Employee Compensation: Definition, Types, and Importance Explained

Employee compensation is the payment given by employers and organizations to employees for their services. Employee pay rates vary per industry and job position.

Different factors must be considered when calculating wages and salaries. As such, it is important to understand how choosing a compensation package impacts workers’ morale and motivation to continue with their jobs.

This article will help you understand the meaning of employee compensation, how compensation benefits work, and how you can pay your workers more competitively.

Key Takeaways

• Employee compensation is the salary, benefits, and additional perks paid to employees in exchange for the work or services they offer.
• Direct, indirect, and non-monetary are the three types of employee compensation.
• Competitive salaries and compensation packages underscore the need to boost employee morale and adhere to federal and state labor regulations.
• Conducting market research, identifying essential employee benefits, establishing a pay structure, and updating compensation benefits are ways to determine employee compensation.

What is Employee Compensation?

Employee compensation is a collective term referring to the wages, salaries, bonuses, pay adjustments, and benefits paid to employees.

Employers must adhere to federal and state labor laws when preparing compensation packages for their staff. The pay rate and benefits must justify the nature of the work and the level of expertise required to fill each job position.

After all, planning how to pay and reward employees is part and parcel of calculating the business’s accruals and budgeting their expenses.

In response, employees will feel more compelled to stay with a company that pays them at least the minimum salary requirement. It is worth noting that employee expectations change as industry trends shift and pave the way for flexible work arrangements.

For instance, the demand for higher pay, alongside remote work options and better benefits, significantly increased after the pandemic. It is, therefore, crucial for businesses to be capable of adjusting to such changes in the workplace.

Types of Employee Compensation

The different types of employee compensation are direct, indirect, and non-monetary employee compensation.

Direct compensation is usually paid in cash or monetary form. Indirect employee payments may or may not be tangible, but they still have economic value and are often given as additional perks.

Non-monetary pay has no monetary value and is typically given to tenured employees or those who are already making comfortable annual living wages before taxes.

Most people assume that employees' compensation is limited to monetary payment. In truth, employee compensation also includes paid time off, health and life insurance coverage, and other forms of incentives.

Employers may offer different employee compensation packages or fringe benefits, a combination of monetary and non-monetary compensation voluntarily given to employees.

Direct Employee Compensation

Direct employee compensation is money paid to employees for their services. Employers disburse this type of payment into their workers’ bank accounts every payday. It is based on the employee’s base pay and the number of work hours completed in each pay cycle.

Below are the most common types of direct compensation:

#1. Hourly Compensation

Hourly compensation is typically paid to non-exempt employees or workers who qualify for overtime pay according to FLSA regulations. When a worker is paid hourly, they are compensated only for the work hours they have rendered.

If they work beyond the required number of hours in a regular work week, they are entitled to overtime compensation, or time and a half of their regular hourly pay.

In the US, the standard rate for hourly wage earners is $7.25, but it can also go as high as $28.16 to $66.11, depending on the kind of work they are paid to do.

#2. Salary

Salary is a type of compensation given to regular employees or those who get paid at fixed rates. Unlike hourly wage earners, salary earners have more job security and a stable income. However, they are not eligible for overtime pay.

Instead, they may qualify for paid time off, wherein they can accumulate the work hours they have rendered in excess and offset these extra hours to take a paid day off.

Salary rates for each employee are usually indicated and broken down in their employment contracts. Examples of jobs with a fixed salary rate include IT personnel, accountants, and employees holding administrative and executive positions in the company.

#3. Commission

Employee compensation paid in commission is usually based on an employee’s average sales. It is commonly used in sales, real estate, and recruitment jobs.

There are different ways that employers can use commission as employee compensation, such as:

• Straight commission. Employees only get paid commissions as part of their regular income.

• Bonus commission. Employees receive bonus commissions only upon exceeding their average sales rates.

• Salary plus commission. The commission is paid to employees on top of their base salary.

• Draw against commission. In a draw against commission setup, employees are given a specific amount called the ‘draw.’ Employees whose sales rate exceeds the draw get to keep the money; the extra amount they make in sales is their commission.

