What Is an Employee Compensation Plan & How to Create One

Employee Compensation: Planning, Strategies & Best Practices
October 27, 2023
11 min read
October 27, 2023
6 min read

employee compensation

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

Employee compensation is undeniably a vital aspect of any organization's strategy for attracting, motivating, and retaining top talent. It goes beyond the mere provision of monetary rewards. It encompasses various components contributing significantly to an employee's overall job satisfaction and well-being. 

In this extensive guide, we will delve deep into the world of employee compensation and non employee compensation, exploring its different facets, current trends, and best practices that can help you achieve resounding success in your pursuit of creating an enticing compensation package for your workforce.

Understanding the Complexity of Employee Compensation

Employee compensation requires scrutiny because it is typically a multifaceted approach to rewarding employees for their valuable organizational contributions. Employee compensation plan includes several key components, each playing a unique role in shaping the overall compensation package:

  • Salary and Wages: Salary and wages represent employees' core financial compensation for their work. This can take the form of hourly wages or annual salaries and may include commissions. These payments are typically disbursed at regular intervals, such as bi-weekly or monthly.
  • Benefits: Benefits are another crucial element of employee compensation. These encompass various employer-provided offerings, including health, dental, vision, and life insurance, retirement plans, stock options, profit-sharing plans, and different types of leave. Some benefits are mandatory by law, while others are at the discretion of the employer.
  • Bonuses: Bonuses are additional financial incentives provided to employees. They are often tied to specific performance goals or the company's financial performance. Bonuses are processed through payroll but may not be paid out with every regular paycheck.
  • Additional Perks: Additional perks are the extra benefits or privileges that enhance the overall work experience for employees. These perks can be diverse and may include company-provided lunches, on-site parking, employee stipend, flexible work schedules, professional development opportunities, stipends for home offices, and more. Employers offer these perks at their discretion to attract and retain talent.

Total Compensation vs. Employee Compensation

While the terms "employee compensation" and "total compensation" are sometimes used interchangeably, they have distinct meanings. Employee compensation refers to the specific components of compensation (salary, benefits, bonuses, perks). 

In contrast, total compensation represents the sum of all these components. To calculate an employee's total compensation, one must add up the monetary value of salary and wages, benefits, bonuses, and perks.

Types of Employee Compensation


Employee compensation can be categorized into three primary types, each serving a unique purpose in the overall compensation strategy:

  • Direct Compensation:

Direct compensation includes the monetary payments made directly to employees, such as their base salary or hourly wage. It also encompasses variable compensation, such as bonuses, commissions, and overtime pay. Direct compensation is what employees see as their net pay after deductions.

  • Indirect Compensation: 

Indirect compensation has a monetary value but is not paid directly to employees in cash. Instead, it covers non-cash benefits provided by the employer. Examples include retirement plan contributions, stock options, and profit-sharing plans. The specific benefits offered can vary based on location and regulations.

  • Non-Monetary Compensation:

    Non-monetary compensation consists of benefits that do not have a direct monetary value but contribute to employee satisfaction and engagement. These include flexible work schedules, opportunities for professional development, company volunteerism programs, and more. These discretionary perks often set an organization apart as an attractive employer.

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 Employee Compensation Plan:

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 Salary.com 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.

Benefits to Include in Employee Compensation Package

Creating an appealing and competitive compensation package is paramount for employers seeking to attract and retain top talent. Employers should consider offering a well-balanced mix of benefits and leave options to achieve this. Some key benefits to consider include:

  • Health, Vision, and Dental Insurance: Comprehensive health coverage is fundamental to any attractive compensation package. It not only promotes employee well-being but also offers peace of mind.
  • Disability and Life Insurance: These insurance options provide financial security for employees and their families in times of unexpected challenges.
  • Mental Health Coverage: Recognizing the importance of mental health, many organizations now include mental health services as part of their compensation packages.
  • Retirement Plans: Offering retirement plans, such as 401(k)s, helps employees plan for their future and ensures financial security in retirement.
  • Flexible Working Hours: In today's fast-paced world, flexibility in work schedules is highly valued. Allowing employees to balance their work and personal lives is a significant perk.
  • Remote Work Opportunities: The rise of remote work has made it essential to include remote work options in compensation packages, enhancing work-life balance and attracting a broader talent pool.
  • A Budget for Employee Learning and Development: Investing in employee growth and development benefits both the individual and the organization. Setting aside resources for continuous learning is a forward-thinking move.

Leave options are also crucial elements of a comprehensive compensation package. Considerations like maternity, paternity, and parental leave, annual leave, sick leave, bereavement leave, sabbatical leave, compensatory leave, and unpaid leave all contribute to a well-rounded offering that caters to employees' diverse needs.

