How to Create a Compensation Plan: A Step-by-Step Guide

How your company handles pay decisions is a defining part of your culture. A structured compensation plan shows your workers that decisions are thoughtful, consistent, and fair. Without a structured, transparent approach, pay decisions can feel inconsistent and open the door to mistrust or even compliance risks, especially as your workforce grows or spans multiple countries.

In this blog, we’ll walk you through a step-by-step process for creating a compensation plan—from setting your compensation philosophy to benchmarking salaries and integrating benefits—using proven practices that resonate with HR, finance leaders, and execs alike. With our global expertise and powerful payroll and compliance tools, you’ll see exactly how the right compensation strategy can increase retention, reinforce fairness, and streamline scaling in any market.

A step-by-step guide to creating a compensation plan

Before building a compensation plan, it’s important to understand what it is and what it isn’t. Many companies use the terms “compensation strategy” and “compensation plan” interchangeably, but they serve different purposes. Think of strategy as the “why,” and the plan as the “how.”

Your compensation strategy is the high-level framework: how you position yourself in the market, how you balance internal equity with external competitiveness, and what principles guide your pay decisions. It’s a long-term perspective that connects compensation to business goals, culture, and values.

Your compensation plan puts that strategy into action. It includes specific structures like salary bands, job levels, bonus models, and benefits that determine how workers are paid.

An effective compensation plan typically takes 4–8 weeks to build with input from HR, finance, managers, and executives. Here are the nine steps involved in crafting your plan.

Step 1: Define your compensation philosophy

Every strong compensation plan starts with a clear philosophy — a formal statement of how your organization approaches pay decisions. A compensation philosophy defines the principles that shape how you reward workers and align pay practices with your company’s broader mission and goals.

At a minimum, your compensation philosophy should clarify:

1. How you benchmark pay: Will you lead, match, or follow the market?
2. Your stance on internal equity: How will you keep pay fair across teams and levels?
3. The role of performance: How much will results influence salary or bonus decisions?
4. Your approach to transparency: How much will you share with your workforce about pay ranges and structures?

Step 2: Develop a job architecture

A compensation plan demands a clear, consistent understanding of how you define and structure jobs within your organization. A job architecture provides a standardized framework for classifying jobs based on their function, department, and scope. It defines how roles relate to one another, for example, by career progression, managerial responsibility, or impact level. It’s a framework that keeps all compensation decisions grounded.

Building your job architecture typically includes:

• Job families: Grouping roles by similar disciplines (e.g., Engineering, Sales, Marketing).
• Career levels: Defining inspiring career progression paths that help candidates and workers visualize their future with the company and how pay ties into every opportunity. For example, Individual Contributor → Manager → Director → Executive.
• Job leveling matrices: Outlining the skills, responsibilities, and expectations at each level. For example:
  • Engineer Level 2: Executes assigned tasks with moderate supervision; demonstrates technical proficiency in core areas; begins to influence small team outcomes.
  • Engineer Level 3: Owns complex projects; mentors junior teammates; regularly contributes to architectural decisions and cross-functional initiatives.

Step 3: Conduct market research and salary benchmarking

Pay is an incredibly persuasive factor in people’s decisions to remain or depart an organization. According to Gallup’s study on turnover, 30% of workers who have voluntarily quit an organization state that additional compensation and benefits would have caused them to rethink their decisions.

All compensation packages are relative to what competitors are offering, which is where salary benchmarking and market research are key.

To understand what others pay, start by using trusted salary benchmarking tools such as Deel Salary Insights or providers like Mercer. These tools aggregate real-world salary data, helping you establish realistic compensation ranges based on the markets where you hire.

When conducting market research, consider:

1. Industry benchmarks: Pay varies widely between industries, even for similar roles. Understand how your sector influences compensation expectations
2. Role-specific data: Salaries can differ sharply between roles within the same department or team. Make sure you’re comparing like with like
3. Geographic factors: Location remains a significant factor in compensation, even with remote work. Roles based in high-cost cities often command higher pay than equivalent roles elsewhere
4. Pay trends: Economic shifts, emerging skills shortages, and trends like return-to-office mandates can all drive compensation expectations upward or downward. Staying ahead of these trends allows you to make proactive market adjustments rather than reactive, costly corrections

Step 4: Establish salary bands and pay structures

Market data is only useful if it leads to actionable pay decisions. That’s where salary bands translate your benchmarking insights into defined pay ranges for each role, level, and job family.

