How to Calculate Retention Pay: Examples and Best Practices

One major challenge in today’s war for talent is employee retention. More employees are constantly seeking a job that puts them in a more favorable situation in life—whether it’s about money, career, work-life balance, or happiness.

According to research, the younger generation perfectly reflects this dilemma. It’s estimated that 21% of millennials claim they have switched jobs within the past year, a 300% increase in non-millennial employee data. And you know what? This millennial turnover problem costs the U.S. economy a staggering $30 million every year.  

In this article, we’ll discuss one of the best solutions to employee turnover—retention pay. How exactly does it work? What are its pros and cons? And how do you calculate it? Let’s find out. 

What is retention pay? 

Retention pay, also known as a retention bonus or retention package, is a financial reward given to an employee in exchange for a guaranteed stay in the company for a certain retention period. It’s a lump sum of money, usually ranging from 10% to 25% of the employee’s base pay, but this could also be increased to 50% depending on certain circumstances. 

Typical retention bonus packages are usually offered by large companies with thousands of employees. These are subject to tax from the Internal Revenue Service (IRS) and are often paid to highly valuable workers during stressful times to prevent them from being poached by competitors in the highly competitive talent war. 

To calculate the retention pay, you can use this formula:  

Retention Pay = (Annual Base Pay X Retention Bonus Percentage) 

One great way to retain top talent is to reward their positive impact on the organization. Compensation Planning Software can help you easily optimize your company’s salary planning strategies, including supplemental wages and financial incentives to ensure market-competitive pay. 

How and when are employee retention bonuses paid? 

A retention bonus can be paid in two different ways: lump sum payment or installments. 

The first one is through a lump sum payment, where companies issue a one-time, big paycheck at the end of the agreement terms. For example, if a large project will take 9 months to complete, then the retention incentive pay should be paid after 12 months to guarantee that the employee will stay. 

Another method is through installments. For instance, an agreement may include provisions where the employee receives 10% of the bonus each month for five months. Then in the final month of the project, he will receive the final 50%. 

As mentioned earlier, employee retention bonuses work as a "stay bonus" and are paid to highly valuable employees during a difficult time for the company. This may include events such as the following: 

• Business merger 

• Company acquisition 

• Large projects 

• A critical period of production 

• Rise in competition 

Who is eligible to receive retention bonuses? 

Technically, any key employee is eligible to receive retention pay. However, it’s normally given to highly valuable employees such as top executives, senior project managers, and other in-demand workers. Moreover, employees with a significant impact on a company’s flagship product or service are more likely to receive these bonuses.  

Now that the war for talent is getting increasingly competitive, talent management systems fall short where it matters most—compensation. The Compensation Planning Software addresses this issue by helping you incentivize without compromise, making variably pay at scale entirely possible. 

Pros and cons of retention pay 

Aside from allowing companies to retain and secure top talents, this bonus also brings considerable advantages both to the company and the employee himself. However, when executed poorly, giving out these bonuses could do more harm than good.  

As an employer, you should be able to navigate these circumstances and make a decision that benefits the interests of both parties. Below are the pros and cons of retention pay: 

Advantages 

• Retain top valuable employees 

• Enhance workplace culture 

• Improve employee engagement 

• Attract more top talents through competitive pay 

Disadvantages/Challenges 

• This may create internal conflict 

• Failure to address real issues 

• Only acts as a temporary solution 

• Expensive; not suitable for all organizations 

How to calculate retention pay? 5 key steps 

As mentioned above, retention pay can be quite expensive and should therefore require extensive preparation. To ensure the best results, it should be cost-effective, comprehensive, and strategically executed. Here’s a step-by-step process to build a successful workplace transformation plan: 

1. Step 1: Assess the current financial situation of the company

   Identify and assess the current financial situation of the company. As mentioned above, these bonuses are often given out during stressful times. So, make sure to analyze whether or not giving them out is a strategic move. 

2. Step 2: Evaluate the employee’s significance to the organization

   Establish the employees’ significance and impact on the organization. Is he a pivotal part of the company? Are his skills and qualifications essential to a large project? Is he a pioneer and one of the top executives? 

3. Step 3: Determine the employee’s base pay and length of service

   To calculate the retention pay, you would only need to focus on two major aspects: the employee’s annual base pay and the retention bonus percentage. Now, this percentage should only range between 10% to 25%, but it can be influenced by different factors such as: 

   • Length of service 

   • In-demand industry skills 

   • Technical expertise 

   • Involvement in large projects 

   • Value of employment 

4. Step 4: Decide which payment method to use

   Choose which payment method your company wishes to use—either one lump sum payment or through periodic installments. This is a crucial step that can affect major aspects of the company, such as finances and project management. 

5. Step 5: Calculate the retention pay

   Finally, it’s time to have the retention bonuses calculated. To do that, you will only need to use the following formula: 

   Retention Pay = (Annual Base Pay X Retention Bonus Percentage) 

   If the annual employee salary is $100,000 and the bonus percentage assigned to him is 15% (equivalent to his 15 years of service), then the bonus he can expect to receive is: 

   Retention Pay = $100,000 x 0.25 

   Retention Pay = $25,000 

   Although it is proven and tested to be an effective fix to employee turnover, it’s still not a one-size-fits-all solution. Total compensation planning will help your company evaluate its pay practices and assess if giving out retention bonus contracts is feasible or not. 

Retention pay: Sample calculations

To fully understand the concept behind retention pay calculations, let us analyze an example with possible real-life scenarios.  

Situation: Employee A is a senior project manager working for a huge company ABC for almost 20 years now, his annual base pay is $800,000. He’s considered a pioneer and started working with the company when it was founded in 2005.  

He was assigned to manage a multi-million project last year that is expected to be finished in 5 years. Due to employee A’s expertise, several competitors are looking to hire him by giving competitive compensation offers. Therefore, company ABC plans to give him a retention bonus in exchange for his guaranteed stay within the organization. How much would be the retention pay of employee A? 

Solution: After analyzing the situation, you can conclude that employee A is indeed an integral part of company ABC and that they are capable of giving him a significant bonus. Moreover, you can take note of multiple factors that can influence the bonus percentage. 

He has 20 years of service under his belt and handles a multi-million project which is expected to finish in 5 years. Assuming that company ABC is willing to give a 20% bonus percentage to employee A: 

Retention Pay = $800,000 x 0.20 

Retention Pay = $160,000 

Since the project he handles has a duration of 5 years, company ABC could come up with a retention bonus agreement stating that his bonus will be equally divided by 5. (corresponding to project duration) Therefore, employee A will be receiving a $16,000 bonus per year.  

There is no right or wrong answer when it comes to calculating retention pay because it can be influenced by multiple factors, depending on the situation. Only the company will have the capacity to decide and come up with sound agreement terms, that should ideally benefit both parties.