What Is a Discretionary Bonus?

Business owners should create compensation plans to reward motivated and dedicated specialists. There are many methods to increase employee engagement and satisfaction. Providing discretionary rewards is an effective way to motivate staff and recognize their performance. This blog post will explain what a discretionary bonus is and how the firm may use it effectively.

What a Discretionary Bonus Really Means

Essentially, a discretionary bonus is a premium granted at the discretion of firm management. It is not tied to any predetermined algorithm. Such a payment differs from a standard salary or guaranteed rewards because it is a choice. The decision about paying bonuses to employees, payment terms, and recipients is determined solely by the firm. There are no pre-arranged agreements or accrual arrangements.

The criteria to get such a payment are not set in advance. An employee cannot expect to receive a reward even if they have performed well throughout the year. Such flexibility allows business owners to reward specialists one-time, without any future expectations.

Many firms also offer employees non-discretionary bonuses. These are salary increases that the manager provides when specialists meet certain requirements. These are typically ongoing offers that encourage higher productivity.

Knowing the distinctions between discretionary vs non-discretionary bonuses is critical for the HR team to grant compliance with laws on bonus pay, including the Federal Labor Standards Act (FLSA).

Discretionary bonuses are often used to reward exceptional effort or teamwork. You may also share financial successes with all specialists when the entire organization exceeds its annual goals.

Why Businesses Use Discretionary Bonuses

Modern firms implement such rewards because of their psychological impact and greater financial flexibility compared to fixed incentives.

Neuroscience research confirms that the brain produces more dopamine when receiving an unpredictable reward instead of an expected paycheck. An unexpected compensation after a well-done job creates a deeper emotional connection between the specialist’s efforts and the firm’s appreciation. Generous rewards improve morale and the desire to repeat their achievements.

Unlike contractual premiums, which are tied to strict parameters, managers can vary the amount and pay period of discretionary rewards depending on the firm’s current financial situation. If a firm has had an excellent year, it can be generous. In difficult years, it can reduce the premium sum or not pay it at all without breaching the contract. Such rewards do not create long-term payroll liabilities.

Common Types of Discretionary Bonuses

Employers can pay employee bonuses for a variety of reasons, including helping them overcome challenging situations or demonstrating exceptional results. Firm owners can implement the following types of bonuses in their Human Capital Management (HCM) software:

• Performance reward. This incentive is used when an individual or team achieves impressive results that exceed the plan. A development firm might pay a $6,000 compensation to a group of specialists if quarterly revenue exceeds the plan by 25% after presenting a unique digital product.
• Spot bonus. It recognizes significant efforts in a specific situation. An advertising agency might award a designer a $1,000 premium after working 14-hour days to complete a presentation for an important client on time.
• Holiday premium. This is a seasonal reward that is not tied to employee performance. A small firm might transfer $300 to each employee’s account at the beginning of December as a thank you before the holidays.
• Retention or appreciation bonuses. This reward is intended for employees demonstrating long-term service and commitment to the firm. A manufacturing firm may award specialists who have worked for at least 5 years a one-time compensation of $5,000 to recognize their loyalty.

These premiums are not tied to predetermined parameters and are awarded at the administration’s decision.

Developing an Effective Bonus Program

As we know, discretionary bonuses are flexible and lack a strict formula, but they benefit from a structured approach. A well-thought-out system will prevent them from devolving into random favoritism. Key recommendations to create an effective incentive program include:

• Setting clear performance expectations, even if rewards are flexible. Professionals should understand the basic expectations of their role. You can inform employees that a special premium is awarded for efforts that prevented significant client losses or saved the firm a substantial sum of money, but not for routine processes.
• Ensuring fairness to prevent favoritism. The decision to award a premium is made by management, but the procedure must be transparent. The firm can assign a specialist who nominates candidates for premiums and adopts a consistent, high-level review process. It will prevent situations in which certain managers continually reward the same people.
• Maintaining records for legal compliance and payroll purposes. Any bonus, whether $100 or $5,000, must be appropriately documented. Each entry must include the recipient’s personal information, the amount, and the justification of the payment. Such information helps accurately calculate payroll and comply with tax standards. Proper documentation confirms, during audits, that payments were made on a one-time basis and are not part of the specialist’s regular rate of pay.

Don’t forget about budget planning when calculating bonus payments. Funds for the incentive program must be accounted for and kept separately from funds needed to pay salaries.

Common Mistakes to Avoid

Firms that want to build a motivated team must take a responsible approach to rewards. If they avoid common mistakes, rewards will ensure increased efficiency and morale.

The main mistake is giving inconsistent bonuses that create confusion or resentment. If the criteria to earn employee compensation seem arbitrary or favor certain specialists, it can lead to a loss of interest among other employees. Giving a substantial premium to one team while ignoring another that performs less challenging tasks can be highly demotivating.

Another grave mistake is making promises that transform a “discretionary bonus” into an “expected premium.” If a firm consistently pays a holiday premium on the same day, it ceases to be a surprise. During a challenging year, the organization may be forced to cancel such a premium. Employees may perceive this as a reduction in their income and a decrease in motivation. Management should regularly remind employees that such payments are not guaranteed.

Failing to communicate can cause compensations to lose their motivating power. If premiums appear random, specialists fail to see the connection between effort and reward. Suppose a company’s management decides to reward a specialist several months after a remarkable contribution without explaining the reasons. There’s a risk the person won’t fully understand what exactly they did right.

Final Words

A discretionary bonus is an excellent way to offer specialist compensation at a time convenient for the firm. If you try to find options to motivate or reward specialists for hard work, consider such a category of incentive as part of your compensation strategy.

If this seems too complex to adopt in your company, perhaps it’s time to contact the experts at BooksTime. They will help you create and implement a fair compensation system that motivates every employee to work harder and won’t put an unsustainable burden on your budget.