Performance bonuses: How do they work?

You work hard every day, putting in the hours each week to meet your employer’s expectations and possibly hit a monthly quota. While you may get paid a fair hourly wage for this work, sometimes it’s nice to be shown some additional recognition and be rewarded for the time and energy you pour into your job. One way companies show this recognition is through a performance bonus, a form of cash incentive that rewards employees for achieving a specific performance objective. For a lot of employees, it's not so clear exactly how you go about earning a performance bonus, and it can often feel a little bit like the lottery. In this article, we’ll look to demystify some of the confusion around performance bonuses. We’ll explain why performance bonuses exist, how they work, and how you can approach your boss to discuss how your company handles them.

What is a performance bonus?

A performance bonus is a type of additional compensation (paid over and above your base salary) given to employees as a reward for meeting performance goals or targets. Typically, performance bonuses are given for individual performance, meaning you’ll earn this type of bonus based on how you perform during the period (be it monthly, quarterly, or annually). For example, let’s say you work as a production line worker for a manufacturing company. One of your company goals is to increase production by 10%, which for you means upping your output from 100 units to 110 units per day. If, after the year (or other time period specified by your employer), you’ve produced an average of 110 units each day, then you may receive a bonus for your annual performance. Some companies choose to implement team performance bonus plans where everyone on the team is incentivized with a bonus based on team targets or total company performance. Imagine, in this example, that you’re working as a salesperson for a car dealership. Your company sets goals for the quarter, and your sales team needs to sell a total of 90 vehicles for this period. If the dealership is offering a performance bonus, as long as your team sells more than 90 cars (even if one rep sells 20, another 30, and another 40), you’ll each receive the payout. From the employee’s perspective, individual bonuses tend to be the preferred method.

Why do performance bonuses exist?

Bonus awards are given for a variety of reasons. Most commonly, performance bonuses are used as a way of rewarding employees for a job well done. The employer wishes to recognize exceptional employee performance and let their team members know that their efforts and commitment are appreciated. Performance bonuses given for this reason can be used to boost morale and engagement, particularly during difficult transitions such as company restructures. An employee’s bonus can also be used as a way to incentivize additional effort, performance, and productivity. For example, let’s say a manager wants to see a 20% increase in output from their team over 12 months. They decide to implement a performance bonus program. At the end of the period, eligible employees who’ve produced 20% more output (whatever that may be defined as for their role) will receive the bonus. Lastly, companies often choose to implement performance bonus programs when similar employers offer them. If most businesses in their industry give performance bonuses, they may need to do the same to stay competitive in the hiring market.

How is a performance bonus calculated?

Your performance bonus entitlement largely depends on your company and the model it uses for calculating bonuses. Most often, performance bonuses are calculated as a percentage of your salary, with the typical amount falling between 2.5%–7.5%. Let’s look at an example: Imagine you’re a full-time employee working as a recruiter. Assuming you earn the national median salary of $53,000, and your company pays a performance bonus percentage of 5%, then your annual bonus would be $2,650 ($53,000 x.05).x.05).profit-sharing. Things get a little more complicated when performance bonuses are paid quarterly or monthly. In this case, your annual bonus of 5% of your salary is generally divided up throughout the year. For example, if your annual performance bonus amounts to $2,650, and you receive a bonus every quarter, each lump sum payment would be $662.50 ($2,650 / 4).

10 different kinds of performance bonus

Let’s break down ten common types of performance bonuses.

1. Spot bonus

Spot bonuses (also known as on-the-spot bonuses) are one-off payments given to employees to reward a specific behavior, action, or performance. Spot bonuses are discretionary, meaning they are at the discretion of the employer to give and are not an expectation or included in your salary package. For example, imagine you work as a delivery driver for a local furniture retailer. You’ve just come off the back of a particularly busy month where you had to deliver nearly 50% more packages than usual. Your employer might opt to give you a spot bonus to reward you for working extra hard and still ensuring all deliveries made it to customers’ homes on time.

