Understand the difference between compensation and salary, offer competitive compensation packages, and learn how to conduct a compensation analysis.
These days, it takes more than a high salary to attract talented workers. Companies are pouring as many resources as they can into providing benefits to their employees through total compensation packages.
But what is total compensation, and why is it important to understand?
In this guide we'll cover:
Total compensation is the totality of all payments and benefits given to an employee by an employer. Total compensation consists of base salary, bonus pay, employee benefits, perks, commissions, and tips.
Base salary is the amount of money an employee is paid by an employer for performing their job-related responsibilities. An employee’s base salary does not include any additional compensation like benefits, bonuses, or commissions. Salary is calculated yearly and typically increases over time as an employee climbs higher in a company, taking on more roles and responsibilities along the way.
Bonus pay is money given to an employee in addition to their base salary. Companies often give bonuses to their employees as rewards based on performance or time spent working for the company. Bonuses are not mandatory; however, it’s not uncommon for a company to give them out as a token of appreciation for their employees.
Employee benefits are non-monetary services given to an employee in addition to their base salary. Things like health insurance, tuition reimbursement, paid vacations, and stock options are benefits commonly given to employees. Employee benefits can vary greatly from company to company, as many top firms and organizations offer exclusive benefits to attract and retain top talent. While most employee benefits are optional, there are some required by law, such as Medicare, Social Security, and unemployment insurance.
Similar to employee benefits, perks are non-monetary additional offerings given to workers as part of a total compensation package. Perks differ from benefits in that they are not services like health-related insurance. Perks are offered in the form of gym memberships, meal plans, and loan forgiveness. For a more in-depth look at employee perks, check out our ultimate guide.
Employee stock options (ESOs) are a form of equity compensation given by a company to its employees. These ESOs are call options that give owners the ability to buy or sell shares at a pre-arranged price and date. Because they are calls, ESOs are issued in the hopes that the stock will rise. A corporation giving out ESOs must issue their employees new shares when they get exercised.
Commissions are a percentage-based form of compensation given to staff contingent on their sales performance. For example, if an employee brings in $20,000 in sales and is promised a 5% commission, they earn $1,000. Employees of companies that pay both salary and commission are typically given smaller salaries to incentivize work performance.
Tips are most commonly found in the hospitality industry. Service workers—bartenders, baristas, servers, etc.—make a substantial amount of their money from tips (on top of their base wage). Tips can be received in cash as well as by debit or credit. Tips are considered taxable and must be reported when filing a tax return. The IRS has a form for tracking tips to be reported to an employer.
If you think of salary as a cake, then total compensation is the frosting that completes it. Salaries are a fixed sum of money that employees are paid every year, while total compensation is the base salary plus any other benefits. Employees are usually aware of their base salary wage but are often unaware of how much they earn in additional benefits. This is because additional benefits usually come in the form of perks or services like insurance or transportation stipends. Ultimately, these perks and services come as an additional cost to an employer and get factored in when calculating the total cost of an individual employee.
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To calculate total compensation for an employee, take the sum of their base salary and the dollar value of all additional benefits. Additional benefits include insurance benefits, commissions and bonuses, time-off benefits, and perks. Employees are rarely ever paid the exact same amount, so the total dollar value of compensation packages will always vary.
Let’s look at an example: Suppose a financial analyst was just hired by a large financial institution. Their base salary is $75,000 a year, and their additional benefits package comes with health and dental insurance, $1,500 a year toward student loan forgiveness, and 10 days of paid vacation every year. The health and dental insurance combined are $125 a month, which makes the total cost of both $1,500 yearly. Their 10 paid vacation days are worth $3,125 a year. Summing everything up, the total annual compensation for this financial analyst is $81,125.
Total compensation is important because it functions as an effective retention tool. When looking for work, employees will often compare the salaries of their prospective opportunities. If the salaries of two or more opportunities are the same or similar, the difference will come down to what’s offered on top of base pay. Companies competing for top talent know this and are willing to offer generous total compensation packages as a result.
It is important for employers to have good benefits as part of a total compensation package. Prospective employees actively look for attractive benefits like discounted health insurance, student loan assistance, and educational assistance because they are the most useful benefits. For example, young, talented employees working for software companies often have high student debt. Offering them compensation packages centered around employee discounts or perks would probably be less suited to their personal needs. Packages focused on reducing student debt or paying for additional education are much more likely to keep them interested. Offering the right benefits makes employees feel appreciated and wanted—something that’s important for a positive workplace culture.
Pay equity refers to giving employees with similar job responsibilities equal pay regardless of race, gender, ethnicity, or background. While simple in theory, pay equity is something employers can have a hard time properly implementing. In many instances, enforcement of pay equity is a legal obligation. An effective way of tackling this issue is to have a comprehensive compensation strategy.
A compensation strategy is the detailed approach a company takes toward how employees are paid. These strategies carefully consider all forms of compensation an employee may receive to make sure everything is aligned with business and organizational goals. Compensation strategies fortify pay equity by keeping standards and criteria as objective as possible.
For example, asking about a candidate’s salary history may bias decisions on how they should be compensated. The candidate may have been severely underpaid for their actual role and responsibilities. A solution to this is to build a salary range that is based on national averages for a position.
Transparency is another key aspect of maintaining pay equity. Employees want to know if they’re being paid fairly but often feel uncomfortable directly addressing the issue with management. This leads to awkward conversations between coworkers comparing their earnings with one another. A compensation strategy that emphasizes transparency nips this problem in the bud. To show their dedication in the battle against bias, Buffer, a social media planner company, publicly lists the salaries of all their employees on their website.
