The total payment an employee receives for the services they provide is compensation. Since it contains many details, including salary, bonuses, benefits, and other incentives offered by the company, it must be attractive enough to retain the employees.

One thing companies can do is create an excellent compensation plan. In addition, they can do whatever is necessary to guarantee the employee is content with their remuneration package. A well-designed compensation package keeps your organization competitive and promotes employee engagement and retention. If you don’t know how to make a compensation plan, we can help you.

What Is an Employee Compensation Plan?

What Is an Employee Compensation Plan & How to Create One

An employee compensation plan, also known as a “total compensation plan”, is a written document showing how much an employee gets after providing service to the company. A structured system that outlines how to pay and reward an employee according to their services.

Not only does it help retain older employees, but it helps you get future employees easily. If they know about your compensation plan and find additional benefits, they’ll indeed find more attraction in your company.

A good compensation plan must contain the following details.

  • The name of employees that are getting the compensation
  • What kind of compensation is the company providing (bonuses, benefits, salaries, or more)?
  • The reason behind the compensation. So, if other employees raise a question, the company can provide them with proof
  • Amount of compensation (it can be a specific percentage or a fixed amount. Also, the company must mention all the compensations)
  • How often will the company be giving compensation, monthly, bi-yearly, or annually?

If your compensation plan is solid and competitive, it can support your business in the following ways.

  • It helps support your business strategy required for your operations and workforce
  • You maintain a level of vigilance in monitoring your industry's rivals
  • It helps attract more talent and retain high-performing employees
  • An excellent employee compensation plan helps improve job satisfaction and employee performance

What Are the Different Types of Compensation?

Before creating a compensation plan, it is better to know its types. This will help you understand the most suitable plan for your company for maximum benefits. The idea is to provide the employee with enough benefits without causing a loss to the company. Direct pay and indirect pay are the two main types of salary structures.

Direct Compensation

The type of salary an employer provides to the employee is based on the services they offer. It contains base pay, differential pay, and variable pay.

  • Base Pay

This is the employee's hourly, monthly, or annual pay without any incentive or bonuses. Basic income is fixed, but increases as the employee reaches higher levels. Also, employee performance plays a vital role in altering their basic pay.

The basic pay must be on par with the industry to attract new talent. Plus, it must be flexible, so those with more skills can get more money from the start. A person who believes in working more effectively and efficiently will ask for more basic pay. So, if you keep it flexible from the beginning, you’ll have less time to settle it with the employee.

On the other hand, the base pay must be defensible and reasonable, and it must be good enough that the employee won’t raise any questions. Most states and countries have a limit for hourly and monthly base pay, so ensure it won’t go lower.

  • Variable Pay

Simply put, variable pay won’t be the same amount every time you pay it to the employee. Many factors are involved in establishing variable pay; in some cases, many employees are not eligible to receive it. 

For example, an employer sees an employee working overtime to learn something for a project. They can add “overtime salary” to the compensation plan structure and provide the employee with a specific amount. However, this same employee won’t get any overtime pay next month simply because they are no longer staying late.

On the other hand, some employers offer their employees dinner or lunch for working on off days or overtime. Variable pay is the best option for an employer to retain employees and improve their performance and job satisfaction.

Since employees are there to earn money to pay bills and other stuff, a little extra cash can help remove a lot of stress from their minds. Also, there is no limit on variable pay, so the employer can provide compensation without facing any loss.

Variable pay is provided through bonuses, commissions, incentive pay, and cash awards, and some companies offer it in profit-sharing plans.

  • Differential Pay

Differential pay is usually a part of the manufacturing industry, where people have to stay late in adverse weather or undesirable conditions. However, if an employer tells an employee to stay late for some particular work, its remuneration will be paid under the differential pay category. The idea is to pay the difference in cash or credit to the person working extra.

Indirect Compensation

Apart from the benefits that are part of direct compensation, whatever the employer pays an employee, willingly or unwillingly, is indirect compensation. Instead of paying them directly, like direct compensation, these are given to enhance the overall life of the employee. The main idea behind indirect compensation is to ensure a person has something extra to enjoy their lives. Indirect compensation mainly includes the following.

  • Health insurance
  • HSA (health savings accounts) and FSA (flexible spending accounts)
  • Wellness benefits
  • Paid holidays
  • Retirement plans
  • Employer assistance program
  • Insurances
  • Discount programs
  • The company provided vehicles and more

Now that you know what to expect while creating a compensation plan, let’s move on to why it is important.

Why Do Business Owners Need a Compensation Plan?

Why Do Business Owners Need a Compensation Plan

A compensation plan indicates how a company treats its employees, and a company offering competitive salaries and benefits has more chances of getting more employees. An organization needs a compensation plan for the reasons given below.

  • Attract and Retain Talent

A compensation plan can help a company attract new talent much more directly than usual. Clearly stating what the company offers to its employees makes it easier to decide whether to join you. Additionally, it also keeps you up to date with the competition, allowing you to set your standards accordingly.

  • Motivate Employees

A well-designed compensation plan can also motivate your employees, as they’ll know that they’ll be paid for any extra work they do. Also, performance bonuses are one way to encourage your employees, as they know they’ll get something after completing a task with fewer errors and on time.

  • Budgeting and Forecasting

For budgeting, it is better to learn about upcoming expenses. A compensation plan helps you understand what expenses you must expect and how to handle them properly. It can also help you understand how much compensation you must provide the employee to avoid losses.

