What is incentive pay?

Incentive pay is a form of performance-based compensation that rewards workers for achieving specific goals tied to business objectives.

Unlike base salary or base pay, which are fixed amounts paid regularly regardless of outcomes, incentive pay is variable. It depends on a worker meeting or exceeding specific performance targets.

Organizations use incentive pay to motivate workers, strengthen alignment between individual efforts and company goals, and drive improved worker performance.

What is the difference between base pay and incentive pay?

Base pay refers to a worker’s fixed compensation, typically an annual salary or hourly wage, for fulfilling the core responsibilities of their role.

Incentive pay is variable compensation tied to specific achievements, such as reaching performance goals, hitting sales targets, or contributing to team outcomes.

While base pay offers financial stability, incentive pay plans are designed to motivate workers and reward high performance, often through monetary or other employee incentives.

Are incentives considered wages?

In many jurisdictions, including in the US, incentive pay may be considered part of a worker’s total wages. As a result, certain types of incentive pay, such as sales commissions or profit sharing, may be subject to wage laws, tax reporting, and inclusion in calculations for entitlements such as pensions.

What are the different types of incentive pay?

Incentive pay programs come in many forms, each designed to motivate workers and reward specific performance outcomes related to their roles and team objectives. Common types include:

• Individual bonuses: One-time monetary incentives for meeting or exceeding personal performance goals
• Team-based incentives: Shared rewards for achieving group outcomes, helping to encourage employees and foster collaboration
• Commission: Typically used in sales roles as a percentage of sales revenue tied to sales targets
• Profit sharing: Distributing a portion of company profits to workers, linked to overall business performance
• Stock options or equity: Granting ownership in the company to align worker interests with long-term organizational success
• Spot awards: Immediate rewards for exceptional performance or behaviors, often given outside of scheduled review cycles
• Non-monetary incentives: Gift cards, extra leave, or other perks that supplement or replace cash rewards

Incentive pay plans should align employee performance expectations with organizational objectives to be effective. Consider the following examples of how different types of incentives work best in different contexts:

Startup vs. enterprise organization

Startups rely on lean compensation models with a focus on equity-based compensation, such as stock options, to align workers with ambitious growth objectives.

In contrast, enterprise organizations offer more structured incentive pay programs, including profit sharing, bonuses, and formal incentive plans that link to individual and team performance metrics.

Sales team vs. engineering team

Sales teams are driven by individual performances, motivated by commission-based incentives, and individual bonuses tied to targets such as sales quotas.

Engineering teams rely more on team-based incentives that reward collaboration, project milestones, and innovation. Organizations can also use occasional spot awards or gifts to recognize exceptional technical contributions.

Company-wide incentive program vs. role-specific programs

A company-wide incentive program, such as profit-sharing, can help build a sense of shared ownership and align workers with business performance.

Role-specific programs feature more tailored incentives that reflect different teams' unique goals and contributions, including performance goals for operations staff or recognizing innovation for R&D teams.

Is incentive pay the same as pay for performance?

Incentive pay is a form of pay-for-performance but they’re not always interchangeable:

• Pay for performance is a broader concept that includes various compensation methods, like merit pay, bonuses, and profit sharing
• Incentive pay refers specifically to monetary incentives or rewards tied to the achievement of defined performance goals

Read more: How to Run Merit Cycles: A Complete Guide for HR Leaders

What is the difference between merit pay and incentive pay?

Merit pay is a permanent increase to a worker’s base salary, often awarded during annual reviews. In contrast, incentive pay is typically a variable, one-time reward for achieving specific goals.

Both aim to to motivate workers, but they differ in structure, timing, and long-term impact.

Is incentive pay a raise?

Incentive pay is not a raise. A raise increases a worker’s base pay or base salary on an ongoing basis. In contrast, incentive pay is a temporary or one-time reward tied to specific performance outcomes.

What is the purpose of incentive pay, and why is it important?

