Types of Compensation: What to Include in Your Compensation Plan

What types of compensation should you offer to your employees? Use our guide to create an attractive compensation package and ensure the best employee benefits for your workforce.

Anja Simic
Written by Anja Simic
September 27, 2021
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As an employer, you pay your employees for the work they perform for you. Almost every employer worldwide provides monetary compensation for their workers, but many still don’t know that a compensation package involves more than their employees’ base salary.

Base pay is only that - the base of the total compensation you may offer to your employees, based on the work they perform, their experience, and job title.

In fact, there are several types of compensation, which we’re going to examine more closely in this article.

Read on to find out more about different types of compensation, employee benefits, and other incentive plans that can make you a more competitive employer and help you build a strong business.

What is employee compensation?

Simply put, employee compensation is the payment you make to your employees to compensate for the work they’ve done for you.

Also called remuneration in different English-speaking regions, workers’ compensation typically includes several types of benefits that employees receive other than their base salary. These perks may include bonuses, different types of insurance, paid time off, etc.

What are different types of compensation?

There are two main types of employee compensation based on the form in which they’re paid: monetary and non-monetary compensation. Monetary compensation can be further divided into several other subcategories that can be paid to the employee directly or indirectly.

Non-monetary compensation

Non-monetary compensation typically involves rewarding high-performing employees with a benefit that doesn’t include cash: a trip, a shopping voucher, public recognition, career development opportunity, tuition assistance, etc.

Monetary compensation

This type of compensation refers to an employee’s base pay and other perks that have a monetary value. Some of them are given to the employee directly, as an addition to the base salary, while others are received in an indirect form.

Indirect compensation

Indirect compensation has monetary value, but the employer doesn’t pay it to the employee in form of cash. Instead, these are typically paid in form of a benefits package, and they can involve the following:

  • Health insurance
  • Stock options
  • Paid time off
  • Retirement plans
  • Disability insurance
  • Life insurance
  • Fringe benefits (catered lunch or company car - benefits that can't always be measured in dollar amount)
  • Gym memberships and similar wellness services
  • Daycare
  • Tuition reimbursement

Direct compensation

Direct compensation, on the other hand, refers to the money paid directly to the employee. It can either be fixed (base pay) or variable (depending on the employee’s performance).

  • Base salary

This is the type of fixed direct compensation that salaried employees receive. These payments can be done weekly, biweekly, or monthly, depending on the initial agreement. Most countries around the world have set a minimum wage that an employer needs to pay to their workers if they want to be compliant with the Fair Labor Standards Act (FLSA) and avoid legal issues.

  • Hourly wages

Hourly wages are also fixed direct compensation but typically assigned to part-time workers or new employees or entry-level workers who have yet to prove their skills. Small businesses are more likely to hire part-time workers who don’t have an annual salary, but an hourly wage-based pay.

  • Bonuses and commissions

A bonus is a type of variable compensation that an employee may receive based on their achievements, typically within a month or annually. In many companies, salespeople earn incentives this way: they receive bonuses or commission if they reach their monthly target.

  • Overtime pay

If your employees work overtime, these hours aren’t included in their base salary. They’re added, for example, to their monthly payment. Overtime pay is an example of what total compensation includes.

  • Profit-sharing

Many companies offer their employees a profit-sharing plan. It means that, based on the company’s annual or quarterly profits, a worker can get a share. That can serve as great motivation for employees to put maximum effort into their work. However, there’s usually a policy with guidelines on how an employee can withdraw this money.

  • Merit pay

Merit pay is a type of bonus provided to the employees whose performance either meets or exceeds the business owner’s expectations. For example, hitting the pre-set monthly or weekly target would be a reason to give an employee merit pay.

  • Incentive pay

Incentive pay is another term for different bonuses and commissions that employees receive based on their performance rather than the number of hours spent at work.

  • Cost of living adjustment

Sometimes, an employee’s base pay will need to increase due to inflation. If the cost of living increases, salaries and hourly wages need to rise as well. You can calculate the Social Security Cost of Living Adjustment (COLA) by using the CPI-W (stands for Consumer Price Index for Urban Wage Earners and Clerical Workers).

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How to determine what types of compensation work for your company

Determining the best type of compensation for your employees may be a complex and challenging question. Your human resources department may come up with suggestions based on thorough research that involves looking at other businesses in your industry, but also in your area, since taxes may vary by state.

Other factors that may affect your decision are:

  • Your budget

Don’t forget that there’s a difference between an employee’s gross pay and what they actually take home. Take your time to calculate what part of your overall funds can be directed to employees’ compensation.

  • Your worker’s education, experience, and previous wages

You may want to make a difference between entry-level workers and seniors. For example, new employees may not be entitled to paid days off immediately, but need to spend some time working before they can take a paid day off. The hourly wage for juniors may also be lower and then increase over time.

How much your employees worked for before they started at your company is also relevant. They may be looking for higher pay, or at least the same-level salary that your offer should match.

  • Your worker’s performance

Top-performing employees will deserve merit pay, bonuses, and commissions more often. You can set different forms of compensation depending on employee engagement and the results they achieve, but also need to ensure you have enough room in your budget for these bonuses.

Before you create a compensation management strategy, make sure you can afford all the benefits you’d like to offer to stay competitive and attractive to new hires.

And don’t forget one thing - many companies don’t mention at least the salary range in their job posts. But if you post a job description, you should also include a couple of benefits your prospective employees can expect if they become a part of your company.

Note that both full-time employees and contract workers can receive some kind of additional pay in form of bonuses.

Want to know how much hiring workers overseas is going to cost you? Use our employment calculator to get an estimate.

What’s the best compensation plan for remote employees?

Employers who hire internationally may have a tough job deciding how to organize their compensation packages for remote employees. Total compensation generally depends on various factors, and when you hire globally, the employee’s location also comes into play.

How do you make it fair and affordable for all parties involved?

Many companies are faced with three options:

  • Base the salary on the employee’s location
  • Base the salary on the employer’s location
  • Use the national average as a reference point

This decision may affect a company’s employee retention rate, so it’s something to consider carefully. As many US companies have started hiring remotely, they may find that the difference between a US salary and an average salary in a different location is big. One way to go about it is to cover the difference with employee benefits such as health care perks or education opportunities.

There isn’t a one-fits-all solution when it comes to the best compensation policy for remote workers. It depends on your budget, industry, and what talents from your target pool want. Asking them directly what they’d like to have is a good idea.

Create an ideal compensation plan for your business

It may be a challenging task, but creating a good compensation plan for your company can help you to both attract new talented people and keep high-performing employees who bring success to your company.

Now that you know what types of compensation there are, you can assess your possibilities and needs and determine what benefits package will work best for you, your staff, and your future employees.

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