Each salary band should include a minimum, midpoint, and maximum base salary for a given position. To anchor your compensation decisions, your ranges should reflect:

• The external market rate for the role
• The internal job architecture you’ve established
• Your compensation philosophy (e.g., paying at market, above, or below)

Without salary bands, pay conversations become ad hoc and difficult to justify. But with them, hiring managers, HR, and finance teams all sing from the same hymn sheet.

Read more
Learn more about building salary bands with our step-by-step guide.

You’ll also need to decide how your workers’ location influences your pay structures. GitLab, for example, uses a transparent compensation calculator that applies a “location factor” to each person’s pay. Rather than tying salaries to the cost of living, GitLab evaluates local labor markets and benchmarks each against San Francisco’s rates as a baseline.

Others like Basecamp opt for location-independent pay, offering the same salary, benchmarked against the San Francisco market at the 90th percentile, irrespective of where a worker works.

Step 5: Incorporate variable pay and incentives

Base salary is only one part of a complete compensation plan. To attract and retain top performers, many companies layer in variable pay, which workers can earn based on certain conditions or outcomes rather than a guarantee. Common types of variable pay include:

• Sales commissions: Compensation is tied directly to revenue or quota achievement, often a major component in sales roles
• Profit-sharing: Company-wide incentive programs distribute a portion of profits to the workforce, typically on an annual basis
• Equity and stock options: Long-term incentives are often used in startups and growth-stage companies to reward commitment and align workers with company performance
• Retention bonuses: Targeted incentives are designed to retain key talent during critical periods such as restructuring, leadership changes, or major product launches
• Performance bonuses: One-time payments are based on individual, team, or company-wide results
• Merit increases: Pay raises are tied to consistent high performance, or the acquisition of new responsibilities or skills

Of course, there’s no single model that works for every organization or role. That’s why it’s important to align variable pay with the nature of the job, the level of responsibility, and your overall compensation philosophy. Here’s how variable pay could differ by role:

• Sales roles: Often include commission-based compensation tied to quotas or revenue targets. High performers may earn 40-50% of their total compensation through bonuses or commissions
• Executives: Commonly receive a mix of performance bonuses, long-term incentive plans (LTIPs), and equity awards to align leadership goals with company performance
• Customer support or operations: Typically includes lower variable components but may still offer performance bonuses tied to KPIs like customer satisfaction or resolution time
• Product and engineering teams: May receive stock options or annual performance bonuses based on company milestones or peer-reviewed impact

Step 6: Outline benefits and perks

Often thought of as “extras,” benefits and perks are integral to your total compensation package. According to a MetLife benefits study, when employees feel cared for by their employer, they’re 1.5x more likely to say they’re happy and feel a sense of belonging at work.

While salary may get someone in the door, benefits often determine whether they stay. In competitive hiring environments, they can tip the balance for candidates weighing multiple offers. And in retention strategies, they’re a reliable way to reinforce satisfaction without defaulting to salary increases.

Today’s competitive packages often include:

• Health insurance: Medical, dental, and vision coverage remain standard in most markets
• Paid time off (PTO): Includes vacation, sick leave, and personal days, increasingly with flexibility to accommodate different working styles
• Retirement savings plans: 401(k)s, pension schemes, or region-specific equivalents
• Parental leave: Extended and inclusive policies for both birthing and non-birthing parents
• Remote work stipends: Support for home office equipment, internet, or coworking space memberships
• Mental health benefits: Access to therapy, mental health days, or stipends for wellness programs
• Learning and development budgets: Funds for upskilling, certifications, or coaching
• In-kind or localized benefits: Transportation allowances, childcare support, or region-specific perks that create parity when designing benefits for global teams.

These offerings signal the kind of culture your company wants to build. Benefits show whether you’re optimizing for short-term efficiency or long-term loyalty, and talent notices the difference.

Step 7: Ensure legal compliance and pay equity

Compensation planning must align with local laws wherever your workers are based. These include labor and tax regulations, minimum wage laws, social contributions, and pay equity and transparency requirements.

Pay transparency laws are one of the most significant regulatory shifts shaping compensation practices today. Here’s a look at how different regions are responding:

United States

States like California, New York, and Colorado now require employers to include salary ranges in job postings. Some states also mandate that employers disclose pay range information to existing workers upon request or during performance reviews. These laws are designed to promote pay equity and reduce bias in compensation decisions, especially for historically underpaid groups.