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A compensation analysis is a process companies use to evaluate the total cost of an individual employee. Companies use this process to compare employee salaries both internally and externally to see if they line up with industry standards. Changes and shifts occur frequently within the job market, and one of the best ways a company can keep up is to perform frequent compensation analyses. Compensation analysis also helps companies maintain pay equity within their own workplace and fight wage bias.
Compensation analysis is critical because it gives companies the necessary information about how to properly manage their employee budget. For example, if a company is underpaying employees relative to industry competitors, that company can use compensation analysis to make the necessary adjustments. If it’s unclear what a fair wage should be, compensation analysis is used as a guide to determine what employees should be paid.
A skilled, competent labor force is essential for any company to have success. But what happens when a company is struggling to hire the talent they need? Compensation analysis can help by determining whether their offer measures up to their competitors. This also allows businesses to see how they can get ahead of the competition by offering compensation packages that are above the industry standard.
Since compensation analysis is an objective tool, it can also be used to eliminate bias when determining how much a candidate should be paid. Transparent and open pay structures enable employees to be compensated strictly on merits as opposed to their race or gender. Being transparent when it comes to wages also seems to help reduce the gender pay gap. When done right, these decisions go a long way in helping companies stay in compliance with the law while fighting wage inequality.
Now that we’ve covered what compensation analysis is and why it’s crucial to any company, let’s discuss how to conduct it. Follow the three steps below to run a compensation analysis.
The first step is to collect salary and compensation data. Without gathering this data, companies are left guessing at how to properly pay their employees. Some important factors to look for in the data include professional experience, education level, and location. It may also be necessary to consider factors like race or gender to avoid any potential bias.
Data should also be properly sourced. Government sources like the US Bureau of Labor Statistics are excellent resources for collecting high-quality salary data. HR and recruitment firms also conduct salary surveys that are publicly available and free to use.
Once you’ve gathered all the necessary data, it’s time to set goals. What is your company looking to accomplish with a compensation analysis? Are you looking to see where you stand among the best in your industry? Do you want to address pay equity by improving the packages of your current employees? Regardless of what your goals are, your analysis should be in line with your company’s philosophy. Every team member performing the analysis should be on the same page.
The goals you set out to reach will also determine how compensation analysis is performed. For example, the process for identifying your business’s highest achievers will be different than addressing pay equity amongst your staff. No one strategy will work for two or more different goals.
The data is accounted for and all goals are set. Now, it’s time to implement the strategy and track developments over time. You do this by comparing the salary data gathered previously to the current compensation of your employees. Are the comparisons at or above market average? Are they far below? With these questions answered, you can make appropriate changes and adjustments. Companies will often use pay structures centered around salary ranges as part of their solution.
Over time, trends in the labor market will shift, meaning that the data you used may not always be relevant. To keep up with market changes, it’s important to perform compensation analysis frequently. Goals and philosophies also tend to change as companies get larger, so it’s important to keep these factors in mind as your business moves forward.
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Unless otherwise noted by the IRS, all employee compensation is considered taxable. This is because bonuses, commissions, perks, and benefits are all seen as forms of payment. It’s important for both employers and employees to properly report their compensation on tax forms.
The exceptions to this rule are forms of compensation not considered payment. Things like health-related benefits, life insurance, athletic facilities, and educational assistance are all nontaxable. The IRS keeps an updated list of benefits considered nontaxable.
Here some examples of both taxable and nontaxable employee compensation:
Total job benefits are only part of an employee’s total compensation package. Job benefits include things such as health, life, vision, or dental insurance, paid time off, and employee stock options. An employee may have these benefits and more—such as perks like free gym memberships or transportation credits—that make up a total compensation package.
Total compensation packages will differ depending on an employee’s role and industry. Typically, employees can expect a total compensation package that includes their salary or hourly wage, some form of health-related insurance, retirement benefits, and some kind of PTO.
According to the BLS, salary accounted for a little over 70% of total compensation on average for employees in the private sector nationwide. An employee can expect their benefits to be valued at just under a third of their salary. Keep in mind that these numbers are considered averages and don’t take into account the nuances of specific roles and industries.
We’ve just covered a lot of ground, so let’s summarize.
Total compensation is the sum of an employee’s salary plus any additional payments. Benefits, bonuses, commissions, perks, and tips are all considered forms of additional payment. Companies use total compensation as both a retention tool and a way of attracting top talent within the industry. Besides a few specific exceptions, all payments from a compensation package are taxable. To keep up with market trends and stay ahead of the pack, companies use compensation analysis. This process is also used to address issues like pay equity and to make sure all employees are being paid at least a market average wage.
The importance of a total compensation package cannot be understated. Salary alone is no longer enough to attract and retain top talent. Employees need more than just the figures they see on their paychecks. They need to feel appreciated by employers, and great total compensation packages are among the best ways to do it.
Find out how Compt can help you offer competitive personalized perks that attract top talent. Build the perfect perks program by downloading the free benchmark report on the most popular employee perks.
Definitions and Differences Between Salary and Compensation (Compt)
How to Use Pay Transparency to Negotiate a Better Salary (CNBC)
Salary Transparency: Why More Workers Are Demanding Open Conversations About Their Pay (ZDNET)
If You Don’t Know the Value of Your Work Benefits, It’s Time to Find Out (MarketWatch)
All Workers Deserve Paid Family Leave — Not Just the Lucky High Earners Getting It Now (MSNBC)
Need an HR Benefits Upgrade? Here Are 16 Perks That Can Help Employees Prosper (Forbes)
4 Employee Benefits Your Small Business Should Offer (Motley Fool)