2. Commission bonus

Commissions are a form of performance incentive that are most typically paid to salespeople as a way of sharing company success. There are a few different kinds of commission structures. The most simple commission structure is being paid a percentage of every sale you make. This might be calculated based on the gross sales price or on net profit, depending on the company. More typically, commissions are target-based, meaning sales reps have a quota or expectation each month or quarter and are only paid a commission if they meet this goal. For example, a sales rep might have a quota of selling $20,000 worth of goods each month. If they meet this goal, they’ll receive a commission payment, usually increasing for every dollar they sell above the goal. Another kind of commission bonus structure is the tiered commission, where reps receive a greater percentage of the profit as their monthly sales volume increases.

3. Mission bonus

Mission bonuses (also known as task bonuses or milestone bonuses) are a form of performance bonus given to employees for achieving a specific goal, such as finishing a project. Mission bonuses are less focused on performance, output, or productivity and are instead given for meeting a milestone. These types of bonuses usually have a deadline. They can be individual, targeted goals or more general achievements everyone can work towards. For example, a team leader might be given a mission bonus for growing their team to ten employees. The deadline for this goal could be three months.

4. Profit-sharing bonus

Profit-sharing is a way for companies to reward employees directly for company performance. Each year, when the business earns a profit, a percentage of this is “shared” with each employee. It’s a way of saying, “Thank you for playing your part in earning our company a profit this year.” ​​While most profit-sharing bonuses are paid at the end of the year, there can also be one-off payments. For example, a team may have been working on a project that resulted in a big revenue boost. The company may share the success with a bonus paid at the end of the quarter.

5. Non-cash bonus

Sometimes employers offer non-cash bonuses to show their appreciation. For example, if a team member goes above and beyond, their boss may give them a voucher to a local store. Every month your company may choose an "employee of the month" or give a shout-out to outstanding employees on social media. They could reward you with a vacation day or give you your own office. If you're interested in training for a promotion, you may be reimbursed for a short course. These types of bonuses are all designed to make the employee feel valued while rewarding good performance.

6. Referral bonus

Hiring managers can have trouble finding new employees, especially if it's a unique role or a remote location. And advertising and interviewing candidates costs time and money. To make the hiring process easier, your boss may offer a referral bonus. How does it work? When an existing employee recommends someone, and they get the job, there's a reward. The referral bonus can vary depending on the company and the job type. It can either be a cash payment, or a non-cash bonus, such as a gift voucher.

7. Raise

A raise is an ongoing increase to your salary. Pay raises can be based on performance. For example, if you've been promoted, increased your workload, or gained new skills, you should get paid more. Alternatively, if the company is growing and performing well, team members may get an hourly pay increase. Then, there are standard raises that may be given when you've been at the company for a while. Let's say you've been in your role for a year. If you've done your job to a high standard, it wouldn't be unreasonable to ask for a 2% or 3% raise.

8. Holiday bonus

Some employers offer holiday bonuses. These are either lump sum payments or gifts given during the winter holiday season. For example, it could be a $100 cash payment or a gift voucher. Sometimes this bonus will be an employee perk. It could be paid time off (PTO) or a four-day work week. Holiday bonuses are given to all employees and aren't usually tied to just performance. The idea is to boost morale and make every team member feel valued.

9. Retention bonus

A retention bonus is a one-off payment that can be given to loyal employees. Companies rely on talented teams, and when someone leaves, the efficiency of the business can suffer. Retention bonuses are often given to employees with specific skill sets. If the person stays at the company for a set period of time, they'll be rewarded with extra cash. It's good for the employer because they get to retain staff members. And, it's good for the employee because they get extra money in their pocket. The retention bonus amount can vary but it is normally a percentage of the employee's base pay.

10. KPI bonus

KPI stands for key performance indicator. This type of performance bonus is commonly used in the sales, finance, retail, and tourism industries. Companies set measurable goals for employees and keep track of their progress. As an example, if it's a sales business, there may be a monthly sales target. Managers can monitor this KPI and see how team members are progressing. If a salesperson hits the target, they receive a bonus. Sometimes, KPIs are group targets rather than individual ones. For example, if a team is working on a project and completes each stage before the deadline, they may receive a cash or non-cash bonus.

How to ask your boss about performance bonuses

For some, bringing up the subject of performance bonuses with your employer can be an uncomfortable situation. However, if you don’t ask, you likely will never get one. So, here are some steps you can follow to have a productive conversation with your boss about performance bonuses.

