst time to lose top talent? Right in the middle of a critical project. Nothing can derail things faster. Retention bonuses ensure stability during major undertakings, like launching a product, by retaining key employees and their expertise. Tie bonus payments to major deliverables and milestones.

Preventing key employee loss

You cannot understate the value of long-term employees. They carry with them institutional knowledge, important relationships inside and outside the company, and help motivate your team. If they start looking for new challenges, you can motivate them to stay with training and development programs and sweeten the deal with a retention bonus.

Succession planning or retirement

When a critical employee plans to leave or retire, you can’t just wait around for a qualified candidate to show up. You’ve got to be proactive in identifying and training a suitable replacement. If you’re working against the clock, a retention bonus can motivate the departing employee to stay a little longer, giving you more overlap for training and knowledge transfer. These situations can be a bit tricky, as your key talent has already decided to leave and may initially discount the idea. But with the right offer, you may be able to convince them to stay long enough to support a seamless transition.

Economic uncertainty or market volatility

Turbulent times, such as economic downturns or periods of industry volatility, can make employees nervous, and nervous employees may start looking for more secure positions. Retention bonuses can calm those nerves and send a message that no matter the circumstance, you’re in it to win it–and remain committed to your employees.

High-demand skill shortages

When things are booming, many industries, like data science and cybersecurity, face serious talent shortages. Retaining your best people can be a challenge if your competitors are trying to lure them away with highly competitive compensation packages. Retention bonuses help you stay competitive without changing your current pay structure. They’re fast, flexible, and give you more time to work on a long-term incentive plan.

Retention bonus vs. other incentives

Retention bonuses aren’t the only incentives that you can offer top talent. There are several other alternatives that you can choose, and, depending on the situation, they may be a better option. Here’s how the most popular compensation incentives compare to retention bonuses:

Retention bonus vs. signing bonus

Retention bonuses are typically used on short notice as an emergency measure to retain key personnel from leaving your organization. This helps stabilize your workforce and maintain existing strengths.

A signing bonus is a one-time, upfront payment offered to new hires as an incentive to accept a job offer. It's a more proactive measure that helps attract new talent. They appeal to potential hires who might be considering roles with your competitors. They’re common in candidate-driven markets, such as technology and healthcare, or for specialized roles. Signing bonuses help make up for what a candidate might walk away from, such as bonuses or unvested equity.

Retention bonus vs. performance bonus

Retention bonuses reward loyalty, whereas performance bonuses reward results and achievements. One retains talent, the other motivates them to perform at higher levels.

Companies use performance bonuses to meet and exceed sales targets, complete projects, and achieve other organizational goals. These bonuses are part of your company's existing compensation strategy, and you can pay them quarterly or annually. They help drive performance and success, both individually and for your company.

Retention bonus vs. stock options

In many cases, a retention bonus is offered as a lump sum, but you can spread it out over the length of the contract or offer it at the end. Stock options differ in that they’re a long-term incentive that can pay the employee big dividends if the company does well.

Retention bonuses are the right choice when you need to lock in talent for a short period. Stock options are for the long game. Depending on the vesting schedule, they motivate employees to stay for a longer period. Vesting schedules typically span several years, during which employees gradually earn access to a portion of their stock over time. For the organization, there’s no upfront monetary hit. But the value of this incentive is directly tied to the price of the stock and your employee’s belief in the company.

How to structure an effective retention bonus program: 5 tips

An effective retention bonus program is more than throwing money at a problem. It needs to be well-thought-out and legally compliant while motivating talent to stay for the right reasons. Here are five tips to keep you on track:

1. Define clear objectives and eligibility

What are your goals, and who is going to get you there? Consider the reasons for offering retention bonuses, whether it’s to keep key personnel during times of upheaval and change or to hold on to top talent when your competitors are nipping at your heels.

Next, create your eligibility criteria. You might base it on:

• Role criticality

• Individual performance

• Tenure with the company

Be sure that whatever criteria you use will hold up under scrutiny. Ensure you apply them equally. If the eligibility criteria are vague or uneven, you might face legal consequences and resentment from employees who feel the process is biased towards certain members of your team.

2. Determine bonus amounts

It’s a delicate dance between offering an enticing bonus and not stretching your finances to the breaking point. Typically, bonus amounts are based on an employee’s current pay, what competitors are paying for a similar position, and the most significant factor: the cost of replacement, which includes recruitment, onboarding, and productivity losses.

A small retention bonus won’t be effective in retaining your talent, and they might even see it as an insult. But if you offer too much, it may hurt your bottom line. A good starting point is 10-15% of the employee’s yearly compensation, adjusting for the significance of the role and its impact on your goals. Some retention bonuses can go up to 25 or 30%.

3. Create a retention agreement

Your retention agreement spells it all out. Include details like the bonus amount, payment schedule, timelines, and consequences of violating the agreement’s terms. You’ll also need to cover areas such as payback terms, and any confidentiality obligations. The text should be clear and reviewed by your legal team to ensure that both parties are protected and the agreement complies with all applicable laws.

4. Align with payroll and HR systems

Retention bonuses can be difficult to manage. Will your HR and payroll systems be able to process them efficiently? To avoid problems, check with your relevant teams to ensure they can manage the complex details of retention bonuses, including specific tax rules, payment schedules, reporting requirements, and compliance obligations.

Retention bonuses can also impact benefits. Coordinate with your benefits people to see what impact the bonus might have on insurance coverage or retirement contributions. And finally, ensure that your company’s systems can create documentation for compliance reviews and audits.

