An employer’s guide to retention bonuses
By Laura Ojeda Melchor●7 min. read●Feb 26, 2025
Offering an employee a retention bonus is a significant investment. You're handing over a chunk of cash to an employee in exchange for their commitment to staying with your company.
But this incentive can be the difference between keeping a valuable team member and losing them to a competitor. And the cost of losing an employee goes far beyond the price of hiring a replacement.
Today, you’ll learn everything you need to know about how to keep your team together with this powerful tool.
What are retention bonuses?
A retention bonus (or stay bonus) is a cash reward given to employees as an incentive to stay on the job for a set period. It’s usually a pretty generous amount — around 10 to 30% of the employee's salary.
Unlike a performance-based employee bonus program, the goal of a retention incentive is to reduce turnover.
These bonuses can be paid out in a lump sum or installments during the agreed-upon time frame. This pay is separate from an employee's regular compensation and is considered supplemental wages by the IRS.
These financial incentives are often used in five key situations:
During a merger or acquisition to retain key employees and keep things stable as a company undergoes major changes.
To retain high-performing employees in specialized or hard-to-fill roles.
When a key employee receives a competing job offer to retain a valuable team member.
During leadership changes or restructuring to prevent turnover during big company-wide changes.
For project-based retention to keep key employees committed until a major launch or expansion is complete.
Retention pay vs. retention bonus
The terms retention pay and retention bonus are often used interchangeably.
Both refer to financial incentives designed to keep employees from leaving, but companies might use the terms differently depending on their retention strategy.
A retention bonus often refers to a one-time lump sum payment given to an employee after they stay with the company for an agreed-upon period.
Retention pay, on the other hand, can refer to a structured, ongoing incentive rather than a single payout. It’s essentially a retention bonus distributed in installments instead of one lump sum.
Because the payments are stretched out, retention pay can incentivize employees to stick around longer than a single retention bonus.
Is retention pay worth it for employers?
Retention pay is a powerful investment in the health of your organization. When employees leave, they take valuable institutional knowledge and client relationships with them. And according to Gallup, the true cost of replacing an employee can be up to two times their annual salary.
A single employee's departure can stall projects, slow production, and even delay product launches. Worse, it can dampen morale and trigger the rest of the team to start their own job searches.
How do employee retention incentives work?
A retention incentive begins with a formal agreement that outlines the terms to employees. This agreement should specify:
The bonus amount
The retention period (how long the employee must stay to receive the bonus)
Any specific performance expectations or goals
Payment terms (lump sum vs. installments)
Tax implications
If the employee fulfills the terms, they receive the bonus. If they leave before the retention period ends, they forfeit the incentive.
While stay bonuses are effective, they aren’t enough to keep employees engaged and happy in their roles. Pair financial rewards with a healthy company culture, meaningful recognition, and room for career growth.
A well-rounded retention strategy makes your monetary incentives that much more impactful.
Benefits of retention pay
Retention pay can be a win-win for both employers and employees. Employees get extra financial security, and employers hold on to key team members longer.
Let’s put this into perspective with an example scenario. Say a company has 750 employees and a turnover rate of 15%. Between recruiting costs and training time, they’re losing $3000 on average every time an employee leaves.
That adds up to $339K in annual turnover costs. And that's before accounting for downstream effects on productivity and company culture.
Here’s what could happen if this company offered a retention incentive:
Targeted reduction in turnover: 30% (saving ~34 employees per year)
Retention incentive per employee: $5,000 (for 34 key employees)
Total retention incentive cost: $170,000 (for 34 employees)
Turnover cost savings: $102,000 ($339,000 - $237,000)
Without retention payments, turnover costs $339,000 annually. But with it, turnover costs drop to $237,000. After paying $170,000 in bonuses, the company saves $102,000 in turnover costs.
A retention incentive requires an upfront investment, but it’s worth the long-term benefits.
How to design, launch, and implement a retention bonus program
You can set up a retention program to drive loyalty from employees who stick with your organization in a few easy steps.
Figure out who’s eligible
Picking which employees are the most crucial to your organization is a tough task, so make your process as objective as possible. A few key factors to consider include:
Performance metrics: Review your entire team’s productivity and key performance indicators (KPIs). Who stands out?
Specialized skills and expertise: Consider which employees have unique skills and experience that make them hard to replace.
Influence: KPIs aren’t the only thing that matters. Include employees who play an important role in mentoring other team members or improving morale as well.
