Bonuses for employees

They can help attract and retain staff who value financial incentives at work — which, let’s face it, is most people. And performance-related bonuses can help to keep staff engaged, by promising a higher level of reward for stronger performance.

But are bonus schemes really for everyone? And what’s the best way to set one up and manage it?

Which companies use bonus schemes, and why?

Bonus schemes are very widely used in the UK. More than half of organisations use at least one performance-related reward or incentive scheme. Almost 60% operate individual bonuses, making that the most common type of scheme. And around 50% of companies also expect to increase their variable pay spend in the near future.

But bonuses aren’t favoured by organisations in every sector — nor for every kind of employee. In private sector services, where employees often have individual sales targets, nearly 70% of companies use individual bonuses. In non-profit sectors, the percentage is just 45%. Management and professionals are also 13% more likely to be offered bonuses than other employees (CIPD 2013).

The common thread? Bonus schemes are considered most effective where an employee or team’s performance is measurable and financially significant.

Contractual vs discretionary bonus schemes

If you decide to operate an employee bonus scheme, a key decision is whether to make it contractual or discretionary.

• Contractual: As the name suggests, contractual bonus schemes are written into the contract. You have no discretion on whether to pay a bonus — if the employee has earned it, you must pay it in accordance with the contract terms.
• Discretionary: Discretionary schemes aren’t written into the contract, so you have more flexibility in adjusting terms and bonus amounts.
• Mixed: Most employers take a best-of-both approach, offering employees a contractual right to join the bonus scheme but keeping bonus sums at their discretion.

Group, non-cash and other incentives

Individual cash bonuses aren’t the only type of incentive scheme available to you. You can also consider:

• Group incentives: When individual performance is not your focus, you can base your bonus scheme on other criteria such as overall business results, team performance, project outcomes and others.
• Non-cash incentives: Offering merchandise (e.g. electronics or watches), activities (e.g. nights out), travel or retail vouchers can tie in with team building and other goals. Non-cash incentives can also offer more value than cash when purchased in bulk at low cost.

Tax rules on bonuses

Both cash and non-cash bonuses you pay to employees are subject to tax and National Insurance.

Tax and NI on cash bonuses

As far as HMRC is concerned, cash bonuses you pay to employees are no different to regular pay. You should count bonus pay and non-variable pay as one sum, and deduct PAYE tax and National Insurance contributions as normal.

Tax and NI on non-cash bonuses

There are many types of non-cash bonus you can offer, from mobile phones to Caribbean holidays. Unfortunately, many different tax and reporting rules also apply. For example, voucher values are added to the employee’s earnings at the cost you paid for them. Always check the latest HMRC guidelines.