1. Understand the different performance bonus structures

You’ve already taken the first step by educating yourself on the types of performance bonuses that exist and how they’re calculated. This will help you have a better conversation with your manager and allow you to understand how your company approaches performance bonuses and why.

2. Request to book some time to discuss

It’s best to ask your manager to book some time to discuss so that they don’t feel like they’re being ambushed or caught off guard. Try to catch your manager at a good time (when they are in a good mood and not in the middle of something else) and ask if you’d be able to schedule some time to discuss how your company makes decisions around performance bonuses. For example: “Hi [manager’s name], I’m wondering if you’d have some time early next week to talk about how performance bonuses work at [company name]?” Approaching the conversation this way shows that you respect their time. However, they might simply invite you to discuss the issue right away, so be prepared for this.

3. Ask if the company has a policy on giving performance bonuses

The best way to initiate this conversation is to approach it with a mindset of curiosity. You’re not saying, “Hey, I want a bonus.” You’re saying, “I’d like to understand how this whole thing works.” So, start by asking your manager if the company has a policy on performance bonuses: “I’d like to know how [company name] approaches performance bonuses. Is there a policy or structure for that?”

4. Suggest how a performance bonus agreement could work

It’s possible that your company doesn’t have a performance bonus structure in place. If that’s the case, then it may be a matter of negotiation. If the answer you get to the previous question is “We don’t really have a policy for that,” then your next question should be, “Is it something we could investigate and look at putting in place?” Assuming you get a positive response from your manager (that is, they’re interested in discussing this matter further), then you should suggest a structure for how a performance bonus might be implemented. You should link this directly to your output and productivity as an employee, whatever that might be for your role. For example, if you’re a food production worker, you might suggest a performance bonus structure linked to a production metric such as the number of food items produced.

How to ask for a raise?

If you've been in your current position for a while, it may be time to ask for a raise. Your employer won't usually offer you more money — it's something you have to ask for. Before you ask for a raise, think about why you deserve it. For example, have you been with the company for over a year or recently gained new skills? Have you taken on more responsibility or put in extra effort on a big project? Or have you been offered a new job with a higher salary? You should also look at industry trends. What is the average salary for others in similar roles? The Bureau of Labor Statistics (BLS) is a good place to start for up-to-date salary information. Once you have your evidence ready, you can ask for a raise. You can write a letter or email, or you can request a meeting with your boss to ask them in person. Be confident in your abilities, and if they say "no," try not to take it personally.

FAQs about performance bonuses

This article was written for informational purposes only and should not be construed as legal, financial, tax, or any other kind of advice. Let’s break down some frequently asked questions about performance bonuses.

Do performance bonuses get taxed?

Yes, performance bonuses get taxed. They are considered supplemental wages by the IRS and are taxed at a rate of 22%.

How do I get a performance bonus?

Performance bonuses are generally tied to your productivity or output as an employee. Each company has a different structure for giving performance bonuses, so you’ll need to discuss this with your manager and set out a plan for achieving the performance targets. Refer to the above section for tips on how to ask your boss about performance bonuses.

How much is a performance bonus?

The typical performance bonus is between 2.5%–7.5% of your annual salary, though your company has the discretion to set an amount that's appropriate to them. Amounts of 10% or 15% of your salary are pretty common too.

What to do if your employer says “no” to a performance bonus?

If you ask your boss for a performance-based bonus or a raise, the best outcome is a "yes." But, what do you do if your manager says "no"? It's easy to feel disheartened, especially if you've put in an outstanding performance. Do your best to remain professional and try not to make any spur-of-the-moment decisions. Don't be afraid to ask for feedback because there can be different reasons why your request was denied. For example, the company may be facing hardship and unable to afford any extra perks right now, or you may not have been in your job long enough to get a bonus. If you can have an open conversation, your boss may have tips on how you can earn a performance bonus. They may want you to complete a short course or increase your responsibilities. Don't feel valued? It may be time to look for another job.

Ready to chase down a performance bonus?

Now that you better understand performance bonuses, including how they work, why they exist, and the different kinds of structures employers use for giving bonuses out, there’s one question left to answer: How can you get one? Start the conversation with your boss to explore whether performance bonuses are a possibility at your company. For more information on bonuses, pay, and other benefits, visit the Employee Benefits Resource Center.