Business impact: Identify which employees’ work directly contributes to revenue, customer satisfaction, or operational success.
Retention risk: Assess which team members are more likely to leave. Is there a high demand for their skills? Is job satisfaction faltering? Have they received a recent offer from a competitor?
Project and role dependency: Think about including employees who are essential to ongoing projects or hold critical positions within your company.
Decide on a bonus structure
The next step is to choose a bonus structure that makes sense. Will you offer a flat amount, like $5,000 per employee, or a percentage of a person's salary? Will you offer a lump sum payment or installments? There are no strict rules to follow here, so do what feels right for your organization.
For instance, you can offer tiered bonuses based on an employee's level or role in the company. Or, you can spread the money out in installments as retention pay to help incentivize long-term loyalty. Just make sure the payment structure works for your budget before you set it in stone.
Create an employee retention bonus agreement
Work with your in-house counsel or use a legal service to create an employee retention pay agreement. In the agreement, outline the:
Bonus amount
Retention period
Performance expectations
Payment terms
Include language about what happens if the employee leaves or is terminated before the end of the retention period. Clearly define all conditions under which the stay bonus might be forfeited.
Make sure the contract follows all the relevant local, state, and federal laws before you officially present it to employees. Again, legal counsel is your huge help here.
Share the details with eligible employees
Schedule one-on-one meetings to discuss retention incentive pay with each eligible employee. Be transparent about why you're offering the bonus and what you expect from them in return.
The most successful programs are ones in which employees willingly participate. Take time to ask employees for feedback on your retention program and get them excited about it.
Follow up each meeting with written documentation for both the employee's and your company's records.
Monitor the program's effectiveness
Once you enroll employees, keep track of retention rates among bonus recipients. This data will help you understand whether your investment is working.
Consider sending out monthly or quarterly surveys to ask the employees how satisfied they feel with the program. Ask for suggestions to improve your retention pay incentive and your workplace overall. The more you show your team members how much you value them, the more invested they’ll be in your organization’s success.
Who is eligible for retention payments?
Retention pay is often offered to executives and highly skilled employees who would be difficult to replace. But it can be used to retain all types of workers at any level, including:
Software engineers with specialized knowledge of a company's proprietary systems
Sales representatives with strong client relationships
Project managers overseeing a critical, long-term initiative
Retail store managers and associates with a proven track record of driving sales
In other words, there's no reason this type of incentive should be reserved only for C-level execs and senior management.
According to a Mercer study on M&A retention, companies are offering retention pay to 35% of workers who are not necessarily critical for integration. The bottom line? Stay bonuses are often more cost-effective than hiring, onboarding, and training new employees.
Even a modest incentive can go a long way in retaining valuable employees across all levels of your organization. A small bonus might be just the morale boost needed to keep a talented retail employee or customer service representative happy.
How much should a retention incentive be?
A retention incentive can range from 10% to 30% of an employee's annual salary. The size depends on a number of factors, including the employee's role, the length of the retention period, and the company's budget.
For example:
A senior executive earning $200,000 could be offered a bonus of $20,000 to $50,000.
An employee earning $50,000 annually might receive $5,000 to $12,500.
A sales associate earning $22 per hour (~$46,000 annually) might get a retention incentive of around $1,000 to stay through a frenetic holiday season.
The key is to offer an amount significant enough to motivate the employee to stay without putting your HR budget at risk.
Legal and tax implications of giving retention bonuses
Retention incentives come with specific legal and tax considerations. The IRS views retention incentive pay as supplemental wages to an employee's base pay, just like commissions, overtime, and other types of bonuses. This means employers must withhold taxes on retention pay.
Here's a quick breakdown of the rules:
Flat rate withholding: If a retention sum is paid separately from regular wages or clearly identified in the same paycheck, the IRS requires a flat 22% withholding rate. This is the easiest and clearest way to withhold taxes.
Aggregate method: If the bonus is combined with regular wages in a single payment and isn't separately identified, withholding is based on the employee’s W-4 and the IRS tax tables.
Social Security & Medicare taxes: Regardless of the payment method, bonuses are subject to Social Security tax (6.2%) and Medicare tax (1.45%). If an employee's salary exceeds the Social Security wage base, only Medicare tax applies.
For more guidance, check out IRS Publication 15, Employer’s Tax Guide, which lays all the rules out in detail, and seek advice from tax and legal advisors to stay compliant.
FAQs
Updated February 26, 2025
