All About Retention Bonuses
To understand retention bonuses, it is important to first have a general understanding of what a bonus to an employee is, and the differences between the two types of incentives. Simply put, a bonus is an extra payment, other than an employee’s base salary, that is typically awarded if there is a surplus. In particular, retention bonuses are awarded in circumstances where there is risk of the employee leaving the organization, or if the company as a whole is going to be sold, if the employee does not stay for some period of time.
Many bonuses are considered "discretionary" and are not tied to any particular performance by the employee. However, the retention bonus is connected to performance, but the employee does not perform to earn the bonus; rather, the employee is rewarded for remaining with the company either through work or employment, usually for a certain and specific period of time . A retention bonus is not about "how well" the employee navigates his or her responsibilities; it’s about whether or not the employee is present to perform those responsibilities.
While some parties may be opposed to it, companies find that offering a retention bonus, instead of the more common sign-on bonus, is a great way to avoid having to pay significantly higher portions of the bonus for a few years as the employee’s tenure with the company continues. If offered a sign-on bonus, an employee must receive the funds up front and in a single lump sum payment up front. However, a retention bonus is offered to an employee at the very end of his or her commitment, meaning that he or she never touches the money early. For the employer who is trying to save money over the long term, the retention bonus is a great way to incentivize employees without the fear of paying them more than was agreed at the start of employment.
Components of a Retention Bonus Agreement
When crafting a retention bonus agreement template, it’s important to include several key elements. First, the agreement should clearly state the eligibility criteria for the bonus. This may include specific positions within the company, length of employment, or a combination of both. For example, the agreement might stipulate that only certain employees or "key employees" will be eligible for the bonus. Next, you should outline the payment terms. This section should detail when the bonus will be paid, how much it will be, and any additional bonuses or benefits that may be offered as part of the retention package. Depending on the structure of your company and the intended purpose of the retention bonus, these terms may vary widely. It’s best to be as transparent as possible about the details of any monetary awards. The agreement should also outline any commitments required of the employee in order to receive the bonus. This may include an agreement to provide notice, to work until a certain date, to give up certain administrative rights, and any other requirements you see fit. In addition, don’t forget to include a confidentiality clause. This is crucial to prevent the applicant from discussing the bonus with other employees who may then expect similar treatment whereas the other employees are not eligible for a bonus, thus creating conflicts that could affect morale. Finally, you may decide if you would like to include a dispute resolution section. This isn’t always necessary but can help to resolve issues more quickly should they arise. Be sure to leave space after each clause for signatures and print outs so that you have a record of the agreement.
Legalities and Best Practices
The legal considerations when implementing a retention bonus cannot be overlooked. To start, the terms of the agreement itself must comply with the applicable laws and regulations, because if they don’t, the language will be ignored. Certain types of compensation, including an inducement to continue employment, must be adequately disclosed in advance under rules promulgated by the Office of the Chief Accountant of the U.S. Department of Labor’s Employee Benefits Security Administration. 29 C.F.R. Part 2550 sets certain limits on forfeiture provisions in the context of plans governed by ERISA and applicable Department of Labor regulations. For example, the document should state whether the payment is guaranteed, and if the payment is contingent, the conditions for payment should be clearly explained. If the retention agreement is offered to an employee of a Collective Bargaining Unit (CBA), the employer should make sure that the CBA allows the company to enter into such agreements without having to bargain the matter with the Union, or the Union must agree to the deal. These concerns are fairly straight forward and can easily be overcome.
What requires more attention and diligence is the restrictions an employer might want to put on the employee after the employee receives the retention payment. Employers often put restrictions on trade secrets, customer contacts, and other matters. But there are restrictions that are frowned upon by Courts, because they don’t protect the legitimate interests of the employer, but are instead designed to prevent competition. Agreements not to compete, called restrictive covenants, are disfavored at the moment in New Jersey. The theory is that competition is good for the economy, costs consumers less, and results in better services for everyone. If the restriction can’t be demonstrated to be needed to protect the employer’s interest, Courts will be reluctant to uphold the restriction. The same is true in most states, but each state has different requirements. In Pennsylvania, for example, no consideration is required for a restrictive covenant if the covenant is signed when the employee began working for the employer. This analysis changes if the agreement is signed during the employment, requiring additional compensation to support the covenant. In New York, there must be consideration in some form – either the new position or future promotions. This could be an additional promotion or a promise of not being downsized.
