Discretionary Bonus
Discretionary bonus meaning
A discretionary bonus is a sum of money given to an employee at the employer’s discretion, typically as a reward for exceptional performance, contribution to the organization’s success, or other discretionary reasons.
The key characteristic of discretionary bonuses is that the employer decides whether to give them and how much to give without a prior formula or promised expectation.
To ensure that a bonus qualifies as discretionary under legal standards, HR must ensure they meet specific criteria:
- The employer is solely responsible for granting the bonus
- No advance notice or regular review is required
- There is no expectation of recurrence or entitlement.
Discretionary bonus examples
Discretionary bonuses can vary widely depending on a company’s goals, the industry, and the roles of the employees receiving them. Here are some of the most common examples:
- Spot bonus: This bonus is awarded spontaneously to recognize exceptional effort or achievement in a specific project or task. It is given immediately following the noteworthy accomplishment.
- Holiday bonus: Often given at the end of the year, this bonus is a way for employers to share profits and spread holiday cheer. It’s typically not guaranteed and can vary from year to year based on the company’s performance.
- Retention bonus: A bonus given to an employee as an incentive to remain with the company during a critical period. This type of bonus is often used during times of significant organizational change, high turnover in the industry, or on the completion of a crucial project.
- Referral bonus: Although sometimes structured as non-discretionary, referral bonuses can also be discretionary. An employer might give a bonus for referring a candidate who gets hired, depending on the specific needs and timing of the hiring.
- Special recognition bonuses: Granted for unique or exemplary contributions that do not fall under regular performance metrics. For example, an employee who leads a successful initiative that boosts company culture or effectively mentors other employees might receive this bonus as a form of special acknowledgment.
Discretionary vs. non-discretionary bonus
Differentiating between discretionary and non-discretionary bonuses is crucial for HR professionals to ensure compliance with legal regulations, particularly under the Fair Labor Standards Act (FLSA).
Some of the key differences between the two are:
Description
A bonus given at the employer’s discretion without prior promise or based on a set formula.
A bonus that employees expect based on meeting predetermined criteria or performance targets.
Employee expectation
Employees do not have a guaranteed expectation of receiving the bonus regularly.
Employees predict and expect the bonus based on predefined criteria.
Payment frequency
Payment can be irregular, with no set schedule. It is often given as year-end bonuses or special occasion rewards.
Often follows a regular schedule, like annually or quarterly, as determined by meeting performance benchmarks.
Criteria for payment
Typically not tied to specific criteria; may be based on overall company performance, individual contribution, or as a token of appreciation.
Based on explicit criteria, such as achieving sales targets, productivity goals, or other measurable performance standards.
Discretionary bonus vs. performance bonus
While discretionary and performance bonuses reward employee efforts, they differ in nature and application. Discretionary bonuses are subject to the employer’s discretion and are not tied to specific performance metrics. On the other hand, performance bonuses are awarded based on meeting or exceeding specified performance criteria that are established in advance.
Calculating discretionary bonuses
- Step 1. Determine the bonus pool: Determining a bonus pool can vary depending on the organization, its goals, and its financial health. Some common methods include:
- Percentage of profits: A straightforward method involves allocating a percentage of the company’s earnings to the bonus pool.
Example: XYZ Enterprises has decided to allocate 10% of the annual profits towards discretionary bonuses for the fiscal year. They recorded a net profit of $1,000,000 for the year.
Bonus Pool Calculation: Bonus pool = 10% of $1,000,000 = $100,000. - Revenue-based allocation: Another method ties bonuses to revenue targets. A certain percentage of the company’s revenue might be allocated to the bonus pool, with individual bonuses determined based on performance.
- Performance metrics: Bonuses can be tied to specific performance metrics, such as sales targets, customer satisfaction scores, project milestones, or other key performance indicators (KPIs).
- Profit sharing: Some companies offer profit-sharing arrangements where all employees receive a portion of the company’s profits based on predetermined formulas or criteria.
- Long-term incentives: Some organizations offer bonuses in the form of stock options or other long-term incentives.
- Percentage of profits: A straightforward method involves allocating a percentage of the company’s earnings to the bonus pool.
- Step 2: Choose the right calculation method: When selecting a suitable method for distributing the bonuses, several factors should be considered:
- Individual performance: Employees who have demonstrated exceptional performance or exceeded predefined targets may be eligible for more substantial bonus rewards.
- Team achievements: Within environments that prioritize teamwork, bonuses can be allocated based on collective achievements, fostering collaboration and providing incentives for employees to work as a team.
- Discretionary considerations: Additional discretionary factors for awarding bonus distributions could encompass aspects like leadership competencies, innovation, or contributions to fostering a positive organizational culture.
HR tip
Enhance the impact of discretionary bonuses by tying them to specific goals or values. Aligning bonus awards with strategic goals can reinforce desired behaviors and drive employee engagement and performance.
What to include in your discretionary bonus policy
Creating a well-defined discretionary bonus policy is crucial for ensuring clarity, fairness, and transparency in how bonuses are awarded within an organization. Here are the key elements to include in your policy:
- Purpose and eligibility criteria: Define why bonuses are being offered (e.g., rewarding exceptional performance, motivating employees) and decide which employees are eligible to receive them based on factors such as employment status, tenure, or performance.
- Performance metrics: Although the bonus is discretionary, providing guidelines on what kind of performance or achievements will be rewarded can help manage expectations. Include examples of criteria that might be considered, such as:
- Meeting or exceeding project goals
- Exceptional teamwork or leadership
- Innovation and initiative
- Contribution to company culture.
- Calculation method: Offer a broad description of how bonus amounts are determined, including factors like the available bonus pool, company profitability, and individual contribution.
- Payment timing: Set up the frequency and timing of bonus payments, such as the end of the fiscal year, after the completion of a project, or during a specific holiday period. This helps employees know when to expect potential bonus payments.
- Tax implications: Provide clarity on the tax treatment of discretionary bonuses to ensure employees understand the financial implications.
A comprehensive discretionary bonus policy not only helps maintain consistency in how bonuses are awarded but also motivates employees by making the criteria and process as transparent as possible.
