# What Is a Retention Bonus? Definition and How It Works

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*— Investopedia / Julie Bang*

## What Is a Retention Bonus?

A retention bonus is a financial incentive offered as a one-time lump sum payment to retain key employees during crucial business cycles or projects. It aims to retain senior executives and key employees amidst organizational changes like mergers or restructures, by securing their skills and corporate knowledge. Companies, especially in competitive industries, use retention bonuses to prevent valuable employees from joining competitors.

Depending on factors like employment length and service, retention bonuses are typically less costly than ongoing salary increases and are especially valuable in strong job markets.

### Key Takeaways

*   A retention bonus is a one-time payment given to employees to incentivize them to stay during critical business periods.
*   Companies use retention bonuses during organizational changes, mergers, or when retaining skilled employees is vital.
*   Retention bonuses are generally taxed at a flat rate and can be structured as lump sums or periodic payments.
*   Employers benefit from retention bonuses by keeping key talent and avoiding the costs of hiring and training new employees.
*   Employees gain financial incentives and career stability from retention bonuses, although it requires a commitment to stay with the company.

## Exploring the Role and Importance of Retention Bonuses

When an organization is going through a disruptive period of organizational change, it may offer financial incentives to senior executives and key employees to persuade them to stay with the company through the rough times. The financial incentive is referred to as a retention bonus.

Retention bonuses may also be extended to preserve company-specific skills and information during a project or technical knowledge that may be difficult to replace.

During a merger, [restructuring](https://www.investopedia.com/terms/r/restructuring.asp), or [reorganization](https://www.investopedia.com/terms/r/reorganization.asp), a company will attempt to retain its best employees to make certain that it has enough people on-site during challenging times. For example, a business that is shutting down a department or a project may offer retention bonuses to its best performers to ensure that the project gets done.

## The Impact of Economic Conditions on Retention Bonuses

In a strong [job market](https://www.investopedia.com/terms/j/job-market.asp), businesses risk losing top employees to competitors. Retention bonuses help companies keep key employees in flexible job markets.  

Companies offer retention bonuses to trained employees to keep them from taking skills elsewhere. In addition to losing an employee with an advanced skillset, a company runs the risk of the employee joining a competitor.

A retention bonus is typically a one-time payment. Companies may prefer to offer a retention bonus rather than a raise that commits them to a long-term salary increase.

Depending on the company, the value of an employee’s retention bonus may be tied to the employee’s length of service with the firm. The bonus may be paid out at periodic intervals or at the end of a period as either a percentage of the employee’s current salary or a lump sum of money.

For example, if a project will take 12 months to complete, the employee retention bonus may be paid after 15 months to ensure that the employee stays.

> **Important**
>
> Not all employment agreements contain a retention bonus, and retention bonuses may be included as a financial incentive at any time during an employee's term.

## Key Elements of Retention Bonus Agreements

Retention bonus agreements vary, but they share common points.

*   **Financial terms**: This includes the dollar amount if the payment is to be a lump sum or the valuation amount if the payment is in the form of an equity distribution.
*   **Employment status**: The employee must be employed by the company in a specific capacity on a specific date. This date is often called the vesting date or vesting period.
*   **Financial health**: The company must be [solvent](https://www.investopedia.com/terms/s/solvency.asp) and meet specific liquidity conditions for the bonus payment to be made.
*   **Continued employment disclaimer**: This language often stipulates that the retention bonus agreement does not confirm or guarantee employment after the vesting date has passed.
*   [**Non-disclosure agreement**](https://www.investopedia.com/terms/n/nda.asp): This means an employee must not disclose specific information to competitors or external parties during the duration of the agreement.
*   **Bonus assignment**: This language confirms that should the company be acquired or merged with another company during the retention period, the employee's retention bonus may be assigned to a different legal entity.
*   **Reimbursement agreement**: Should a retention bonus be paid in periodic installments, employees might have to repay bonuses if they leave before the final payment.
*   **Signature**: The agreement requires a signature from the company and the employee to be legally binding.

## How Retention Bonuses Are Taxed

The IRS treats all bonuses, including retention bonuses, as supplemental wages. A supplemental wage is defined simply as compensation paid in addition to the employee’s regular wages. Retention bonuses are taxed using the aggregate or percentage method.

Under the percentage method, bonuses are separated from the employee's salary and taxed at a flat rate of 22% directly. If the bonus amount is over $1 million, it will be taxed at 37% (or the highest income tax rate for that year).

The aggregate method is used when the employer withholds tax by combining the retention bonus with the employee’s regular salary into a single payment. The tax rate used is found in the withholding table, which is based on information submitted in the employee’s IRS [W-4 Form](https://www.investopedia.com/terms/w/w4form.asp).

> **Fast Fact**
>
> Retention bonuses are often subject to withholding taxes. The retention bonus agreement will stipulate the terms of withholding.

## Advantages of Offering and Receiving Retention Bonuses

### Benefits for Employers

The obvious primary benefit for employers offering a retention bonus is the retention of the employee. Retaining key employees allows companies to:

*   Have better cross-training opportunities
*   Have support in place throughout the life of a key project
*   Deny competitors a talented person
*   Get better operational results by motivating an employee

Employers who offer generous retention bonuses become known for it. This can enhance their recruiting efforts. Current employees may feel motivated to work harder and gain specialized knowledge in hopes of receiving a retention bonus.

