Retention Bonus: Definition and How Retention Pay Works (2024)

What Is a Retention Bonus?

A retention bonus is a one-time lump sum payment given to an employee with the stipulation that the employee must stay on the job for a certain length of time or relinquish part or all of the money. It may be paid to a new employee as an incentive to take the job or to any valued employee at the start of a crucial business cycle or project.

Retention bonuses have become increasingly popular in recent years as companies in highly competitive industries strive to attract and keep their best talent.

Key Takeaways

A retention bonus is a targeted one-time payment that is offered as an incentive to keep a key employee on the job.
Retention bonuses are often used as a way to keep key employees when an organization is going through a disruptive period of organizational change.
They may also be offered to employees whose skill sets are greatly in demand, prompting their bosses to fear they'll be lured away by competitors.
Terms of a retention bonus agreement may also include non-disclosure terms, assignment right terms, and reimbursem*nt terms.

Understanding Retention Bonuses

When an organization is going through a disruptive period of organizational change, it may offer financial incentives to senior executives and key employees to persuade them to stay with the company through the rough times. The financial incentive is referred to as a retention bonus.

Retention bonuses may also be extended to preserve company-specific skills and information during a project or technical knowledge that may be difficult to replace.

During a merger, restructuring, or reorganization, a company will attempt to retain its best employees to make certain that it has enough people on-site during challenging times. For example, a business that is shutting down a department or a project may offer retention bonuses to its best performers to ensure that the project gets done.

Booming Economies and Liquid Labor Markets

In a booming economy with a strong job market, the probability of a business losing its most valuable employees to its competitors is high. With a liquid labor market allowing workers to move from job to job more easily, retention bonuses provide a way for companies to keep key employees.

In addition, employees who have obtained new skills or completed training that is vital to the operations of a business may be offered retention bonuses to ensure that they do not take their skills elsewhere. In addition to losing an employee with an advanced skillset, a company runs the risk of the employee joining a competitor.

A retention bonus is typically a one-time payment. Companies may prefer to offer a retention bonus rather than a raise that commits them to a long-term salary increase.

Depending on the company, the value of an employee’s retention bonus may be tied to the employee’s length of service with the firm. The bonus is paid at the end of a period as either a percentage of the employee’s current salary or a lump sum of money.

For example, if a project will take 12 months to complete, the employee retention bonus will be paid after 15 months to ensure that the employee stays in place.

Common Criteria of Retention Bonus Agreements

Retention bonus agreements differ in the details. However, they all touch the same points.

Financial Terms: This includes the dollar amount if the payment is to be a lump sum or the valuation amount if the payment is in the form of an equity distribution.
Employment Status: The employee must be employed by the company in a specific capacity on a specific date. This date is often called the vesting date or vesting period.
Financial Health: The company must be solvent and meet specific liquidity conditions for the bonus payment to be made.
Continued Employment Disclaimer: This language often stipulates that the retention bonus agreement does not confirm or guarantee employment after the vesting date has passed.
Non-Disclosure Agreement: This means an employee must not disclose specific information to competitors or external parties during the duration of the agreement.
Bonus Assignment: This language confirms that should the company be acquired or merged with another company during the retention period, the employee's retention bonus may be assigned to a different legal entity.

Reimbursem*nt Agreement: Should a retention bonus be paid in periodic installments, an agreement may require the employee to repay the company for previously received retention bonuses should the employee leave before the final payment.
Signature: The agreement requires a signature from the company and the employee to be legally binding.

Tax Treatment of Retention Bonuses

The IRS treats all bonuses, including retention bonuses, as supplemental wages. A supplemental wage is defined simply as compensation paid in addition to the employee’s regular wages. Taxes are usually applied to a retention bonus using either the aggregate method or the percentage method.

Under the percentage method, bonuses are separated from the employee's salary and taxed at a flat rate of 22% directly. If the bonus amount is over $1 million, it will be taxed at 37% (or the highest income tax rate for that year).

The aggregate method is used when the employer withholds tax by combining the retention bonus with the employee’s regular salary into a single payment. The tax rate used is found in the withholding table, which is based on information submitted in the employee’s IRS W-4 Form.

Retention bonuses are often subject to withholding taxes. The retention bonus agreement will stipulate the terms of withholding.

