Employee compensation is the combination of wages and benefits you pay each employee in exchange for their work. While a compensation package can include things like salary, benefits, commissions, and stock options, the right compensation for each employee will depend on several factors. Offering fair and competitive employee compensation is crucial for attracting and retaining top talent, which is why it is important to understand the various types of compensation packages available.
5 types of compensation packages to consider
There are five primary compensation packages you can offer employees. Keep in mind that you may choose a combination of these packages. According to Amy Roy, chief people officer at Namely, standard employee compensation packages "are usually made up of cash, equity, and non-cash components (e.g., insurance benefits, other types of benefits, and perks)."
The right compensation type for each employee depends on multiple factors, such as their job description and seniority level. [Read related article: What Is Total Compensation?]
Here are five types of compensation packages to consider:
1. Base pay package
A base pay package is a standard amount of money an employee receives in exchange for working a set number of hours (typically 40 hours per week). Employees who receive a base pay package are paid an hourly wage or a salary. Although most employees work for base pay, whether they are salaried or hourly employees depends on their role.
"An employee working on a project or with defined tasks will usually prefer a base salary package," Jeremy Jarry, CEO of stock-option consultancy B3GIN, told business.com. "Hourly-type packages are often for entry-level positions or low-paying jobs."
2. Commission package
A commission package is compensation given based on employee performance. Some commission packages include a low base-pay salary and high commissions, whereas others offer only commissions. A commission package incentivizes employees to perform well, since their paycheck is tied to their performance.
"Often, these compensation packages are given to individuals working in sales," Jarry said. "They will receive a percentage on the turnover they generate or a flat dollar amount if they hit a sales target."
3. Equity package
Employers can create equity compensation packages by offering employees a base pay salary plus stock options.
"Stock options are a financial instrument that gives its beneficiary the possibility to purchase a certain number of shares in a company at a fixed price," Jarry said, adding that types of stock options include incentive stock options, nonqualified stock options, and restricted stock units.
Equity packages are typically offered to employees in leadership positions or for hard-to-recruit profiles. However, Jarry said giving every employee access to stock options can create a culture of sharing and inclusion, as well as align the interests of investors, founders, and employees.
"Equity will vary by organization and may be used as a larger component if cash is tight (e.g., at a startup) and as a method to incentivize employee retention," Roy said.
4. Benefits package
An employee benefits package includes additional perks that workers receive on top of their base wages. There are a few employee benefits you are legally required to offer, including family and medical leave, health insurance (for companies with 50 or more full-time employees), FICA (Social Security, Medicare, and federal insurance contributions), unemployment insurance, and workers' compensation.
Other standard employee benefits include dental and vision insurance, tax-free accounts for medical expenses (such as health savings accounts, flexible spending accounts, or health reimbursement arrangements), life and disability insurance, paid time off (holidays, sick leave, vacation time, parental leave), retirement plans, commuter benefits, gym reimbursement, tuition assistance, and employee assistance programs.
Although including these benefits may sound expensive, there are a variety of options that can work for a range of employer budgets.
"There are lower-cost supplemental benefits (e.g., online fitness programs, financial wellness, telemedicine, flexible work schedules) that could be included in your compensation package that could help create a more attractive package," Roy said.
5. Bonuses
Bonuses are often tied to the performance of the employee, their team or the company. Although you can offer bonuses to employees of any level, many employers give bonuses to employees in leadership roles.
"For VP through the C suite, there's generally a higher percentage of a bonus that's available, and it often ties to the team's performance as well as your own and the company's financials," said Tara Furiani, CEO of people consultancy firm Not the HR Lady.
When you're creating a bonus plan for your business, consider the company's financials, projections and goals.
The importance of employee compensation
Although it is important to stay within your budget, it often pays off to offer competitive and desirable employee compensation, because you can use it to recruit and attract the best employees, encourage company loyalty, and reduce employee turnover.
It's also a good idea to review employees' compensation throughout their tenure with the company. Rewarding your employees' hard work with competitive raises and bonuses can boost employee satisfaction, encourage high performance, and improve your overall company reputation. It can also help you retain your best workers; you don't want good employees to leave your company because they feel undervalued.
"A good compensation package is a part of why an employee will decide to join or stay in a business," Jarry said. "Thus, combining a good corporate culture, strategic vision, and right compensation package will be fundamental."
How to determine compensation
There is a good chance you will have a variety of compensation packages throughout your organization to accommodate different job types, seniority levels, and expertise. If you are wondering how to determine the right compensation for each employee, follow these four steps:
1. Research current market rates.
The first step is to do your research. You can search online job boards, view open jobs on competitors' websites, and read market rate studies to identify what others in your industry are paying for similar positions. You can also survey current employees with similar roles within your organization to see their expectations.
When you're analyzing market rates and determining your compensation management strategy, Roy said, ask yourself the following questions:
- What are the market and competitors doing?
- How do you want to compete against the market rate?
- What is expected in your industry (e.g., tech employees may expect different benefits than hospitality employees)?
- What is your strategy to attract new talent or retain employees, and are you having difficulty doing so?
- What is your budget?
- What do your employees value most?
2. Establish standard company benefits.
Although some businesses overlook this step, it's important to establish standard company benefits. Create a list of the basic offerings that every employee will receive, like overtime pay and health insurance. Furiani said you can also create a list of standard offerings for each position type (e.g., entry-level, professional individual contributor, manager, senior manager, director, vice president, C-level executive).
This list of benefits can help you maintain a fair and equal workplace. Be intentional about what type of compensation you are offering, and reward similar levels of work the same, regardless of whether employees ask for it.
For example, "while it may seem counterintuitive, you don't want your chief marketing officer (a woman) whom you just hired to not have equity because she didn't ask for it, when all of her other C-suite counterparts (men) do," Furiani said. "This is how you 'accidentally' create a biased workplace and pay inequity."
3. Create a pay structure.
Establish a pay structure with different grades containing the minimum wage requirements and a grade range or step increments.
"For specific positions (such as sales), each grade will also have a defined commission program," Jarry said. "At a more advanced level, the pay structure should be catering to each business department and seniority level."
Make sure to consider your current compensation budget, your financial forecasts, and potential promotions.
4. Modify compensation as needed.
Your compensation packages need to grow as your business does. If your business becomes extremely profitable, you might want to adjust your compensation packages to reward your team with higher wages and increased benefits.
You will also need to continually update your pay structures to account for inflation and evolving industry expectations. Furiani recommended conducting a pay equity study to ensure you're offering appropriate compensation for both existing and new roles.
"This should be done annually, by an unbiased professional organization, the results of which will help determine pay ranges, to ensure you're competitive in the market while being fair and equitable at your company," Furiani said.