Ch. 13
Total Rewards
What "total rewards" includes
Total rewards is everything of value an employee receives from employment:
- Direct compensation: base pay, wages, overtime, bonuses, commissions and incentives.
- Indirect compensation (benefits): health insurance, retirement plans, paid time off, legally required benefits, and so on.
- Non-financial and intangible rewards: recognition, development, flexibility, culture and well-being.
A total compensation (total rewards) statement shows each employee the full value of their package, including the employer's benefit costs. It is a strong retention and communication tool.
Compensation philosophy
A compensation philosophy is the organization's formal statement of how it will pay relative to the market and what it will reward.
| Strategy | Meaning | When used |
|---|---|---|
| Lead | Pay above the market rate | To attract and keep top talent, for critical or scarce skills |
| Match (meet) | Pay at the market rate | The most common approach. Competitive but cost-controlled. |
| Lag | Pay below the market rate | Cost constraints. Often offset with strong benefits, mission, stability or equity. |
| Lead-lag | Pay above market at the start of the plan year, so that by the end of the year (as the market moves up) pay is below market. On average, the organization matches the market. | Keeps pay competitive on average across the year |
Other philosophy choices include entitlement vs. performance-based pay (rewarding tenure vs. rewarding results), internal equity vs. external competitiveness, and the mix of fixed and variable pay.
Gathering market data
- Remuneration (compensation) surveys: collect prevailing pay data (base pay, ranges, starting rates, variable pay, PTO). Sources include consulting firms, industry associations and the U.S. Bureau of Labor Statistics (BLS).
- Benchmarking: match benchmark jobs (common, stable jobs that exist in many organizations) to survey data. The job content must match, not just the title.
- Labor market trends: supply and demand for skills, inflation, cost of living and the geographic market.
- Comparable worth (BASK glossary): the idea that jobs primarily filled by women that require skill, effort, responsibility and working conditions comparable to similar jobs primarily filled by men should be classified and paid the same. This is broader than the Equal Pay Act, which covers substantially equal jobs only.
Compensation system design
Job analysis → job documentation (descriptions) → job evaluation → pay structure
Job evaluation methods
Job evaluation (BASK): the process of determining a job's value and price by comparing it with other jobs inside the organization (internal equity) or with similar jobs at competing organizations (external competitiveness).
| Method | Type | How it works |
|---|---|---|
| Job ranking | Whole-job, non-quantitative | List jobs from highest to lowest value. Simple, but subjective and doesn't show how much more one job is worth than another. |
| Paired comparison | Whole-job ranking | Compare each job with every other job, one pair at a time, then rank by the number of "wins" |
| Job classification (grading) | Whole-job, non-quantitative | Write descriptions for each grade or class, then slot jobs into the best-matching class. Example: the U.S. federal General Schedule (GS). |
| Point-factor | Quantitative, factor-based | Choose compensable factors (such as skill, effort, responsibility and working conditions), assign points to each level of each factor, then add up the points for each job. This is the most widely used quantitative method. |
| Factor comparison | Quantitative, factor-based | Rank benchmark jobs on each factor and assign dollar values per factor. Complex and rarely used. |
| Market pricing | Market-based | Set pay mainly from external survey data for benchmark jobs, then slot other jobs in |
★ The Equal Pay Act's four factors (skill, effort, responsibility and working conditions) are also the classic compensable factors.
Pay structures and range math
A pay grade groups jobs of similar value. A pay range sets the minimum, midpoint and maximum pay for a grade.
| Term | Formula / meaning |
|---|---|
| Midpoint | (Minimum + Maximum) ÷ 2. Usually set at the market rate for a fully proficient employee. |
| Range spread | (Maximum − Minimum) ÷ Minimum × 100. Ranges are wider for higher-level jobs. |
| Compa-ratio | Employee's pay ÷ range midpoint (× 100 for a percentage). 1.00 (100%) = at midpoint; below 1.00 = below midpoint; above 1.00 = above midpoint. A group compa-ratio averages across employees. |
| Range penetration | (Employee's pay − Range minimum) ÷ (Range maximum − Range minimum). Shows where in the range the pay falls: 0% = at the minimum, 100% = at the maximum. |
| Broadbanding | Combining several narrow grades into a few wide bands. It gives more flexibility for lateral moves and growth and supports flatter organizations, but makes pay harder to control. |
| Red-circle rate | Pay above the range maximum. The usual practice is to freeze the base or give lump-sum increases until the range catches up. |
| Green-circle rate | Pay below the range minimum. The usual practice is to raise it to the minimum promptly. |
| Pay compression | Little pay difference between employees despite differences in experience, skill or tenure. It often happens when market rates for new hires rise faster than raises for current employees. |
| Pay inversion | New hires or subordinates earn more than experienced employees or their supervisors. This is extreme compression. |
Worked example: The range is $50,000 to $70,000, so the midpoint is $60,000. An employee earns $54,000.