#4. Bonuses

Bonuses are employee compensation incentives or additional payments given to employees, usually in exchange for their exemplary work performance. Aside from performance bonuses, other types of incentive-based pay include:

• Retention bonus. Compensation is paid to retain valuable talent or employees who show promising skills and progress within the team.

• Signing bonus. This type of bonus is paid to recruits upon signing their employment contract with an organization or company.

• Holiday pay. Additional compensation is given to employees who work during the holidays.

• Referral bonus. A referral bonus is paid to staff who help the company recruit new people by recommending applicants to fill job openings.

Indirect Employee Compensation

Indirect employee compensation includes non-cash benefits, such as retirement plans, healthcare coverage, office meals, and vacation leave or paid time off.

Although indirect employee compensation isn’t given or paid in cash, it still has significant monetary value, as exhibited by the examples below:

#1. Equity

Equity compensation can come from stock options, performance shares, or restricted stock. It is one of the most cost-effective indirect compensation methods used to motivate employees and help companies manage their expenses.

Here’s a closer look at the different types of equity paid to employees:

• Incentive Stock Option (ISO). It is exclusively given to employees, regardless of whether they work full-time or part-time. With ISOs, taxes are not immediately levied on stocks. Employees only pay taxes on their stocks upon selling them.

• Non-Qualified Stock Option (NSO). Compared to ISOs, non-qualified stock options can be given to non-employees, provided that they have some kind of affiliation with the business. As such, investors and freelancers may be offered an NSO.

• Performance Shares. It is given to executives and corporate managers only when specific key performance metrics are met.

• Restricted Stock. Restricted stocks are nontransferrable and unregistered company stocks. Employees must meet specific conditions before they can sell or transfer their shares.

#2. Benefits

Companies offer benefits as employee compensation to uphold employee safety and welfare. Life insurance, health insurance, retirementor pension plans, and group-term life insurance fall under indirect compensation.

Employers may partner with different insurance companies to accommodate their employees’ needs. For instance, employees may add dependents, such as their children, spouses, or elderly relatives, to their company-sponsored health insurance plan.

#3. Student Loan Repayment

Student loan repayment programs apply to employees with existing student loans. To implement this program, employers must implement nondiscrimination regulations to determine eligible employees for student debt coverage.

Employers also calculate the monthly loan repayments they want to contribute.

They may also establish specific work expectations or standards for qualified employees in exchange for helping them settle their loans.

#4. Housing and Transportation Coverage

Companies in areas where employees would have to travel far to reach their office and report to work may offer a transportation allowance and company cars.

Some companies also have shuttle services that ferry employees to and from a designated pick-up point to ensure their safety.

Employers may also offer housing assistance if the workplace is based in a highly urbanized city where housing costs can be high for their workers.

Non-Monetary Employee Compensation

Non-monetary employee compensation is payments that may not be directly converted into cash or have intrinsic value but help promote work-life balance for employees.

When paired with direct and indirect compensation, non-monetary remunerations boost employee retention and motivation while also attracting new talent to join the company.

Some examples of non-monetary compensation include:

• Annual leave
• Bereavement leave
• Parental, maternity, and paternity leaves
• Sabbatical leave
• Sick leave
• On-site childcare services
• Gifts or gift cards
• Merchandise
• Office meals and snacks
• Recognition in the form of awards or plaques
• Wellness programs
• Flexible or remote work options
• Skills training and seminars

Employers who hire staff internationally must align employee compensation and benefits with specific labor regulations applicable to the country or location where the employee is based.

The Importance of Competitive Employee Compensation

Competitive employee compensation enables companies and organizations to retain and attract existing and new talent.

According to various employee compensation surveys conducted by Business2Community, approximately 63% of employees are open to other work opportunities that offer higher salary rates.

Most employees who responded to their surveys also stressed the importance of PTO and employer-sponsored health savings account coverage as motivation for staying with a company.

Remember, employees are an asset to the company. Since they are instrumental to the business’s growth and success, workers deserve payment and benefits that underscore their safety, motivation, and work satisfaction.

