Employee compensation is what employees receive for services or work rendered at a company or business. While it typically refers to the money that workers get from employers, there are many types of employee compensation. Aside from wages and bonuses, it includes non-monetary items like stock options and benefits (such as health insurance plans).
Together, the measurable pieces make up a worker's total compensation or compensation package. Knowing what employee compensation is and its different forms can help you create a competitive package for attracting qualified candidates, retaining employees, and managing business finances.
Employee compensation types
The amount of money you pay workers is only a part of employee compensation. It consists of different elements, which can be monetary and non-monetary items. Below are its three main types, including a few common employee compensation examples.
This refers to the money employees earn and directly receive in their paycheck or bank account. Base pay usually takes the form of a wage or salary and follows the company’s payroll period, which can either be weekly, biweekly, monthly, or semimonthly. However, state payday requirements may limit how infrequently you pay employees.
Other examples of direct compensation include:
- Overtime and shift differential payouts
- Commissions
- Bonuses
- Achievement or recognition award payments
- Tip income
- Incentive payouts
Did You Know? A salary does not automatically make an employee exempt from overtime. Nonexempt employees may be hourly or salaried and generally earn overtime after working more than 40 hours in a workweek. Most federal executive, administrative, and professional exemptions also require salary and duties tests. Check the current federal thresholds and your state rules, which may be stricter.
While this doesn’t involve a cash payout to workers, it’s considered part of employee compensation because of its financial value. The items that fall under this are the different types of benefits and perks that employers offer. Below are some indirect employee compensation examples:
- Health, dental, vision, life, and disability insurance
- Employer contributions to retirement and savings plans
- Paid time off (PTO), holidays, and sick leave
- Legally required benefits, such as the employer share of Social Security and Medicare, unemployment insurance, and workers’ compensation
- Stock options
- Child care or education assistance
- Gym membership
- Company car or transportation benefit when it provides personal value to the employee
Keep work tools separate from compensation. A laptop or phone supplied mainly so an employee can perform the job generally belongs in your equipment budget, not the employee's compensation package. Tax treatment can change when a fringe benefit provides personal value, so review the current IRS Employer's Tax Guide to Fringe Benefits when you are unsure.
Intangible compensation is similar to indirect compensation, wherein employees don’t receive any cash payment. What makes it different is that it doesn’t have easily measurable financial values. However, it generally contributes to workplace culture—helping make your company a good place to work. Here are some examples:
- Flexible shift or work schedules
- Remote or hybrid work arrangements
- Professional development opportunities
How to create employee compensation plans
Developing a compensation plan for employees isn’t an easy task. It takes time to complete because you have to consider and look at several factors—from your budget to labor laws and local and/or state pay-related regulations. While there are different strategies for creating employee compensation packages, below are the common steps.
Step 1: Make a Position List
Create an inventory of all the positions in your company, not the people currently holding them. You may need to write job descriptions, as these allow you to determine the value of each position based on job complexity, work responsibilities, and other requirements (such as technical skills).
Job descriptions are also helpful for comparing the role’s work responsibilities with the job duties of similar positions in the market. However, you mustn’t rely on position titles alone. A senior accountant role in your company may have slightly different tasks compared to a competitor’s senior accountant. One may have more complex duties than the other, which would likely push that role’s salary or compensation package up.
Step 2: Conduct Market Research
Check how much your competitors and other organizations in the same industry are paying for similar positions in your company. Compare the data with what you’re currently offering or plan to provide. Use the position titles and applicable job descriptions as the basis for comparison.
However, don’t look at only salary and wage amounts. Take time to research the benefits, bonus and merit increase percentages, and other employee perks that these businesses offer. The Bureau of Labor Statistics’ Occupational Employment and Wage Statistics program provides a reliable baseline for hundreds of occupations across national, state, local, and industry views.
You should also consider your company’s competitiveness in terms of total employee compensation. Are you offering more or less than other companies or your competitors? Or is your salary package at par with market rates but your employee benefits plans are below standard? Understanding the gaps in your compensation plan lets you know which areas to improve.
Step 3: Set Salary and Benefits Levels
Once you get your market data and have completed your comparison of positions, identify the direct compensation items for each role. Do you plan to provide bonuses or incentive pay in addition to salaries and wages?
You also need to determine the standard benefits that all employees can enjoy. These can be paid time off, maternity and paternity leaves, and insurance plans (like medical, dental, vision, and retirement plans). Don’t forget to consider federal and local laws, such as tipped minimum wages per state and overtime regulations. Use our state payroll directory as a starting point, then confirm requirements with the relevant government agency or qualified adviser.