  • Performance Management

Since companies keep a record of all the compensation given to the employees, it helps monitor their performance. You can check the variable pay to see how well they performed before and match it with their current performance. That way, an employer can learn whether to retain an employee with more compensation or give them a warning.

How to Create an Employee Compensation Plan

Compensation Plan Process

While you can create a compensation plan based on the rules and regulations of your business, here are some general steps to make things easier for you.

1. Appoint a Compensation Manager

This one step will make things much easier, as a professional has experience in this field. This person can research and check which position is more suitable for your company and find that talent. This saves tons of your time, as you don’t have to start anything from scratch.

2. Define Your Compensation Philosophy

Every company has a unique compensation philosophy: its moral pay position and benefits based on its value. It is a system that helps you maintain and utilize the money properly. You don’t want to spend all your money on employees or give them so little that they run away. It is all about paying people decent salaries, so they don’t feel overburdened for the work they are getting paid for.

This policy also indicates how much to pay based on the skillset and the burden. Also, it must not be lenient regarding age, race, gender, or more. A fair working environment is excellent for a company where no one takes sides.

3. Know Your Goals

Knowing what you want to achieve narrows down the list of who you want to hire and how much to pay them. Furthermore, this also helps you bring out the intended outcome in your current employees. Make the necessary changes and inform them with a special announcement that they are getting paid more for better work.

  • You should write down and narrow your business goals to be precise and easy to follow.
  • Give your goals a priority ranking to determine which goals you should pursue first. This might help you determine where your money is going and how to better allocate it.
  • Monitor where you still need the key hires to get an idea of human capital needs. Once you know that, you can hire the right people on reasonable terms to pursue company goals.
  • Derive a compensation benchmarking strategy to make a threshold for providing bonuses and other benefits. Once an employee starts falling above the given point, they get more benefits.
  • Communicate the findings and solicit input from your team. It is better to check your strategy multiple times and get professional help before finalizing it.

4. Develop Pay Range

This might require some research, but your manager is here to do that. You'll need to check what employee stipends other companies offer for that particular position, so you can set your range accordingly. One way is to check everything manually, and another way is to use platforms like Indeed, LinkedIn, Glassdoor, and to understand the current pay range.

The benchmark platforms allow you to check salaries based on regions, and you can increase them a bit to attract more professionals. This also helps you understand whether the payroll for that particular position will increase. Furthermore, you can check which companies offer more, so you can change your payment to retain your employees.

5. Decide the Benefits

The next step is to determine which benefits you want to include in your compensation plan. A number of factors, especially those within your control, can be checked while you're making this decision. One way to check for good benefits is to see what your competitors offer and what you can legally provide to your employees.

Furthermore, you can make separate benefits for full and part-time employees. You might need to calculate a pro rata salary for them. The benefits you need for your workforce and what you can offer to exempt and nonexempt employees. Once the list is made, check which of these benefits you can easily provide and opt for them initially.

6. Add the Incentives

Employees can be motivated through the use of incentives. You can add bonuses, paid holidays, or gifts, but they should be based on employees' performance. However, these incentives must have some value; your employees won’t feel motivated if they are poor.

7. Communicate With Employees

All employees must know about the compensation plan at the same time. This will ensure that anyone who needs assistance can come to you with their inquiries. If your employees speak a different language, provide the compensation plan to them in their native language for better communication.

Sample Compensation Plan



Company name and address


Employee name and ID


Employee position and department



DIRECT COMPENSATION - fill out as needed


Hourly rate


Hourly rate overtime













Payment delay


Sign-on bonuses


Salary-based bonuses


Referral bonuses


Holiday bonuses



BENEFITS - fill out as needed


Health insurance




Family and medical leave


Dental care plan


Hazard pay 


Severance pay


Other benefits


How Do You Implement a Compensation Plan?

The impact of compensation on employee performance is huge as long as the provided benefits offer good value to the employee. Implementing a compensation plan is not complicated, but you must keep some points in mind. You can start by defining the plan’s objective and what you want to achieve from the plan. The second step entails doing a job analysis to determine the relevant competencies necessary to achieve the company's goals.

The third step is to determine the compensation structure, including all the benefits it will provide and what levels of employees will get what benefits. It is important to keep an eye on the plan before putting it into action so that any problems may be identified and resolved and the strategy can be optimized for success. Our payroll advice can help in this instance.

Frequently Asked Questions (FAQs)

What is the best way to compensate employees?

There is no right answer to this as every employee would require something else, but providing them cash or extra money in their account could be the best compensation.

How do you calculate employee compensation?

To calculate employee compensation, you add basic pay, commission, bonuses, and all other company benefits and adjust for factors such as taxes and payroll deductions.

How do you create a compensation plan that motivates employees?

A compensation plan that provides the customer peace of mind is the best motivation plan. If they know they are getting a good salary for their work and have paid leaves each year, their motivation level will reach the top. In addition, working from home can also motivate employees.

What are the 4 components of compensation?

The four compensation components are base pay, benefits, incentives, and perks.

What is the HR compensation process?

HR compensation refers to all the rewards an organization provides to its employees for their work and services, including base salary, bonuses, commissions, benefits, and other perks.

What is the difference between salary and compensation?

A salary is a regular payment made to an employee in exchange for their services. Compensation features all financial and non-financial benefits an employee receives for working in a company.

Final Thoughts on Employee Compensation Plan

Creating an employee compensation plan is not difficult as long as you have all the data, including how much you want to pay and what area to target. This article covers all details about creating a compensation plan and a sample to help you make one without making a lot of effort.