How to Structure Your Organizational Template
Just as no two bonus agreements are exactly the same, neither are bonus templates. While a good template will give you a strong starting point, it still needs to be tailored to your organization. Even the best retention bonus template won’t do you much good if it doesn’t fit your structure, culture, or goals. The first part of the retention bonus agreement you’ll need to adjust is the introduction. Some agreements start off by defining employee and employer. But if your legal team is comfortable with these definitions—and they can be derived from the language of the document—those definitions aren’t a problem. If you’re working with a professional services organization, on the other hand, you may need to define what constitutes both employee and employer. If your organization has different employer entities (e.g., the management company), you may need to detail how the bonus should be split among those entities and which entities will be responsible for payment.
The next section you’ll need to tweak is the explanation. Until you know what type of program you need, you won’t know how to explain the mechanics of the program. Supplemental to this explanation, you can include a more general overview of the program’s design and goals. This is especially helpful to participants if your organization has multiple types of bonus plans. For example, if a participant qualifies for both a retention or success bonus, you can explain the difference in these two programs to help them understand when and how those bonuses are paid. Next, determine which boilerplate options (if any) you’ll include in the template. Then, delete the non-applicable options: It’s likely that your organization will qualify for one of the bonus templates above; however, that doesn’t mean you should use every option in your template. A core principle of bonus design is that providing complicated options is a great way to create an unintelligible and frustrating program. You should aim for the simplest bonus plan possible to achieve the desired outcome and fix specific problems. While you want a comprehensive agreement, you also want to keep it simple. After you’ve deleted the unused options, you’ll want to modify the terms of the selected option. Don’t forget to change the variables:
Retention Bonus Agreement Pitfalls
Employers often make several big mistakes when creating a retention bonus agreement. First and foremost, the objectives of the retention bonus must be clear and compelling and not appear contrived. The objectives cannot be simply to save money or shoehorn an employee into accepting a departure that may not even be the employer’s greatest desire. They also cannot be so vague as to be meaningless or unenforceable. If the employer sets the terms of the retention too low, it may not get what it desires – such as a further commitment from the employee, their assistance with training or hiring, or perhaps their absence from a competitor. These kinds of objectives should be sketched out as clearly as possible at the outset – that is what is most compelling in any bonus agreement and what the courts will look to review. An employer should cast the net wide by asking the departing employee or, if at some point really necessary, a number of departing employees, what they think they could do in the time they remain employed to ease the business’ burdens. Even if you do not end up using that feedback, the bonus agreement will likely be more meaningful to the employee and, therefore, tempting. As an aside, I have in practice seen performance-based objectives, such as "do what you normally do," which really means no change at all to employee behavior anyway, or objectives which call for doing what the employee already knows how to do. These objectives are worse than meaningless and, in my experience, nearly always result in the employee leaving on his or her way out the door . So far, it sounds simple, right? A compelling objective, cast wide. Well, the second part is harder and here is where most employers fail to understand that the government is watching. Many retention bonuses and plans are supposed to be exempt under the Internal Revenue Code Section 409(A) rules for short-term deferrals and performance-based compensation, but frequently fail to meet the requirements for those exemptions. There is often only a small time frame between the date of departure and the payout date and that may well defeat the purpose of the short-term deferral rule, which exists to excuse the taxation during the year of departure of compensation that must be paid out in a short period of time after the end of the performance period. Again, make sure that the specific requirements of the exemption you hope to use are actually satisfied. This is all a bit arcane, I admit, and if you haven’t done this before, there are hidden booby traps. You do not want an ill-prepared retention bonus scheme to be subject to the cafeteria plan reimbursement and taxation rules (401(h) of the Internal Revenue Code) or the gold-plated awards taxation rules under Section 409A that impose a minimum tax penalty equal to 20% of the bonus payable. These penalties are huge and can be more than the amount of the actual bonus paid. In other words, a badly handled retention bonus plan could cost you more to enact, than the benefit itself you are hoping to derive from it.
Advantages of Using a Retention Bonus Agreement
A well-structured retention bonus agreement can provide significant advantages not just for employers but employees as well. By offering a financial incentive for employees to stay with the company for a designated and extended period of time, employers can boost employee morale and retention rates.
For employers, such agreements can improve employee morale and loyalty by demonstrating that the company values its employees’ contributions and is willing to invest in their future. This, in turn, can reduce turnover and the associated costs of recruiting, hiring, and training new employees. Retention bonuses can also help to ensure that critical skills and knowledge are retained within the company, which can be especially important during times of transition or when a company is facing significant changes.
For employees, a retention bonus agreement offers the benefit of financial security. Knowing that they have a guaranteed bonus waiting for them if they remain with the company through a specified date can give employees the motivation to stay, even during periods of uncertainty or change.
Beyond the individual employee, retention bonuses can also enhance team cohesiveness and collaboration. When bonuses are dependent on the entire team or department remaining in place, employees may be more likely to support their colleagues and ensure that no one leaves the company prematurely.
