Think about the last time a checkout clerk offered you a bonus discount on an item or you came across a bonus feature in a movie. You probably felt pretty great, right?
People love the idea of bonuses because “extra” or “free” stuff is hard to pass up. It’s why we get excited as consumers, and also why they intrigue us when considering a job offer.
However, bonuses come with a lot of caveats, too. Understanding how they work and why they’re provided in the workplace can help you choose between a job with poor compensation and one where you’re set financially. We’ll break them down so you come out feeling like a pro:
- What is a bonus?
- Why do companies provide bonuses?
- What types of bonuses are there, and how do they work?
- What is a typical bonus?
- Are bonuses a guaranteed thing?
- Can bonuses be negotiated?
- How can I ensure I’ll receive a fair bonus?
- How are bonuses taxed?
1. What is a bonus?
A bonus is a form of compensation that’s not guaranteed and is usually paid after the completion of a certain event,” according to Adi Dehejia, a business coach and fractional COO, as well as The Muse’s former CFO.
Bonuses come in many shapes and sizes (all of which we’ll explain later), but generally speaking they’re performance-based, meaning a company distributes them based on how an employee or group of employees contributes to team or company goals—typically revenue-based ones.
That said, a lot of bonuses are discretionary, meaning rather than the bonus being tied to a specific quota, your level, or your performance, a manager simply gets to decide who is and isn’t worthy of one, as well as the amount of the bonus.
As you can imagine, this makes bonuses a pretty complicated subject for companies and employees alike.
2. Why do companies provide bonuses?
Often bonuses are provided because that’s what the market tells companies to do. If other organizations of similar size, industry, or geography are offering their employees bonuses, a company may feel obligated to do the same to compete for good talent. This is why you’ll rarely find a sales role without a bonus structure.
They also want to hire people who they know are going to perform, and when there’s a reward for output, you’ll attract a certain kind of person.
The main reason employers are drawn to bonuses though is because they encourage employees to work hard to help the company succeed. “They want to align incentives—like, ‘You do well if the company does well,’” Dehejia says. It also tends to pay off.People who know they can make more money by bringing in more revenue—whether directly (like sales) or indirectly (like marketing or executive leadership)—are going to be highly motivated to do so.
“They’re trying to share the risk between the company and the individual,” Dehejia says. When a company does poorly because of poor performance, the employee pays the price with lower compensation—as opposed to someone with no bonus structure who gets paid the exact same way no matter how well the company does.
Some people may find this concept stressful. On the flip side though,having a yearly salary without a bonus means there will be times when you work extra hard and aren’t compensated for that work. It’s a trade-off, and one certain people are willing to make.
Dehejia notes that bonuses are never meant to be the sole driver of employee retention and motivation. Compensation is one means to drive performance, but “it doesn’t substitute for management, [and] it doesn’t substitute for praise, learning and development, training, [and] opportunities,” he says. That’s why companies should always be thinking about the value of their bonus plans and balancing them with other perks and benefits.
3. What types of bonuses are there, and how do they work?
Some bonuses are distributed quarterly, others yearly. Some are a one-time thing, others are recurring. It all depends on what role you’re in, what level you’re at, what you contribute, what your leadership is like, and what kind of company you work for (among many other things).
Here are the most common types of bonuses, and how they each work:
Annual bonus
An annual bonus is usually based on overall company performance. This means you may get a large or small bonus (or no bonus at all) depending on how successful your organization or specific department was that year, as well as how big a part of that success you were. This can also be considered “profit sharing.”
The reason companies wait a full year before paying you is simply because it means you have to stick around longer—which is why very few people leave their jobs before collecting their yearly bonus. It’s also, again, tied to company goals, so they want to ensure they’re driving performance for all 12 months, not just a chunk of the year.
Spot bonus
A spot bonus is for people who go above and beyond and is “usually tied to a task that was outside the scope of your role,” Dehejia says . If, for example, you helped out with a special project, worked extra hours, or played an integral part in the company’s success in an unexpected way, your manager can use their discretion to offer you some additional compensation. It’s normally a one-time thing, if not an occasional occurrence, depending on budgeting, priorities, and your leadership.
Signing bonus
A signing bonus is a one-time bonus provided when you sign on to a new role and is basically a way to incentivize candidates to accept the job. Companies might offer it when an employee is walking away from something better, or if the employee is moving to a new city for the job and the company wants to cover some of the costs—this could also be in the form of a relocation bonus or package. It’s also a way for employers to make up for salary demands they can’t meet.
“And then generally speaking, there’s a clause in your employment contract...which says that if you leave before a certain amount of time, typically a year, you owe the money back to the company,” Dehejia says. Unfortunately, it’s hard for companies to enforce this. The risk that companies take is hoping that the bonus actually gets you over the first-year hump and encourages you to stay on longer.
