An overview of annual bonuses

Last updated: May 19, 2024
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Sara Jones
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An overview of annual bonuses
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Each year, as December 31 draws near, many companies offer their employees an annual bonus. They’re a great way to reward and motivate employees for a job well done over the course of the year.

It also helps employers retain key talent, providing additional financial compensation beyond base salaries and other incentive programs.

But what should employees expect when it comes to annual bonuses? What are the criteria for a bonus, and does everyone receive one?

This article will answer common questions about bonuses, including crucial information on annual, Christmas, and common bonus structures.

What is an annual bonus?

An annual bonus is a one-off lump-sum payment given to employees once a year.

An annual bonus is in addition to your regular salary or wage and is typically discretionary, meaning it's not related to performance targets or expectations.

Annual bonuses have several names. They are often called yearly bonuses or year-end bonuses. Because many companies give out annual bonuses at the end of the calendar year, they are sometimes called Christmas or holiday bonuses.

Most annual bonuses are cash payments, though companies can provide non-monetary bonuses such as stock or additional holiday leave.

Though annual bonuses are relatively common, they are certainly not an expectation. In the US, for example, roughly 1/3 of businesses give out annual bonuses. So, how much should you expect if you get a yearly bonus?

The average annual bonus in the US is 5.6% of your wages. That means if you earn a salary of $35,000 annually, your yearly bonus would be $1,960.

Annual bonus payments vary significantly by industry, however.

Common types of bonuses

Once you know what an annual bonus is, it’s time to learn about the different types of bonuses available.

The most common forms of bonuses are discretionary, nondiscretionary, performance-based, milestone bonuses, signing bonuses, referral bonuses, and employee retention bonuses. These bonuses come in several forms, so let’s closely examine each option.

Discretionary bonuses

One of the most common forms of bonus is a discretionary bonus. This type of bonus is typically awarded at the discretion of management and is usually based on company performance or the performance of the team or individual.

In other words, discretionary bonuses are given out without expecting you to meet a specific target or goal. These bonuses are usually awarded annually or semi-annually and can be in the form of cash, stock options, or other incentives.

Nondiscretionary bonuses

Unlike discretionary bonuses, nondiscretionary bonuses are given out when specific goals are met. These bonuses can be tied to individual or team performance and can be awarded at the end of a project or during different milestones.

For example, if you work on a project that requires meeting deadlines, your employer may offer a bonus if you complete the work on time. Nondiscretionary bonuses can also be used to reward employees for hitting certain sales targets.

Performance-based bonuses

Performance-based bonuses are similar to nondiscretionary ones, but they are usually awarded based on individual performance rather than team or project performance. For example, if you exceed your sales target for the quarter, you may be rewarded with a performance-based bonus.

It's important to note that performance-based bonuses are often tied to a specific job or role and can vary by experience level. The higher your experience level, the higher your performance-based compensation will be.

Milestone bonuses

Similarly to nondiscretionary bonuses, milestone bonuses are awarded when goals or milestones are met. These bonuses are typically given out at key points in a project and can be tied to completing a particular task or successfully meeting a goal.

With the help of milestone bonuses, employers can incentivize their employees to reach important milestones on time and help keep projects on track. This type of bonus is typically paid out in cash, but employers can also award non-monetary incentives such as additional vacation days or stock options.

Signing bonuses

A signing bonus is a type of bonus that is given out when an employee accepts an offer from a company. These bonuses are typically one-time, lump sum payments used as an incentive to draw new talent.

Signing bonuses can also be used to retain and reward veteran employees for their loyalty. Companies often use signing bonuses to award employees for staying with the company, even in tough times.

Referral bonuses

Companies use referral bonuses to encourage their existing employees to refer new talent. These bonus plans are usually given out when a referral is hired and can take the form of cash or additional vacation days. Many companies offer referral bonuses because they are an effective way to find and attract top talent.

Retention bonus

A retention bonus is a type of bonus that rewards eligible employees for staying with the company for a certain period of time. This type of bonus is often used to encourage employees to stay longer and can be in the form of cash or additional benefits such as increased vacation time or stock options.

Retention bonuses can be used to motivate employees and reward them for their commitment to the company. This type of bonus is often used when a company is undergoing changes or going through a difficult period, as it helps to ensure that valuable employees stay with the organization.

Cost of living bonus

A cost of living bonus is a type of bonus given out to eligible employees that must live in a certain area or have been affected by a cost of living increase. These bonuses typically take the form of cash payments that are given out regularly, often monthly or bi-monthly.

Cost-of-living bonuses can help offset the effects of inflation and can be used to reward employees living in areas with high living costs. By offering this type of bonus, employers can ensure that their employees can make ends meet.

All of these types of bonuses can be used as effective incentives to reward and motivate employees. It's crucial to consider which type of bonus is best suited for each individual situation to maximize its effectiveness.

Employers should also ensure they comply with all applicable laws and regulations when offering any bonus.