In summary, having a retention bonus agreement in place benefits both parties by increasing employee loyalty and reducing turnover. It creates a win-win situation for both employees and employers by providing financial security for the employee and a key retention strategy for the employer.
How to Implement Your Template
Once a retention bonus agreement template is created, the next step is to implement it in the organization. Communicating the agreement to employees should be a top priority so that there are no surprises and everyone is on the same page. Select a few key people to be the face of the retention bonus program and put them in charge of the communication effort. Consider sending an email, hosting a town hall meeting or publishing something on the company intranet. Another important part of the process is obtaining buy-in from employees. This can be accomplished by making the play for the agreement, which could be as simple as letting employees know it’s a requirement of the business in order to reduce costs. If the retention bonus program is tied to terms of employment, that fact should be communicated as well. Letting employees share in the "pride of ownership" for the retention program, by allowing them to be part of the design process, can be beneficial. To maximize the success of the retention bonus agreement, it’s important to monitor the effectiveness of the agreement at each business unit. Keeping tabs on whether the agreement works as planned and whether employees are satisfied with it, is key to achieving organizational goals with it. This could be done by holding quarterly check-in meetings with the retention program implementation team. Doing a pulse of retention bonus program participants to see how it is working for them can also be helpful. If employees feel unhappy with the agreement or it is not fulfilling its purpose of retaining them, then it probably needs to be modified or updated for their benefit or eliminated altogether. Communicating the retention bonus agreement program to employees is essential if it is going to succeed. Having the right people in place to help drive the message is also important. Involving employees in its design can foster good will and help ensure the retention bonus program achieves its purpose. Monitoring the agreement and making sure it continues to serve its purpose is crucial to keeping employees happy and invested in their work.
Sample Retention Bonus Agreement Template
Retention Bonus Agreement
This Retention Bonus Agreement (the "Agreement") is made as of [insert date] between [insert employer name], a [insert form of business entity, e.g., "California Corporation"] (the "Company"), and [insert employee name] (the "Employee"). The Company and Employee entered into this Agreement to set forth the terms and conditions by which the Company will pay a retention bonus to Employee.
- Retention Bonus. Subject to the terms and conditions of the Agreement, the Company shall pay Employee a retention bonus in the amount of [$ insert dollar amount] (the "Retention Bonus") for remaining employed with the Company though the close of business on [INSERT RETENTION DATE: e.g., "March 31, 20XX"].
- Payment. The Retention Bonus shall be paid to Employee no later than [INSERT DATE: e.g., "April 15, 20XX"]. The Retention Bonus shall be paid in a single lump sum payment together with any other wages and accrued PTO earned through the close of business on the Retention Date.
- Contingent on Acknowledgment and Affirmation. The Company’s obligations under this Agreement are contingent upon Employee’s acknowledgment and affirmation of this Agreement, which may be made by signing below and returning a copy of this Agreement to [insert contact person] at Company’s corporate headquarters in [insert city and address] on or before [insert date] at [insert time].
- Effect of Departure Before Retention Date. If Employee’s employment with Company ends for any reason (including, but not limited to, termination by the Company, resignation, Employee death, or Employee disability) for any reason prior to the close of business on the Retention Date, then the Retention Bonus shall be deemed forfeited and Employee shall have no further rights to the Retention Bonus . If Employee is terminated by the Company without cause before the close of business on the Retention Date, then Employee must submit a claim for a bonus pursuant to the Company’s "run-off" or similar bonus payment plan for company terminations to receive such bonus payment, if any.
- No Right to Employment. The execution of this Agreement by Employee does not give Employee any right to be retained in the employment of the Company, nor does it interfere in any way with the right of the Company to terminate Employee’s employment or alter the terms and conditions of that employment.
- Choice of Law and Forum. This Agreement shall be governed by, and construed in accordance with, the internal laws of the State of [Insert state], without regard to the principles thereof relating to conflict of laws. Each party hereto irrevocably submits to and accepts in [Insert city], [Insert county], [Insert state] the jurisdiction of the state and federal courts located therein, and irrevocably agrees to be bound by any determination made thereby and to refrain from asserting any claim or defense to the contrary.
- No Other Rights and Full Agreement. This Agreement constitutes the entire agreement with respect to its subject matter and may not be modified in any respect except by an instrument in writing executed by both parties. It supersedes and merges any and all other agreements between the Company and Employee relating to Employee’s entitlement to a retention bonus. Employee acknowledges that Employee has fully read or has had this Agreement read to Employee, that Employee fully understands this Agreement and that this Agreement is full and complete.