Retention bonus
A retention bonus, similar to a signing bonus, is about retaining valuable talent. It’s typically provided during an acquisition, merger, or big company restructuring to convince someone to stick around for an extra period of time, if they were looking to leave or have a competing offer elsewhere.
“Retention bonuses are really paid on the backend,” Dehejia says, meaning you don’t get it until the time period is up.
Referral bonus
A referral bonus is meant to encourage current employees to refer great candidates for jobs at their company. It’s typically not given until the candidate is hired and has stayed on for several months.
The bonus itself, Dehejia says, has to “be interesting enough that you actually refer someone,” so it’s usually a good amount of money depending on the job and level—anywhere from $1,000 to several thousand. “Sometimes they just do [a] flat [rate] for every role, some companies do a higher amount for roles that are harder to fill,” he adds.
Holiday bonus
Also known as a “13-month salary” or “Christmas bonus,” a holiday bonus is another way to recognize employees for a year of hard work, and to give them an extra boost during an especially expensive time of year. It’s a lot more common for companies based outside the U.S. It’s often—but not always—a set percentage of your annual salary, say anywhere from 5% to 10%.
Commission
Like bonuses, a commission is considered “non-guaranteed compensation,” but legally they’re often defined separately, and they work slightly differently.
Commission is about individual performance. Tons of jobs work under a commission structure (like sales, account management, real estate, finance, and recruiting, to name a few), and payment can be distributed monthly, quarterly, or yearly, depending on the plan and when commission is considered “earned.” For example, “earned” may be defined as when a client signs a contract, meaning that the employee who sold the deal won’t get their commission until a signature is collected and the deal is verified.
Commission can be a set percentage—say, a recruiter gets an amount equal to 15-20% of their hire’s first-year salary—or can be defined by a formula, the idea being that everyone at the exact same level has the same formula. This makes it easy for companies both to measure success and hand out compensation and avoid being accused of favoritism.
Your commission is generally tied to a quota or goal, which can be a dollar amount, an amount of items sold, or an amount of closed deals or booked meetings. The idea is that if you get to 100% of your quota, you’ll earn 100% of your commission.
4. What is a typical bonus?
What’s considered “typical” or “good” for a bonus amount really depends on the type of bonus you’re receiving. An annual bonus of 5-10% of your yearly salary is standard in a lot of industries, just as a 5-10% annual raise is considered standard. However, if you work on commission, you may see a significantly higher percentage.
Your industry, company revenue, location, and level also heavily inform what’s expected. A $5,000 relocation bonus may feel like a lot for someone moving to a small town with a low cost of living, while someone moving to a bigger, more expensive city may balk at that number. When you’re just starting out in your career, a couple thousand dollars can go a long way—but as a senior leader, it’s not unusual to see bonuses in the five, six, or even seven figures.
5. Are bonuses a guaranteed thing?
The short answer is no. Most bonuses are discretionary and an addition to someone’s salary, making it practically impossible to force companies to provide them. There’s also no real federal law that states you have a right to a bonus.
If employment is at-will, this means a company can fire you without cause or compensation. “So unless you have a written contract, there’s no guarantee that you’re going to get anything. As long as [the bonus is] discretionary, they can do whatever they want,” says employment attorney Brian Heller, a partner at Schwartz Perry & Heller, LLP.
Commission does sometimes fall under the category of mandatory compensation. New York State Labor Law, for example, states that any “earned” commission is “legally considered wages and must be paid to the salesperson,” even if that person is fired, laid off, or leaves a job.
However, allowing companies to define what “earned” means gives them a lot of leeway. “There [are] a lot of bonuses that say you have to be working for the company when the bonus is issued in order to get it,” Heller says. If you’re terminated (or leave) before your bonus or commission is paid out, you may not technically be entitled to it, even though you feel you’ve rightfully earned it.
There’s also nothing stopping companies who do provide bonuses from dividing them up unequally amongst employees. “Favoritism is not against the law, unless it’s based on some type of discrimination,” Heller says.
6. Can bonuses be negotiated?
If you truly believe you deserve more, it’s worth negotiating in some way. This is the case for salary as well as bonuses.
Chelsea Williams, a career strategist and the Founder and CEO of College Code, advises that bonuses be negotiated “before a formal contract is shared”—meaning before you’ve agreed to or signed anything—and that you should go into the conversation with a clear target. “Of course, this target should be higher than what you truly are hoping to receive,” she adds.
Theresa Merrill, a salary strategist and interview coach, worked with a client who would have ended up with a gap between jobs based on their offered start date. “[We] asked for a signing bonus to cover that period of time. First, we asked for an increase in the salary and commission. I always advise clients to negotiate that first. But if you can’t move them on that, then go for the signing bonus. Companies would rather pay that than increase the salary,” she says.