Avoid giving special perks to specific positions or employees to prevent pay inequity. If you decide to provide additional benefits or perks, it should be based on job roles. For example, providing a company car or a car allowance for all managerial and/or field sales roles.
Step 4: Create Pay Structures
Establish salary bands or pay grades for each position based on the market data you collected and the role’s job description. With this pay structure, you can identify the minimum, midpoint, and maximum salary amounts to give and even set up pay adjustments per pay grade.
You also need clear rules for where new hires enter the range and what helps an employee move through it, such as stronger proficiency, sustained performance, or expanded responsibilities. This makes it easy to calculate the starting wages for new hires and the promotion increases for employees.
A pay range without those rules is just numbers on a spreadsheet. Review proposed offers and increases against the range, the employee's relevant experience, and comparable internal roles before approval. This gives managers a practical way to make consistent decisions and explain them.
Step 5: Review Compensation Plans Regularly
It’s important to compare your compensation plans with market rates on an annual basis given economic conditions (e.g., inflation) and changes in the industry that your business belongs to. This allows you to remain competitive with the salary and benefits packages that similar companies offer.
If you spot potential improvement areas, such as expanding your insurance coverage, check your budget. You may need to create a payroll budget to cover the additional costs. Don’t forget to inquire with your current insurance provider if they can handle the expanded coverage. If not, reach out to other providers and compare quotes to find the right benefits package for your company.
How to calculate total compensation and employer costs
Start with the employee’s total compensation, then add other cost layers only when the business decision requires them.
| Calculation | Formula | Best used for |
| Total compensation | Base pay + cash incentives + measurable equity or fringe benefits + employer contributions to health, retirement, and other benefits | Offers, compensation statements, and internal pay reviews |
| Employer compensation cost | Total compensation + employer payroll and unemployment taxes + workers’ compensation premiums | Hiring and payroll budgets |
| Full cost of employment | Employer compensation cost + recruiting, equipment, software, workspace, and other role-related expenses | Headcount and operating budgets |
Best practices for creating compensation plans
Creating compensation plans requires strong research, analytical, and mathematical skills. It can be challenging to do, especially if you’re new to using salary analysis tools, managing pay equity, and calculating the compa ratio to assess the competitiveness of your workers’ pay. However, there are best practices you can follow to help you create a solid plan that covers the total compensation of employees.
- Set up a compensation philosophy
- Stay within a budget: Try to find the balance between offering competitive pay with top-notch benefits and managing your business finances. Look at financial forecasts to plan your compensation package and update your pay structure for the coming calendar year or as needed.
- Be mindful of payroll compliance: Don’t forget to check local, state, and federal laws when creating and implementing compensation plans. Given that running or doing payroll is connected to the different employee compensation types, you should ensure that payroll compliance is followed at all times.
- Ask employees what they want: While you can rely on competitor data and market research to identify the salaries and benefits to give, running anonymous employee surveys can provide you with insights about what workers want. You can also get their feedback about your compensation plans and ask what works (and what doesn’t).
- Explain the full package: Show employees their base pay, potential incentives, employer-paid benefits, and eligibility rules. A clear total compensation statement can make valuable benefits easier to appreciate without exaggerating what they are worth.
Frequently asked questions (FAQs)
What’s the importance of employee compensation?
Employee compensation, if the remuneration is fair and adequate, helps workers feel valued and motivated to work. A competitive employee compensation package also contributes to high job satisfaction and work productivity levels.
How to determine employee compensation?
Many factors affect employee compensation. To determine the total compensation, you have to look at industry or market benchmarks and the position’s job complexity. The skill sets and work experience required for the role are also considered, along with labor regulations and location-based rules (such as state-related minimum wage and overtime pay laws).
What are the employer costs for employee compensation?
This varies, depending on the employee compensation package that employers offer. However, the usual employer costs include premium payments for health and insurance plans, paid leave benefits, salaries and wages, supplemental pay for overtime and shift differential, and the taxes that employers shoulder (such as Social Security and Medicare taxes).
Bottom line
Compensation plays a huge part in attracting and retaining workers. It also helps boost staff productivity and morale. Understanding what employee compensation is and what goes into it can help you develop a compensation plan that’s fair and competitive. Conducting market research is critical, but you should also consider your budget and business goals in building your company’s salary and benefits package.