The purpose of incentive pay is to motivate employees and workers by offering monetary incentives or other rewards directly tied to achievements. By linking compensation to specific performance outcomes, incentive pay programs encourage workers to achieve specific goals that support broader business objectives.

Incentive pay is important because it helps drive worker outcomes and productivity while promoting a performance-driven culture. When workers see a clear connection between their efforts and financial recognition, they’re more likely to stay engaged, take ownership of their work, and contribute meaningfully to their company’s success.

A well-designed incentive program improves morale, reduces turnover, and helps attract and retain talent in competitive job markets.

How does incentive pay support a company’s broader compensation strategy?

Incentive pay plays a key role in a company’s broader compensation strategy by introducing a flexible, performance-based element that complements fixed base pay.

While base salary provides stability, incentive pay rewards workers for achieving specific outcomes tied to business success. This balance allows organizations to control fixed costs while encouraging workers to perform at higher levels.

By including incentive pay programs in their broader compensation strategy, companies can strengthen the link between compensation and measurable contributions, resulting in a more competitive and strategic total rewards package.

Read more: Discover how to design an effective compensation program through these six real-world examples of compensation strategies from leading organizations.

Who typically qualifies for incentive pay? Is it for all workers or just sales personnel and executives?

While incentive pay programs are commonly associated with sales teams and executives, most organizations offer them to workers across various functions, including operations, engineering, customer service, and administration.

Incentive pay is aligned with each role’s contribution to specific performance or business goals, such as sales targets, project milestones, or customer satisfaction benchmarks.

Incentive programs can be structured to motivate workers at all levels of an organization by using monetary and non-monetary incentives that are either company-wide or tailored to specific roles.

How does incentive pay impact team dynamics?

Incentive pay can have positive and negative impacts on team dynamics:

• Team-based incentives often strengthen collaboration by encouraging team members to work together toward shared performance goals. This improves communication, trust, and group cohesion.
• Incentive pay programs focusing on individual achievements may create internal competition and motivate workers to prioritize personal gains over team success. As a result, they could undermine teamwork.

Organizations can design incentive pay plans that combine individual and team-based rewards to address this, striking a balance between healthy competition and a culture of collaboration.

What factors should HR managers consider when designing an incentive pay program?

To build an effective and equitable incentive pay program, HR managers should consider the following:

1. Alignment with goals: Support strategic company objectives by rewarding behaviors and outcomes that contribute to success.
2. Clear criteria: Include measurable, achievable targets that are easy to interpret and track.
3. Fairness: Provide fair and equal opportunity to participate and benefit, regardless of role or department.
4. Budget constraints: Evaluate the organization’s financial capacity for incentives over time.
5. Worker preferences: Provide incentives that cater to workforce preferences, e.g., monetary incentives, vs. flexibility or recognition.
6. Legal compliance: Ensure lawful and inclusive practices by adhering to relevant labor laws, tax rules, and anti-discrimination regulations.
7. Communication and transparency: Build trust by training managers about the program and clearly explaining how the program works, how performance is measured, and when and how rewards will be distributed.

Read more: Explore our helpful guide to creating an effective and compliant incentive program.

When should organizations offer incentive pay vs. a salary increase?

Organizations should offer incentive pay to reward workers for achieving specific goals or delivering short-term results, such as meeting sales targets or project deadlines. It provides flexibility and helps control fixed costs.

Salary increases should be offered for sustained high worker performance, expanded responsibilities, or market adjustments. It reflects long-term value and enhances worker satisfaction and workforce stability.

While incentive pay programs motivate workers towards immediate objectives, increases to base salary reward consistent contributions, and promote long-term staff retention.

Should incentive pay be visible in total compensation statements?

Incentive pay should be included in total compensation statements to give workers a clear understanding of their full earning potential.

Monetary incentives, such as bonuses, profit-sharing, or commissions, highlight the value of incentive pay programs. They also motivate workers by reinforcing the link to specific performance outcomes.

Including incentive pay in total compensation statements allows HR teams to communicate the total value of employment more effectively, supporting retention and trust.