In the end, companies may find that paying a retention bonus is less expensive than hiring a new employee.

### Benefits for Employees

The obvious benefit for a retained employee is the financial incentive, which can be up to 15% of their annual base compensation.

Agreeing to a retention bonus arrangement also has a positive impact on the relationship between an employee and a company. Though the employee is being incentivized to stay, they may also gain the trust of prospective employers down the road by staying with one company through the retention period. This demonstrates that the employee was a critical part of a company's success.

## Strategies for Securing a Retention Bonus

There's never a guarantee that your company will extend a retention bonus offer to you. However, there are specific conditions that are often in place that make it more likely for a company to financially incentivize an employee to stay. You may be able to increase your odds of earning a retention bonus if you:

1.  **Aim for a job in a specific industry**. Industries needing specialized knowledge often offer retention bonuses.
2.  **Enter project-centric roles**. Some retention bonuses are tied to projects that are highly dependent on a few key staff members.
3.  **Identify [M&A](https://www.investopedia.com/terms/m/mergersandacquisitions.asp) target companies**. Retention bonuses are often tied to companies that merge or are acquired by other companies that fear losing key staff during the acquisition period.
4.  **Continue to advance and be promoted**. Retention bonuses are more likely to be paid to higher-level staff with knowledge worth retaining.
5.  **Search for jobs that specifically mention retention bonuses**. Job postings may list specific positions eligible for a retention bonus, and companies may broadly announce that this is a benefit for working for them.

> **Tip**
>
> If a job doesn't list a retention bonus, consider negotiating for one. Companies may be more inclined to award a higher back-end retention bonus as opposed to a front-end signing bonus.

## Evaluating Whether to Accept a Retention Bonus

Deciding on a retention bonus involves a [cost-benefit analysis](https://www.investopedia.com/terms/c/cost-benefitanalysis.asp). On the one hand, you may be entitled to a lump sum payment should you stay with your current employer in the short term. On the other hand, you may be sacrificing greater potential benefits in return. Consider accepting a retention bonus if it outweighs the following costs:

*   **The financial cost of not pursuing a different job**. This includes forgoing a potentially higher salary, incentive plan, or better company payroll benefits.
*   **The cost of (not) developing your career**. Regardless of pay, accepting a bonus payment prevents an employee from pursuing other and possibly better opportunities.
*   **The cost of being unhappy at work**. Accepting a retention bonus means committing to a job even if you are dissatisfied, stressed, or unhappy with your current role.
*   **The cost of foregoing lifestyle options**. An employee must accept a company's current work culture. A person who is interested in remote work may have to accept an in-office presence, at least for the duration of the bonus commitment period.  
    

## What Is a Typical Retention Bonus?

Retention bonuses are generous but the specifics are unique to each company and position.

Most retention bonuses will be around 10%-15% of an employee's annual compensation. Senior employees and those with highly specialized skills and knowledge may receive higher terms.

## How Are Retention Bonuses Paid?

Retention bonuses may be paid as a lump sum or in a series of payments, such as at the beginning and at the end of a specific period.

Should the agreement be modified or terminated early, the employee may receive a pro rata proportion of the bonus or may forego the bonus entirely.

Some agreements may be structured so that the employee receives small portions over time (i.e. 5% of the bonus each month for five months, then the remaining 75% bonus in the final month of employment).

## Who Is Eligible for a Retention Bonus?

Any employee is technically eligible for a retention bonus. However, companies most often offer retention bonuses to executives and to highly skilled, technically proficient workers who would be difficult to replace.

Employees with integral knowledge about a company, a project, or a department may be more likely to receive an incentive to stay.

## Can You Negotiate a Retention Bonus?

Yes, an employee can negotiate a retention bonus. In addition to negotiating the payoff amount, an employee might negotiate the terms of the agreement to ensure they are comfortable with the date of the payment and the expectation of what the employee will achieve.

## The Bottom Line

Retention bonuses are a strategic tool for companies to keep key employees during critical times or when facing competitive environments. They often provide financial incentives tied to staying with the company over a set period. For employees, these bonuses can offer a substantial financial reward but also require careful consideration of potential opportunity costs, career goals, and personal satisfaction at their current job.

Both companies and employees should weigh the benefits and implications, ensuring that such bonuses align with long-term objectives to maximize their effectiveness.

> **Article Sources**
>
> 1.  Wage and Hour Division. “[Fact Sheet #56C: Bonuses Under the Fair Labor Standards Act (FLSA)](https://www.dol.gov/sites/dolgov/files/WHD/fact-sheets/56c-bonuses.pdf),” Page 1.
>     
> 2.  Society for Human Resources Management. “[Retention Compensation Plans—Please Stay!](https://www.shrm.org/resourcesandtools/hr-topics/compensation/pages/retention-compensation-plans.aspx).”
>     
> 3.  Harvard Business Review. "[Do Retention Bonuses Pay Off?](https://hbr.org/2023/02/do-retention-bonuses-pay-off)"
>     
> 4.  Internal Revenue Service. "[Publication 15: Employer's Tax Guide](https://www.irs.gov/pub/irs-pdf/p15.pdf)," Pages 22-23.