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.

Determining Employee Compensation

When deciding on compensation for employees, several factors come into play:

  • Compliance with Local Labor Laws: Ensuring compensation packages comply with local labor laws and regulations is essential. Failure to do so can result in legal issues and fines.
  • Market and Competitor Research: Conducting market and competitor research is a valuable practice for understanding industry compensation norms. This research helps organizations remain competitive and attract the best talent.
  • Analyzing Candidates' Prior Compensation: Understanding candidates' prior compensation and experience can guide appropriate compensation offers. This ensures that the compensation is aligned with their skills and experience.
  • Salary Benchmarking: Salary benchmarking is a valuable process for ensuring fair, market-aligned, and competitive compensation, especially for global teams. It involves comparing your compensation packages to industry standards to remain competitive and attract the best talent.

Understanding Employer Costs

Employer costs for employee compensation go beyond the employee's salary or wages. Employers must consider payroll taxes and other expenses related to providing benefits and perks. Tools like a Global Employment Cost Calculator can help estimate monthly costs based on factors like the employee's annual salary and location.

Balancing competitive compensation with manageable employer costs is crucial for a company's long-term success. Overpromising compensation packages can strain finances and affect the sustainability of an organization.

What Is A Highly Compensated Employee?

A highly compensated employee (HCE) is a term commonly used in the context of employee benefits and taxation, particularly in the United States. HCEs earn a higher income within a company than the average or non-highly compensated employees. The designation of HCE is often used for various purposes, including determining eligibility for certain retirement plans like 401(k)s and assessing compliance with tax regulations.

In the context of retirement plans, the Internal Revenue Service (IRS) sets limits on how much highly compensated employees can contribute to certain tax-advantaged retirement accounts. This ensures that retirement plans don't disproportionately benefit higher-paid employees.

To be considered a highly compensated employee, an individual must meet certain income or compensation thresholds established by the IRS. These thresholds can change from year to year. What is highly compensated employee? An HCE is someone who:

  • Earns more than a specified income threshold set by the IRS.
  • Owns a significant portion of the company (more than 5%).
  • Is an officer of the company.

It's important to note that the specific criteria for determining HCE status may vary depending on the retirement plan and the company's policies. The designation is used to manage retirement plan contributions and ensure they are made fairly across all employees, regardless of their income levels.

For the most up-to-date and accurate information on highly compensated employees and related regulations, it's advisable to consult the IRS guidelines or a qualified tax professional, especially considering that tax laws and regulations can change over time.

Additional Employee Compensation FAQs

What's the Difference Between Compensation Vs. Salary?

While salary is a compensation component, the two terms are not synonymous. Compensation encompasses a broader range of elements, including salary, benefits, bonuses, and perks.

What Is a Total Compensation Statement?

A total compensation statement is an annual report prepared by employers to provide employees with a detailed overview of all their compensation. It breaks down the various types of compensation and their monetary values, offering transparency and helping employees understand the full value of their compensation package.

What are the key components of a successful employee compensation strategy?

A successful employee compensation strategy typically includes a combination of base salary, bonuses, benefits, and perks. It should align with the company's goals and industry standards while motivating employees to excel.

What are the current trends in employee compensation?

Trends like pay transparency, flexible compensation packages, and equity-based rewards have gained prominence in recent years. Employers are also focusing on holistic wellness programs and work-life balance.

How can a company ensure fair compensation practices?

Fairness can be achieved by conducting regular salary surveys, implementing pay equity audits, and promoting open communication. Employers should also ensure that biases are eliminated from compensation decisions.

What role does performance-based compensation play in employee retention?

Performance-based compensation, such as merit-based raises and performance bonuses, can significantly impact retention. It rewards top performers and encourages others to strive for excellence.

Are there tax implications for different types of compensation?

There can be tax implications for compensation components like stock options, bonuses, and benefits. It's essential for both employers and employees to understand the tax implications to make informed decisions.

How can companies stay competitive in their compensation strategies?

To remain competitive, companies must stay updated on industry benchmarks, listen to employee feedback, and adapt their compensation strategies accordingly. Flexibility and a willingness to evolve are key.

In a Nutshell:

In conclusion, employee compensation is a multifaceted strategy that extends beyond salary to encompass benefits, bonuses, and perks. Crafting a competitive compensation package that complies with legal requirements and industry standards is essential for attracting and retaining top talent in today's competitive job market. 

Employers must balance their commitment to providing attractive compensation with managing employer costs to ensure long-term success. Creating such a package requires a thoughtful and strategic approach, considering your workforce's unique needs and expectations.

To keep track your employee’s compensation plan use Real Check Stubs.