Retention Bonus: Definition and How Retention Pay Works

What Is a Retention Bonus?

A retention bonus is a targeted payment or reward outside of an employee's regular salary that is offered as an incentive to keep a key employee on the job during a particularly crucial business cycle, such as a merger or acquisition, or during a crucial production period. This payment, meant to keep an employee from leaving their position, is typically a one-time payment. In recent years, retention bonuses have become increasingly popular as corporate poaching has increased.

Key Takeaways

A retention bonus is a targeted one-time payment or reward outside of an employee's regular salary that is offered as an incentive to keep a key employee on the job.
When an organization is going through a disruptive period of organizational change, it offers financial incentives to senior executives and key employees to persuade them to stay with the company until it becomes stable.
Key employees may also be offered a retention bonus if their employer suspects they may be looking to leave to a competitor in order to keep them.
Terms of a retention bonus agreement may also include non-disclosure terms, assignment right terms, and reimbursement terms should retention bonus installment payments be made.
Evaluating a retention bonus agreement requires cost-benefit analysis that compares the financial incentive to the downsides of the agreement such as stunted job growth, dissatisfaction in employment, or lack of lifestyle opportunities of interest.

Understanding Retention Bonuses

When an organization is going through a disruptive period of organizational change, it offers financial incentives to senior executives and key employees to persuade them to stay with the company until it becomes stable. The financial incentive is referred to as a retention bonus. Retention bonuses may also be extended to preserve company-specific information during a project or technically-specific information that may be more difficult to replace.

During a merger, restructure, or reorganization, a company will attempt to retain its best employees to make certain that it has enough people working in the company during the challenging times. For example, a business that is shutting down a department or project will offer retention bonuses to its best performers to ensure that it has the much-needed employees to see the project through to the end.

Booming Economies and Liquid Labor Markets

In a booming economy with a strong job market in which employees are being offered and sold attractive job benefits from other companies, the probability of a business losing its valuable employees to competitors is high. With the corporate landscape changing almost daily and a liquid labor market allowing workers to move from job to job more easily, retention bonuses have provided a great 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 the 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 made to an employee. Companies usually prefer to offer a retention bonus instead of a salary increase because they may not have the necessary finances in place to commit to a permanent salary raise.

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 be completely shut down, the employee retention bonus will be paid after 15 months to ensure that the employee stays for the remaining life of the project.

Not all employment agreements contain a retention bonus, and retention bonuses may be included as a financial incentive at any time during an employee's term.

Common Criteria of Retention Bonus Agreements

Every retention bonus agreement will be different. However, retention bonus agreements will broadly touch the same concepts that an employee must agree to in order to be eligible for their bonus.

Financial Terms: This includes the dollar amount if the payment is to be a lump-sum payment or valuation amount if the payment is to be an equity distribution.
Employment Status: This means an 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: This includes the condition that the company must be solvent and meet specific liquidity conditions in order 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 retention bonus agreement.
Bonus Assignment: This language confirms that should the company be acquired or merge with another company during the retention period, the employee's retention bonus may be assigned to a different legal entity.

Reimbursement Agreement: Should a retention bonus be paid in periodic installment, an agreement may require the employee to repay or reimburse the company for previously received retention bonuses should the employee leave prior to the final payment.
Signature: The retention bonus agreement often requires a signature from the company and signature from the employee to be legally binding.

Special Considerations: Tax Treatment of Retention Bonuses

The IRS treats all bonuses, including retention bonuses, as supplemental wages. 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 a flat rate of 22% directly. If the bonus amount is over $1 million, then it will be taxed 37% (or the highest income tax rate for that year). If an employee received $1.2 million as a retention bonus in 2021, $200,000 would be taxed at 37%, and $1 million would be taxed the regular 22% rate.

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, and the retention bonus agreement will stipulate the terms of withholding.

Benefits of a Retention Bonus

Benefits for Employers

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

Have better cross-training opportunities before the employee leaves.
Have support on specific aspects of the company throughout the entire life of a project.
Have continuity between staff members to ensure overlapping periods of headcount.
Have better operational results as the retained employee is financially motivated to meet the criteria of their retention bonus.

Employers may also receive notoriety for offering retention bonuses. This may incidentally lead to greater recruitment interest as prospective workers may be enticed to the company for this reason. In addition, current employees may feel motivated to work harder to gain specialized knowledge in hopes of receiving a retention bonus one day themselves. Last, companies may experience lower net expenses when considering the cost of hiring a new employee.

Benefits for Employees

The obvious benefit for a retained employee is the additional financial incentive. Often equal to up to 15% of their base compensation, an employee will simply get paid more money if they stick around the company offering a retention bonus.

Agreeing to a retention bonus arrangement also has positive impacts on the relationship between an employee or company. The company clearly needs the employee to stay; though bridges may not be burned when the employee departs, a employee is more likely to forge a stronger long-term relationship with company personnel as they help them through the retention period.

Though an employee is being financial incentivized to stay, employees may also gain trust of prospective employers by demonstrating their loyalty by staying through the retention period. This includes the demonstration that the employee was a critical part of the success of the company, helping publicly boost the employee's general value to other employers.

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 temporarily stay. Conditions to increase your odds of you earning a retention bonus include:

Gain employment in specific industries. Technically-advanced industries are more likely to extend retention bonuses as employees may be more difficult to find with company-specific or industry-specific knowledge.
Enter project-centric roles. Some retention bonuses are tied to projects where a company does not want to lose key staff members during the life of the project.
Identify M&A target companies. Other retention bonuses are tied to companies that merge or are acquired by other companies that do not want to lose staff during the acquisition period.
Continue to advance and be promoted. Retention bonuses are more likely to be paid to higher-level staff with more important 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.

Even if a job doesn't list a retention bonus, consider negotiating to have one included. 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 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 career development growth changes. This includes potentially not learning or having greater project opportunities.
The cost of being unhappy at work. A non-financial consideration is an emotional expense of staying in a job an employee may not be happy at. Accepting a retention bonus agreement means an employee must commit to their role even if they are not satisfied, stressed, or unhappy with their current role.
The cost of foregoing lifestyle options. An employee must accept a company's current work benefit or structure. For example, an employee interested in remote work may have to accept that their company requires an in-office presence during their retention bonus period.

What Is a Typical Retention Bonus?

Retention bonuses are highly specific to the individual company and position. Though most retention bonuses will land around 10%-15% of an employee's compensation, more senior employees with more specialized knowledge will often receive more favorable retention bonuses.

How Are Retention Bonuses Paid?

Retention bonuses are often paid as a lump sum on a specified date agreed to by both the employee and the company. 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. In addition, some agreements may be structured where 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 will likely only offer retention bonuses to highly-skilled, technically-proficient workers that will be difficult to replace during a specific time period. In addition, employees with more integral knowledge about a company's specific project or department may be more likely to be incentivized to stay while other staff members are brought up to speed on specific information about the company.

Can You Negotiate a Retention Bonus?

Yes, employees can negotiate their retention bonus. In addition to negotiating the payoff amount of the retention bonus, employees should discuss the term of the agreement to ensure they are comfortable with the date of the payment and the expectation of what the employee will do during the retention bonus period.

The Bottom Line

Retention bonuses are additional incentive payments used to entice an employee into staying with a company. When used effectively, both a company and the employee mutually agree there is a benefit on both ends for the worker to stay. When used ineffectively, an employee may receive compensation for not delivering much value. The decision whether or not to accept a retention bonus depends on extenuating financial and non-financial factors.