She also argues that you shouldn’t just settle for the first offer you get if it doesn’t seem like enough. “If they offer $8K, ask for $10K. Most job seekers get so excited when a signing bonus is extended, they forget to do that.”
She outlines several times when you have the upper hand and thus it’s worth negotiating for a signing bonus:
- When you have multiple companies interested in you—whether you have official offers or have moved on to the second or third round of interviews. “I had a client who was trying to negotiate an offer and the recruiter asked, ‘Do you have other interested parties? That’s something I can go back to the company and present as a reason to up your salary,’” she says.
- When the recruiter or hiring manager is the one who pursued you first
- When you’re leaving an established company to join a startup
- When you’re moving to another city
- When you’re accepting a salary that’s less than what you were previously making
Doing your research and having proof is key. “In all cases, strong performance both on behalf of the company and individual are necessary for effective negotiation,” Williams says. You can ask for a certain number, but if you’re not a high achiever with tangible evidence of your accomplishments or you’re clearly not bringing in a lot of money as a company, you’re not going to make them budge. You should also understand market trends and what others are making in your position to fully back up your claims (these salary calculators can help with gathering the facts).
The best way to be successful is to simply be confident in your approach. Merrill suggests using phrases such as, “I will sign the offer letter today if you can add a $X signing bonus” or “I’m looking at a comparable role where the salary is X% greater. How can you close that gap?” Again, there’s no guarantee it’ll work, but if you walk in as someone who’s well-informed and self-assured, you’re more likely to get what you want.
7. How can I ensure I’ll receive a fair bonus?
Any time you consider accepting a job it’s important to read the fine print and ask thoughtful questions. This especially applies to roles where there’s a bonus structure. Nothing is a guarantee, so when a bonus makes up the bulk of your income, you should know your stuff going in.
Understand how you’re going to be paid. If you’re in an interview, you can ask questions like, “What is the bonus structure for this role?” or “How do bonuses work here?” They may not provide you with an exact number (often because it’s dependent on so many factors), but even a range of pay or idea of how they think about bonuses can be helpful in understanding how they value their employees.
One thing to note is that you should never be having the conversation around money until you’re in the final round of interviews. Also, don’t just take the interviewer’s word for it—lean on your network to get a sense of what people in similar roles are being paid and whether or not this offer holds up.
Another thing to remember is that if it sounds too good to be true, it probably is. If, for example, a company is touting an unusually large bonus, there could be a ton of hidden factors: Your quota to reach it could be unattainable, the bonus could be highly dependent on the company’s performance, or the bonus could be a cover-up for the company paying you much less in base salary.
Also, weigh the pros and cons of the bonus itself and if there are better opportunities available to you. A signing bonus may seem like a lot of money up front, but consider if you were to negotiate a higher salary (or pursue another role with no signing bonus), you might make more in the long run.
Speaking of the long term, understand what accepting a bonus means for your salary trajectory. If your base salary is fairly low (with a bonus making up the bulk of your income), that could affect how you negotiate your compensation down the road, whether you pursue another opportunity in your field or change careers. Always first consider whether you can increase your base rather than your bonus to set yourself up for a better financial situation moving forward.
If a bonus seems reasonable, get it in writing—either through a formal contract or an informal email—and make sure you read all the details and fully comprehend what achieving that bonus means.
“You can’t take any promises at face value about what you’re going to get. Unless they’re in writing, they’re generally not enforceable,”Heller says.
Always assume the worst and factor in what would happen if you didn’t receive that bonus for whatever reason. Would you still be able to pay rent? Afford groceries? Do you still have a decent base salary to work with?
Finally, be willing to put in the work of being in a role where your pay heavily depends on your performance. It’s not for everyone, but plenty of people thrive off this kind of motivation,so know yourself and know exactly what responsibilities you’d be taking on before deciding.
8. How are bonuses taxed?
Bonuses are considered “supplemental wages” by the IRS, which means that they’re often taxed at a higher rate than your regular paycheck in one of two ways:
- At a flat rate of 22%: Employers usually choose this method to streamline taxes and avoid taking too large a cut from employees’ paychecks.
- Using an aggregate method: When your employer combines your bonus with your most recent paycheck, the IRS determines the normal withholding amount based on that sum, subtracts what was already withheld from your last paycheck, and withholds the rest from the bonus amount.
Executives making more than $1 million a year in bonuses, meanwhile, are taxed at a rate of 37%.
It’s human nature to care about money, and if there’s one thing you take away from this article, it should be that understanding how your salary works—including how bonuses are involved—is so, so important.
However, many other factors—company culture, management, team goals—matter just as much in finding a job you’re willing to work hard in and an organization you’re excited to grow at. Make sure you’re looking at the whole picture when deciding your career path. You may find that the extra compensation matters a lot less than the opportunities presented to you.