What role do managers play in implementing incentive pay programs?

Managers play a crucial role in ensuring the success of incentive pay programs by serving as the connection between HR strategy and worker experience.

Manager responsibilities include:

• Communicating program details: Clearly explaining the goals, criteria, and rewards of the incentive program.
• Monitoring performance: Tracking worker progress and ensuring fair and accurate performance evaluations.
• Providing feedback and recognition: Keeping workers motivated and aligned with their performance goals through regular feedback.
• Resolving issues: Promoting trust by promptly addressing concerns or misunderstandings about the program.
• Collaborating with HR: Refining and improving the program over time by routinely reviewing feedback and performance data.

Managers help ensure the program remains effective, fair, and aligned between workers and the business by actively supporting its implementation.

What are common challenges in implementing incentive pay, and how can they be addressed?

Several issues can limit the effectiveness of incentive pay programs or lead to unintended consequences. Here are some common challenges and practical solutions for overcoming them:

Unrealistic goals

Targets that are too difficult to achieve may leave workers feeling discouraged and demotivated.
Solution: Set achievable, data-informed goals that reflect past performance and realistic expectations.

Perceived unfairness

If workers feel that rewards are distributed unequally or arbitrarily, trust in the program may erode.
Solution: Set, track, and evaluate goals in a transparent manner.

Overemphasis on short-term results

Too much focus on immediate outcomes may cause workers to neglect long-term priorities.
Solution: Balance short-term incentives with recognition for sustained performance and strategic contributions.

Budget constraints

Companies with limited financial resources may struggle to fund meaningful incentive programs.

Solution: Start with a modest program and expand as resources allow, using non-monetary incentives where possible.

Lack of communication and understanding

Participation and impact may be limited if workers don’t fully understand how the incentive program works.
Solution: Communicate the program criteria, timelines, and expectations clearly and provide ongoing support through managers and HR.

How does incentive pay relate to legal compliance?

Incentive pay programs must comply with applicable local labor laws and regulations. These can be complex and vary by country and employment classification.

In the United States, for example, the Fair Labor Standards Act (FLSA) requires that nondiscretionary bonuses, i.e., those tied to specific performance criteria, are included in the regular rate of pay for workers who the Act covers.

Certain types of workers, such as executives and professionals, are exempt from some FLSA requirements. For these workers, bonuses may be excluded from regular rate of pay calculations. At the same time, other types of incentive payments may count toward minimum salary requirements based on their amount and frequency.

Incentive structures must also be free from discrimination and offer equal opportunities regardless of gender, race, age, or other protected characteristics.

How do companies measure the effectiveness of incentive pay programs?

Companies use performance data and worker feedback to evaluate whether incentive pay programs are delivering the desired results. Key approaches include:

• Performance improvement: Measure worker or team output before and after implementing the incentive program to assess changes in productivity or goal achievement.
• Worker engagement surveys: Gauge whether workers feel motivated, recognized, and satisfied with the program through survey feedback.
• Turnover rates: Monitor changes in worker turnover, with a reduction suggesting improved morale and retention.
• Tracking business goals: Determine if key objectives, such as increased sales, customer satisfaction, or project completion, were met through the program.
• Worker feedback: Gather direct feedback from workers to understand what’s working and where adjustments could be made to improve the program’s impact.

Implement compliant, impactful global incentive programs with Deel

Deel simplifies the creation and management of compliant and effective global incentive pay programs, helping you reward performance at scale.

With Deel, you can:

• Set clear incentive eligibility criteria using structured job levels with the Deel Engage career module
• Define salary bands, align rewards to worker performance, and conduct compensation reviews with Deel Compensation
• Offer localized equity and benefits through Deel’s equity and benefits platforms
• Track engagement in real-time using Deel Engage surveys
• Manage contractors, EOR, and direct employees through a unified, global HRIS
• Ensure compliance with local labor laws in 150 countries

Book a demo to discover how Deel can help you create and manage strategic, performance-driven incentive programs tailored to your people, wherever they are in the world.