FAQs about annual bonuses

With all of the different types of bonuses available, there are some common questions that many employees find themselves asking. Here are the answers to a selection of the most commonly asked questions about bonuses.

What is the difference between a bonus and a commission?

Both bonuses and commissions are paid over and above your base salary or wage.

The critical difference between the two payment types is that a bonus is discretionary, meaning that the option to give a bonus (or not) is entirely at the employer's discretion.

Because of this, you can think of bonuses as gifts or rewards, either for specific behaviors or performance or simply for working at the company for the year (e.g., the annual bonus).

Commission, on the other hand, is nondiscretionary, meaning the payment is expected to be made, provided the employee meets whatever targets or goals the commission is set against.

How do I calculate my yearly bonus?

First, you need to establish your company's annual bonus policy.

The challenge is that annual bonuses are discretionary, meaning companies don't often disclose their policy, and the annual bonus is generally different each year.

You can use historical data to calculate an estimate, however.

For example, if all employees got a 6% bonus last year, and the year before that, the bonus was 8%, then it's reasonable to assume that your annual bonus will be somewhere in that range.

You can then take the middle value (7%) as an estimate and multiply that by your salary.

So, say your salary is $32,000. You can estimate your annual bonus to be $32,000 x .07 = $2,240.

However, unless your employer specifies a set amount, there is no guarantee of how much your annual bonus will be or whether you'll receive one at all.

Does a Christmas bonus count as part of a salary?

No, your bonus is not part of your annual salary — the federal government treats this payment as supplemental wages. However, it may be calculated as part of your regular income regarding taxes, but only if you receive your bonus along with your steady paycheck.

How do I know if my year-end bonus is fair?

A “fair” bonus is tough to measure, as bonuses aren't guaranteed, and “fairness” is reasonably subjective.

The best way to understand whether you've received a fair annual bonus is to understand the company's policy toward bonuses and previous bonus amounts.

For example, if your company says they give a set percentage to every employee in the business, then it would be “fair” if you received that percentage and “unfair” if you received less.

Can bonuses be negotiated?

It depends on the kind of bonus you receive.

For example, you should be able to negotiate signing bonuses when agreeing to a new position. Spot bonuses and annual bonuses are less open to negotiation.

Why are bonuses taxed so high?

Legally speaking, bonuses are supplemental wages, so they’re taxed at 22% in most cases unless they exceed $1 million during the year. If the latter is the case, the tax rate will be even higher, namely, 37%.

How annual bonuses are taxed depends on whether they’re combined with or identified separately from regular wages. In addition, they’re subject to social security, Medicare, and FUTA taxes, not to mention state income taxes.

High bonus tax rates often come as a surprise and leave both employers and employees slightly disappointed. That’s part of the reason why more companies switch to non-monetary incentives.

Instead of sending all that money to the IRS, they provide diverse amenities and perks to keep employees productive and motivated. Working condition benefits, employee discounts, athletic facilities, and other fringe benefits are exempt from income tax.

What is a typical annual bonus?

In the US, the average annual bonus for hourly employees is 5.6% of their yearly salary. Exempt employees — which most salaried positions are — earn even more, with an average annual bonus of 11%.

How can I get a Christmas bonus without tax?

The IRS has strict requirements regarding bonuses or any other optional payments.

Even gift cards, certificates, vouchers, and other cash equivalents are taxable supplemental wages, so your employer must include them in your annual income statement. On the other hand, holiday gifts can be regarded as de minimis fringe benefits and qualify for the exclusion.

You can do a few things if your bonus is more than a few hundred dollars and you want to lessen the tax bite.

One possible workaround is to reduce your taxable income by contributing more to your employer-sponsored retirement program, such as a 401(k) plan.

You could also increase your donations to qualified charities and claim them when you file your tax return — just make sure to hold on to your receipts. Or prepay your mortgage and get a bigger tax deduction.

You can receive your annual bonus without paying taxes if it qualifies as an employee achievement award, a tangible property with a value not exceeding $1,600 ($400 for nonqualified plan awards).

However, an employee achievement award can’t be given in cash, a cash equivalent, tickets, meals, vacations, stocks, bonds, or other items. The award must meet the requirements discussed in chapter 2 of Publication 535. If you have any queries, speak to your Human Resources department.

Remember that employee achievement awards and achievement bonuses are two different things. The awards are usually given for the length of service and handed out during a formal presentation.

Does your company offer annual bonuses?

Bonus programs are an important part of employee motivation and retention. They come in several forms and can be used to reward employees for their performance and loyalty or offset the effects of inflation.

Understanding bonuses and some of the most common questions around them can help you find a career that aligns with your goals. Determining your annual bonus potential and knowing how they’re calculated can help ensure you get the pay you deserve.

If you're ready to find a new job offering annual bonuses, you can use the Getting Hired Resource Center to get help with your resume, interview preparation, and more. With proper preparation, you'll be able to find a job that offers bonuses and other great benefits.



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