How to create a compensation plan

Published · 4 min read

What is compensation?

Compensation typically refers to the monetary payment awarded to an individual in exchange for their services. In the workplace, a broader compensation definition includes the whole of what is earned by employees—that is salary or wages in addition to the commission, bonuses, and any incentives or perks that come with the employee’s position.

Employers know better than anyone, good help is hard to find. Creating an appealing compensation plan is key to attracting and retaining your ideal employees—the ones who can take your business to the next level.

To attract the best and brightest, you’ll need to offer lucrative pay and generous benefits. But don’t go clutching your wallet just yet. Rest assured, there’s a balance to strike that works out for everyone.

To help you out, we’ll go over the following:

  • Examples of compensation
  • How to create a compensation plan

Examples of compensation

The different types of compensation offerings are as varied as the companies who offer them. Compensation can take many different forms—the key is finding the ideal combination to fit your needs. To start, familiarize yourself with each example of compensation type and determine their priority within your company. Afterward, we’ll go over how to formulate the plan.

  • Annual salary – Salaried employees are paid an annual rate, typically determined by the value they bring to the company, regardless of actual hours worked. Most salaried employees (referred to as exempt) aren’t entitled to overtime pay for exceeding 40 work hours during a given week.
  • Hourly wage – Hourly employees simply get paid a set hourly rate for the time they work, up to 40 hours weekly. After 40 hours, hourly-rate workers (referred to as non-exempt) are entitled to overtime pay, which is typically calculated as one and a half times the employee’s standard rate (sometimes known as “time-and-a-half” pay).
  • Raises – Typically determined by the individual or team performance, pay raises are standard annually among both salaried and hourly employees.
  • Retirement plan – Companies often offer employees participation in a retirement plan such as a 401k. Employees who opt-in have a small percentage of their earnings deducted from each check, a portion of which the employer matches. A 401k plan is subject to a vesting period, during which the full employer contribution is not available—a typical vesting period is one to five years.
  • Bonuses and incentives – Offered as a supplementary means to drive performance, bonuses and incentives are often awarded to employees who hit pre-determined, employer-set goals.
  • Health benefits – Some level of health-care benefits is a standard offering for most companies. Employers cover the bulk of the monthly premium costs, while the remaining cost is deducted from the employee’s gross earnings. Companies usually offer a number of plans with varying coverage.

Creating a compensation plan 

A sound, appealing compensation plan is vital to attracting new workers as well as retaining current ones. The best plan is the plan that works best for you. Follow these seven steps to make it happen.

  1. Establish your company’s unique compensation definition. Every company needs to develop a compensation philosophy. To lay the groundwork for a comprehensive pay plan, you need to produce an overall vision of how you plan to compensate your employees. Think about the full range of benefits you want your employees to receive—aside from base pay, there is commission, bonuses, incentives and various perks to be considered.
  2. Consider the different positions within your company. Make a list of each position complete with titles and job descriptions. Having an overall view of your employee-base on paper can help illuminate your compensation philosophy. If you’re having trouble formulating a job description for a given position, ask yourself if that position is essential to the company—it’s worth giving some thought.
  3. Determine your budget. What is the total amount you will devote to compensation? You want to be competitive, but realistic. Many companies complete salary surveys, in which they report their total compensation for different positions. This formal, company-generated data should be your starting point, as it takes into account full compensation allowances. Tools like Payscale.com and free resources like the Bureau of Labor Statistics allow you to get an idea of what other companies in your industries are allotting to compensation. It’s important to have at least a ballpark figure as you move into the next steps.
  4. Set your salary and/or hourly wages. Now it’s time to hammer out the details. Using the data you collected in step three, set a salary level or hourly wage for each position within your company. Employee-generated sites like Glassdoor.com can help finetune your budget for each position, giving more insight into what employees expect from a role at a company like yours.
  5. Plan for pay raises. To perform their best, employees need to feel like their company is investing in them. As part of your ongoing plan, you have to consider how you will handle annual pay raises. Most employees worth keeping on board should receive an annual bump in pay, anywhere from the minimum to a 5% increase. Implementing a performance management system that can help track employee performance and overall pay is essential to maintaining a thorough compensation plan.
  6. Incorporate incentive components. Going off of the principles from your established compensation philosophy, get more specific about the incentivization components of your plan. It’s helpful to think about the company culture you want to create. If you strongly value a sense of community within the workplace, think about incentivizing at a team-level. If you want to motivate employees to focus on individual excellence, consider a performance-based model that rewards that. Keep in mind, you can blend the spectrum to create your ideal company culture.
  7. Choose your payroll softwareYou’ll need a software solution that can help implement, track, and manage your compensation plan. There are a lot of moving parts involved—this will help keep you organized when you set up other components like taxes and workers’ compensation coverage.

Once you have it all down on paper, review it. Getting your compensation plan set is a big deal, so you want to be thorough.

To recap, the ideal compensation plan is:

  • Attractive
  • Sustainable
  • Mutually Beneficial

Remember: understanding the intricacies and formulating a solid plan is crucial to employee recruitment and retention.

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