When employees receive sufficient compensation and an array of benefits that adhere to their needs, they feel more compelled to stay loyal to the company.

Furthermore, the employer must create a safe, healthy, and positive work environment where employees can nurture their skills and talent.

How to Determine Employee Compensation

The secret to determining an employee compensation plan that works is to strike a balance between what the business needs and what employees expect and demand. Here are some critical steps to consider:

#1. Research the Market

Industry trends tend to dictate the rate at which employers must increase the base salary for each job position comprising their workforce.

For instance, the rapid emergence of new and advanced technology means an increased demand for many IT jobs. Consequently, tech companies must update their compensation packages to entice prospective talents to choose their team.

Conducting market research also means checking the total compensation offered by direct competitors to determine how to adjust the business’s operational costs and retain talents.

#2. Identify Some Basic Benefits

Identifying a few basic or common benefits is a good start for new business owners. Startups and small businesses may struggle to figure out which types of benefits and perks would best suit their workforce.

Medical coverage, life insurance, wellness programs, and retirement plans are some examples of benefits that employees often look for in a potential employer. When choosing insurance plans, take time to compare the plans and packages offered by each insurance company.

Assess the pros and cons of each insurance plan, determine which benefits package would suit the company’s budget, and address employees’ needs.

#3. Create a Pay Structure

Creating a pay structure requires setting a precise limit for the minimum and maximum wage bases for each position in the company. This helps manage the salary expectations of new recruits and employees with extensive experience in their job roles.

Employers must uphold fairness in preparing employee compensation packages to ensure workers are compensated accordingly.

A carefully prepared pay structure also helps set a suitable time frame for awarding salary increases and career advancement opportunities to qualified employees.

#4. Address the Company’s Budget

A competitive salary and benefits package should not be given at the company’s financial expense.

Some employers mistakenly invest an excessive percentage of their revenue and expenses in employee retention programs. As a result, they are left with a minimal budget for other vital components of maintaining the business.

While offering incentives and salaries that rival the toughest competitors in the market effectively boosts employee loyalty, the incentives and salaries should still be in line with the company's size and average profit.

#5. Update Compensation Packages

Ideally, employers should update compensation packages according to job demands and industry trends.

An excellent example of this is how remote work and a combination of office-based and work-from-home recently became a staple in several benefits offered by companies worldwide.

Also, if the company decides to hire interns or fresh graduates, they must be offered compensation packages adjusted to their experience and skills. If the demand for specific job roles increases, assess the need to update the salary benchmarks for the position.

#6. Have an Efficient Payroll Process in Place

Once a concrete compensation package is in place, backing it up with a solid payroll management process is crucial. A well-implemented payroll ensures that salaries, benefits, and other incentives are reflected in each employee’s paycheck records.

Employers can use an employee portal where they can access and check the contributions to their insurance plans or verify whether their remaining PTO and overtime pay are duly updated.

Additionally, online tools, such as an online paystub generator, enable startups and small business owners with limited workforces to prepare pay stubs on time. As a result, businesses ensure timely salaries and timely payroll deadlines.

Final Thoughts

Employee compensation goes beyond paying employees a certain amount of money.

It entails understanding the specific demands of the job required of them and valuing their contributions through competitive and reasonable salaries and benefits.

That said, you can always re-read this article to guide you in implementing a well-thought-out and excellent benefits and compensation package for your employees.

Employee Compensation FAQ

#1. What is the meaning of total compensation?

‘Total compensation’ is a collective term that refers to all types of salaries, wages, benefits, and perks paid to employees.

Companies must assess the total compensation expected in a specific job role to generate an accurate reference on the potential costs associated with hiring recruits.

#2. What type of compensation is the best?

The best type of compensation combines a competitive base pay package, workplace perks and employee benefits, and other non-monetary compensation that highlights work-life balance.

#3. What is the difference between compensation and incentives?

The difference between compensation and incentives is that the former is a standard form of payment given to employees based on their job role. Incentives are added perks or rewards granted to the staff in exchange for performing well at work.