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5. Communicate the value

Some employees may not understand what a retention bonus is or the value that it adds to their existing compensation. Explain how it supports their career objectives in addition to boosting their pay. Lay out how it works, when they can expect payments, and their obligations. Avoid making it feel like a last-minute attempt to keep them from leaving. Frame it as a thoughtful investment in their future with your organization.

Common pitfalls to avoid when offering retention bonuses

Even a well-intentioned retention bonus program can have unintended consequences. Here’s how to avoid costly mistakes:

Offering to the wrong employees

Effective employee retention bonuses are offered to the right employees at the right time. Handing out bonuses without a clear strategy doesn’t work. You want to keep your critical talent, not just firehose bonuses to low-impact employees who aren’t even thinking about leaving. Targeting key team members who are flight risks is a far better use of your HR dollar. Before offering a retention bonus, ask yourself how critical the employee is and if losing them would significantly impact your business.

Poor communication

As with any offer and agreement, clarity is key. Outline, in plain-spoken language, who is eligible, what the employee will get, what’s expected, and any other important details. Clear, detailed communication reduces confusion amongst your team and prevents misunderstandings.

No link to business goals

Clearly outline why you’re offering the retention bonus. Explain to your team how your bonus program is supporting your organization’s goals. It might be finishing a big project, navigating a complex merger, or supporting the company during a downturn. Employee retention bonuses offered without a clear reason may be perceived as favoritism and can negatively impact your team’s engagement and motivation.

Neglecting compliance and payroll accuracy

The last thing you need to deal with during critical times is compliance and tax problems. Different regulations and rules apply to employee retention bonuses (more on that below). Account for FICA (Federal Insurance Contributions Act), federal and state taxes, and any applicable repayment terms from the start. Ensuring you’re on the same page with your HR, finance, and legal teams to avoid any issues down the road. Compliance mistakes can be costly.

Failing to address root causes

A retention bonus won’t fix a broken workplace. If your employees are considering leaving due to toxic management, outdated technology, or burnout, a bonus will only treat the symptoms, not the disease. Even a generous bonus won’t be enough to keep them. Use retention bonuses to give you the time to tackle the issues that have employees running for the exits.

Tax and compliance considerations regarding retention bonuses

If you’re planning on implementing a talent retention strategy, it’s vital that you understand the tax implications of doing so. The IRS considers retention bonuses as supplemental wages, which means that they’re fully taxable and must be included on your employee’s W-2 form. This applies to other incentives, including holiday bonuses and performance rewards tied to an employee’s base salary.

Unlike merit increases that step up an employee’s salary, retention payments require immediate tax withholding. Employers are required to withhold federal income tax, Social Security, and Medicare taxes using either the percentage method (22% for bonuses up to $1 million, 37% for higher amounts) or the aggregate method. For most bonuses, the percentage method is preferable, as withholding amounts are easily calculated. The aggregate approach differs as it adds the bonus to the employee’s normal wages and then calculates withholding as if the total were a regular paycheck. As a result, withholding rates may be higher.

To avoid misunderstandings or legal issues, ensure that you document everything in writing. Your employee retention bonus agreement should clearly state:

• Payment amounts

• Vesting schedules (if applicable)

• Clawback provisions

In addition, specify whether the bonus is a flat sum or a percentage of the employee’s annual salary.

Use retention payments at key points to strengthen your overall compensation plan. Since retention bonuses increase total taxable income, your employees may find themselves in higher tax brackets. You can offset this by grossing up the payment (employer covers the taxes) or spreading payments across different tax years to minimize the tax burden.

Manage retention bonuses easily and compliantly with Rippling

You’ve worked hard to build a strong team, and in uncertain times, you want to keep your top performers. Retention bonuses offer a simple, effective way to hold on to key talent when you can’t afford to lose them.

Rippling handles incentive payments, like retention bonuses, with ease. Rippling gives you a centralized system for managing everything related to your workforce, from compensation, headcount planning, and benefits administration, to onboarding, payroll, and employee spend. And it’s built on a single source of truth: your employee data.

With Rippling, you can automate bonus payouts directly within payroll, ensuring timely and accurate incentive payments. Easily create pay types tailored to your exact needs—choose from defaults like tips or bonuses, or customize unique pay types on a one-off or recurring basis. Plus, Rippling centralizes employment agreements, giving you complete control and easy access to contracts across your workforce.

Rippling payroll software is intuitive and reliable. With 600+ integrations, automated and accurate tax registration and filing, and a dedicated mobile app for employees, it’s a comprehensive solution. You can also track the ROI of your retention programs, ensuring your investments drive real results.

Rippling offers a seamless data pipeline that consolidates all payroll and workforce functions into a single, easy-to-use platform. When combined with Rippling’s suite of benefits management and time and attendance solutions, it simplifies and accelerates your entire payroll process.

FAQs about retention bonuses

Should your employees accept a retention bonus?

For employees, it depends on their situation. If they plan to stay and find the terms acceptable, then accepting a retention bonus certainly has value. If they’re planning to leave regardless, it may not be in anyone's best interest. Employees should review the terms of the bonus offer to ensure they understand the terms before signing.

What is the average retention bonus?

The average employee retention bonus varies depending on a number of factors, but generally most bonuses are 10-25% of their annual salary (not including overtime and other extras). Employees with specialized skills or who are critical to your operations are usually at the higher end of the scale and above.