Benefits of a Retention Bonus

Benefits for Employers

The obvious primary benefit for employers offering a retention bonus is the retention of the employee. By keeping a specific employee for longer, the company may:

Have better cross-training opportunities.
Have support in place throughout the life of a key project.
Deny competitors a talented person.
Get better operational results by motivating an employee.

Employers who offer generous retention bonuses become known for it. This can enhance their recruiting efforts. Current employees may feel motivated to work harder and gain specialized knowledge in hopes of receiving a retention bonus.

In the end, companies may find that paying a retention bonus is less expensive than hiring a new employee.

Benefits for Employees

The obvious benefit for a retained employee is the financial incentive, which can be up to 15% of their annual base compensation.

Agreeing to a retention bonus arrangement also has a positive impact on the relationship between an employee and a company. Though the employee is being incentivized to stay, they may also gain the trust of prospective employers down the road by staying with one company through the retention period. This demonstrates that the employee was a critical part of a company's success.

How to Earn a Retention Bonus

There's never a guarantee that your company will extend a retention bonus offer to you. However, there are specific conditions that are often in place that make it more likely for a company to financially incentivize an employee to stay. Conditions to increase your odds of earning a retention bonus include:

Aim for a job in a specific industry. Technically challenging industries are more likely to extend retention bonuses as employees with company-specific or industry-specific knowledge are hard to find.
Enter project-centric roles. Some retention bonuses are tied to projects that are highly dependent on a few key staff members.
Identify target companies. Retention bonuses are often tied to companies that merge or are acquired by other companies that fear losing key staff during the acquisition period.
Continue to advance and be promoted. Retention bonuses are more likely to be paid to higher-level staff with knowledge worth retaining.
Search for jobs that specifically mention retention bonuses. Job postings may list specific positions eligible for a retention bonus, and companies may broadly announce they this is a benefit for working for their their company.

If a job doesn't list a retention bonus, consider negotiating for one. Companies may be more inclined to award a higher back-end retention bonus as opposed to a front-end signing bonus.

Should You Accept a Retention Bonus?

Analyzing whether or not to accept a retention bonus is an example of a cost-benefit analysis. On the one hand, you may be entitled to a lump sum payment should you stay with your current employer in the short term. On the other hand, you may be sacrificing greater potential benefits in return. You should accept a retention bonus offer if the bonus outweighs the "costs" below:

The financial cost of not pursuing a different job. This includes forgoing a potentially higher salary, incentive plan, or better company payroll benefits.
The cost of (not) developing your career. Regardless of pay, accepting a bonus payment prevents an employee from pursuing other and possibly better opportunities.
The cost of being unhappy at work. Accepting a retention bonus means committing to a job role even if someone is dissatisfied, stressed, or unhappy with their current role.
The cost of foregoing lifestyle options. An employee must accept a company's current work culture. A person who is interested in remote work may have to accept an in-office presence, at least for the duration of the bonus commitment period.

What Is a Typical Retention Bonus?

Retention bonuses are generous but the specifics are unique to the company and the position.

Most retention bonuses will be around 10%-15% of an employee's annual compensation. Senior employees and those with highly specialized skills and knowledge may receive higher terms.

How Are Retention Bonuses Paid?

Retention bonuses may be paid as a lump sum or in a series of payments, such as at the beginning and at the end of a specific period.

Should the agreement be modified or terminated early, the employee may receive a pro rata proportion of the bonus or may forego the bonus entirely.

Some agreements may be structured so that the employee receives small portions over time (i.e. 5% of the bonus each month for five months, then the remaining 75% bonus in the final month of employment).

Who Is Eligible for a Retention Bonus?

Any employee is technically eligible for a retention bonus. However, companies most often offer retention bonuses to executives and to highly skilled, technically proficient workers who would be difficult to replace.

Employees with integral knowledge about a company, a project, or a department, may be more likely to receive an incentive to stay.

Can You Negotiate a Retention Bonus?

Yes, an employee can negotiate a retention bonus. In addition to negotiating the payoff amount, an employee might negotiate the terms of the agreement to ensure they are comfortable with the date of the payment and the expectation of what the employee will achieve.

The Bottom Line

Retention bonuses are incentives used to persuade an employee to stay with a company.

When used effectively, both the company and the employee will agree that there are real benefits to both parties involved. When used ineffectively, an employee may receive extra compensation for not delivering much value.

The decision whether or not to accept a retention bonus depends on extenuating financial and non-financial factors.