Establishing
Variable Compensation Plans
Purpose of Process (see below how HRSource™ can help):
Variable compensation programs motivate employees to accomplish individual performance goals and assist in accomplishing company goals. The cost of funding variable compensation plans vary in concert with the company's ability to pay. That is, when the company's business performance is strong, variable compensation awards will be high, and when the company's business performance is poor, variable compensation awards will be low.
Variable compensation plans are popular. According to a recent survey by Aon Hewitt Associates, variable pay awards as a percentage of exempt payroll was at 11.6% in 2011.
This process features three types of variable compensation plans; a discretionary bonus plan, a profit sharing plan and a miscellaneous rewards plan.
Recommended Steps in the Process - Discretionary Bonus Plan:
- Determine the size of the discretionary bonus pool. For
example, early in the year the President may allocate a
discretionary bonus pool to each organization based on an
assessment of the organization's contribution to the business
interests of the Company.
- Determine eligibility. Full-time, regular employees are
eligible for participation. Typically those who participate in
the incentive plan (see the Incentive
Compensation process) are not eligible to participate in
the discretionary bonus plan.
- Establish bonus award criteria. For example, a bonus can be
given for an employee accomplishment if:
- The accomplishment is identifiable to a specific person or team.
- The performance or accomplishment is substantially above or apart from that normally expected, is for accomplishment under adverse conditions, or is a significant contribution in support of a critical company program.
- The accomplishment results in substantial savings, profit,
problems solved or avoided.
- Establish bonus award guidelines including minimum and maximum
amounts for individual awards.
- Issue awards throughout the year. Awards should be issued as
close as possible to the significant contribution by the
employee.
- A manager observes an outstanding accomplishment and recommends a bonus to his/her manager.
- The organization manager approves the bonus.
- Human Resources reviews and approves the bonus, processes a bonus check request and delivers the check to the manager.
- The manager presents the bonus check to the employee(s)
with a letter of commendation.
- Maintain records on the bonus awards in the recipient's
personnel file (see Maintaining
Personnel Files process).
- Track the bonus expenditures and inform the organization managers of the status.
Recommended Steps in the Process - Profit Sharing Plan:
- In conjunction with the Finance department, establish a
specific definition and measurement of profit (e.g. operating
profit, pre-tax profit, etc.). (Some plans include other
performance criteria such as sales goals or other company
performance goals. Thus, for a plan to achieve maximum pay out,
both profit and other goals must be attained.) Obtain the
approval of the President.
- Work with Finance to establish the formula for generating the
profit sharing pool. Keep the formula simple so it can be
understood by employees. (Some examples include: 10% of profits,
or 15% of profits in excess of the established profit goal, or
1% of company payroll for every 5% of profits, etc.) A typical
target profit sharing pool is 5% of company payroll. Establish
the formula prior to each plan year, based on affordability and
the ability to encourage good performance.
- Determine eligibility. Typically full-time, regular employees
who were regular full-time employees for at least six full
months during the plan year and are still active, regular
employees (or on approved medical or family leave) at the time
of the award payment are eligible under this plan. Those who
participate in the incentive plan (see Incentive
Compensation process) are typically not eligible for
Profit Sharing.
- Establish other plan criteria. For example, allocate the
awards to employees based on a percentage of annual gross wages.
Most profit sharing awards are paid on an annual basis, but some
are paid more frequently, such as quarterly, while other awards
are deferred and act as a retirement program.
- Perform audits (Finance department) on the performance data to
ensure its accuracy. Also, track and maintain the accuracy of
the eligibility list.
- Report and publicize (company newsletter, bulletin boards,
company meetings, etc.) plan performance against targets on a
regular (at least quarterly) basis.
- Issue periodic (quarterly, semi-annual, or annual) profit sharing awards to participants. The award checks can go directly from payroll to the eligible participants.
Recommended Steps in the Process - Miscellaneous Rewards:
Miscellaneous Rewards plans can be an effective motivator. Their advantages include low cost, ease of administration and fast delivery. Like the previous variable compensation plans, these awards should be part of the overall compensation strategy that supports the organizations goals and direction.
- Determine which set of awards to make available to employees.
These can include:
- Gift certificates to restaurants and stores
- Movie or theater tickets
- Trips
- Services
- Extra paid time-off
- Cash awards
- Generate a company-wide budget.
- Create guidelines on eligibility (usually a requirement for
some minimum length of service) and the kind of job performance
that would warrant the employees receiving the award.
- Allocate budgets to department managers and allow them the
discretion to allocate the awards to employees as their
performance warrants.
- Instruct managers to provide the awards with a letter or memo
that explains the reason for the award. A copy of the
memo/letter can be placed in the employee's personnel file.
- Track which employees are given which awards. This can be done by having the awards (e.g. cash, certificates, etc.) housed in a central location (Finance or HR) and distributed to the manager upon request. The central awards administrator can keep track of who receives what award.
A property or service provided to the employee will qualify as a "de minimis" fringe benefit and be excluded from the employee's income tax if the fair market value of the property or service is so small that accounting for it would be unreasonable or administratively impracticable. Check with your tax accountant to determine the amount of award that will qualify as de minimis. Generally this amount would be less than $50 or less than $25.
Process Tips:
Variable compensation plans are growing in popularity. Employees like them because they are able to share in the success of the company, and companies benefit because their payroll costs vary with company performance and employees are more motivated to help the company succeed. Other types of variable compensation plans include:
Sales Compensation - compensation paid to sales representatives which varies in accordance with the accomplishment of sales goals (see Sales Compensation process).
Team Incentives - any incentive program that focuses on the performance of a work team. Award targets are established based on work groups' output goals.
Gainsharing plan - gains made through cost reduction efforts of the work force are shared by all eligible employees.
Lump-Sum Merit Increases - usually provided as an alternative to a merit-based salary increase to employees whose salary is relatively high.
Executive Incentive Plan - a typically annual award for top and middle management and key individual contributors. The amount of the award is based on how the participant performed their job relative to the goals established at the beginning of the year (see the Incentive Compensation process). A survey conducted by the American Compensation Association early in 2000 indicated that this was the top motivator for participants.