Europe

Under the EU Pay Transparency Directive, all member states must introduce new pay transparency and equity regulations by June 2026. The directive includes mandatory salary range disclosures in job postings, a ban on pay secrecy, and reporting requirements for employers over certain headcount thresholds. Companies must also justify unexplained pay gaps and give workers access to pay data by role category and gender.

Canada

Provinces like British Columbia and Ontario have introduced or expanded pay transparency legislation, including requirements for salary disclosures and public reporting.

Australia

The Workplace Gender Equality Amendment (Closing the Gender Pay Gap) Bill 2023 requires large employers to publish gender pay gap data, with more detailed transparency obligations phased in over time.

Step 8: Map your workforce against the newly defined compensation structure

To operationalize your compensation plan, map your workforce to the different job levels and salary bands you’ve defined based on their current responsibilities, qualifications, and impact.

This is often referred to as “leveling,” and is essential for turning structure into action. To do this effectively:

• Review each employee’s current role, function, and scope of responsibility
• Align them to the appropriate job family and levels
• Apply location factors or variable pay models as needed
• Flag any outliers where compensation or level appears misaligned with expectations

Functional leaders bring critical insight to this process in terms of understanding how roles actually operate within their teams. Their participation also drives buy-in across the organization, so the final decisions are considered credible.

Mapping workers after finalizing the compensation structure also prevents legacy decisions from influencing future pay. It creates a clean break — a transparent system you can refer to when explaining or defending any compensation outcome.

Step 9: Communicate the compensation plan effectively

Workers care about their pay—they want to know that they’re earning enough and that you’ve made compensation calculations or decisions fairly. If any aspect of the process feels mysterious, you risk damaging trust and increasing turnover as your workers head to a competitor with a more transparent compensation program.

Here’s how to offer strong communication to your people leaders and individual contributors.

Communication with people leaders

Your people leaders will deliver the message, answer questions, and navigate any anger or disappointment. Make sure you equip them with:

• A clear explanation of the company’s compensation philosophy and how you built the structure
• The rationale behind the mapping process and role-leveling
• Talking points, FAQs, and training to ensure consistency and confidence across departments

Communication with individual contributors

Provide documentation, host Q&As, or use 1:1 meetings to convey:

1. How you determined their compensation (role, level, location, performance, etc.)
2. What each component of their pay includes (salary, bonus, equity, benefits)
3. How they can grow and what it takes to move into the next band or level

A well-communicated plan removes confusion and creates alignment. When your people understand how you determine their pay and what you expect of them going forward, they’re far more likely to trust the process, even if they don’t agree with every detail.

Common challenges when creating compensation plans and how to overcome them

Even with the right structure in place, it’s normal to hit a few bumps in real-world compensation planning. Here are some of the most common challenges companies face and what to consider as you work through them.

1. Handling salary discrepancies and worker expectations

Formalizing pay structures often uncovers inconsistencies, such as two people in similar roles being paid differently based on timing, negotiation, or manager discretion. Although these gaps create friction, don’t try to retroactively justify past decisions. Instead, anchor every discussion in your new framework and focus on how the plan creates fairness moving forward.

2. Adapting to market shifts and economic downturns

Compensation data ages quickly. Inflation, cost-of-living spikes, and changes in the talent market can quickly outdate your pay bands. To stay current, build in regular review cycles and budget time for recalibration, especially in fast-growth or volatile industries.

3. Balancing cost constraints with competitive pay

Early-stage and bootstrapped companies often can’t match big-name salaries, and that’s okay. Remember that only one company can pay the “most” in the market, but you can still compete through equity, benefits, flexibility, and career opportunities.

4. Maintaining fairness and transparency in global teams

One of the most complex questions is whether to adjust pay based on where workers live. Many remote-first companies start with cost-of-living adjustments, but over time, this model can feel arbitrary and unfair, especially when workers in different cities do the same work for different pay.

Location-based pay remains a valid approach for many companies. But if you use it, be prepared to explain the logic and show how it supports your broader values. What matters most is that your model is consistent and built to scale.

How Deel helps companies implement compensation plans

Designing a compensation plan is one task—implementing and maintaining it across a global workforce is another. Deel helps companies manage every stage of this process at scale:

• Use Deel Compensation to manage salary bands and variable pay, run compensation reviews, and comply with transparency obligations in one place
• Access global salary benchmarking tools to build market-aligned pay structures
• Offer and track equity and stock options for high-growth and distributed teams
• Automate global payroll and compliance across 150 countries to meet all local requirements

Whether you’re defining your first compensation plan or refining it for a growing team, Deel helps you do it faster, smarter, and with fewer risks. Book a free Deel demo today.