- Compa-ratio = $54,000 ÷ $60,000 = 0.90 (90%)
- Range penetration = ($54,000 − $50,000) ÷ ($70,000 − $50,000) = 20%
- Range spread = ($70,000 − $50,000) ÷ $50,000 = 40%
Base pay systems and pay increases
| Approach | Description |
|---|---|
| Flat rate | Everyone in the job gets the same rate. Common in union settings. |
| Time-based / seniority (step) | Increases come at set intervals based on tenure |
| Merit (pay-for-performance) | Increases based on the performance rating, often set with a merit matrix that considers both the rating and the employee's position in the range (compa-ratio) |
| Productivity-based | Pay tied to output. Straight piece rate pays the same amount per unit. Differential piece rate (Taylor plan) pays a higher rate per unit after a standard is exceeded. |
| Person-based | Pay for knowledge, skills or competencies acquired (skill-based pay) |
| Cost-of-living adjustment (COLA) | A general increase tied to inflation, such as the Consumer Price Index (CPI), regardless of performance |
| General / across-the-board increase | The same percentage or dollar increase for everyone |
| Lump-sum increase | A one-time payment that is not added to base pay. Useful for red-circled employees. |
★ Merit matrix logic: an employee with a higher rating and a lower compa-ratio gets the largest percentage increase. This moves strong performers toward the midpoint faster.
Variable pay and incentives
| Type | Description |
|---|---|
| Bonus | A one-time payment for performance (individual, team or company) |
| Spot award | An immediate, small award for a specific achievement |
| Commission | A percentage of sales |
| Profit sharing | A share of company profits, paid in cash or deferred into retirement accounts |
| Gainsharing | A group shares the savings from productivity or cost improvements. The classic plans are the Scanlon plan (labor cost savings plus employee suggestion committees), the Rucker plan and Improshare. |
| Team / group incentives | Rewards for meeting team goals |
| Stock options | The right to buy company stock at a set price (the strike or grant price) in the future. They have value if the stock price rises. |
| Restricted stock / RSUs | Shares granted that vest over time |
| Employee stock purchase plan (ESPP) | Employees buy company stock, often at a discount |
| Employee stock ownership plan (ESOP) | A retirement plan that invests mainly in employer stock |
Sales compensation: salary only, commission only, salary plus commission, or a draw against commission (an advance against future commissions).
Executive compensation: base salary; short-term incentives (annual bonus); long-term incentives (stock options, restricted stock, performance shares); perquisites ("perks") such as a car, club memberships or financial planning; deferred compensation (nonqualified plans such as SERPs); golden parachutes (payments on termination after a change in control); and golden handcuffs (rewards that vest over time to keep the executive). Public companies must disclose executive pay, and shareholders have a say-on-pay advisory vote under the Dodd-Frank Act.
Benefits
Legally required (mandatory) U.S. benefits:
| Benefit | Key facts |
|---|---|
| Social Security and Medicare (FICA) | Employers and employees each pay 6.2% Social Security tax up to an annual wage base, plus 1.45% Medicare tax on all wages. Employees also pay an additional 0.9% Medicare tax on wages over $200,000. |
| Unemployment insurance | A federal-state program funded by employer payroll taxes (FUTA and state SUTA) |
| Workers' compensation | State-run, no-fault insurance that pays medical costs and lost wages for work-related injuries and illnesses. In exchange, employees generally cannot sue the employer (the "exclusive remedy"). |
| FMLA leave | Unpaid, job-protected leave for eligible employees (Ch. 22) |
| COBRA continuation | Continued group health coverage at the employee's own cost after a qualifying event (Ch. 22) |
| USERRA | Reemployment rights and benefits for military service members (Ch. 22) |
★ U.S. federal law does not require paid vacation, paid holidays or (for most private employers) paid sick leave. Many states and cities do.
Common voluntary benefits: health, dental and vision insurance; life insurance; short- and long-term disability; retirement plans; PTO; EAPs; tuition assistance; wellness programs; flexible schedules; and others.
ACA employer mandate. Under the Affordable Care Act, applicable large employers (50+ full-time employees, counting full-time equivalents) are not literally required to offer health coverage. They owe a penalty (the "employer shared responsibility payment") if they don't offer affordable, minimum-value coverage to at least 95% of full-time employees (30+ hours per week) and their dependents, and at least one full-time employee gets a premium tax credit on the Marketplace.
Health plan types
| Plan | Key features |
|---|---|
| Indemnity (fee-for-service) | Any provider. The plan pays a percentage after the deductible. Most choice and highest cost. |
| HMO (health maintenance organization) | Must use network providers. A primary care physician (PCP) gatekeeper gives referrals to specialists. Lower cost, least choice. |
| PPO (preferred provider organization) | In-network providers cost less, but out-of-network care is covered at a higher cost. No referrals needed. |
| POS (point of service) | An HMO-PPO hybrid. A PCP referral is needed, but out-of-network care is allowed at a higher cost. |
| EPO (exclusive provider organization) | Network only (except emergencies), but usually no referrals needed |
| HDHP (high-deductible health plan) | Lower premiums and a higher deductible. Required in order to contribute to an HSA. |
| Self-funded (self-insured) | The employer pays claims directly, often with stop-loss insurance and a third-party administrator. Governed by ERISA and exempt from state insurance mandates. |
| Fully insured | The employer buys a policy from an insurer, which bears the risk. Subject to state insurance law. |
Health accounts:
| Account | Who funds it | Key rules |
|---|---|---|
| Health savings account (HSA) | Employee and/or employer | Requires HDHP coverage. The employee owns it and keeps it when they leave (portable). Balances roll over every year. It has a triple tax advantage: contributions are pre-tax, growth is tax-free, and qualified withdrawals are tax-free. |
| Flexible spending account (FSA) | Mostly the employee, through salary reduction (the employer may add) | "Use it or lose it," but a plan may allow either a limited carryover or a 2½-month grace period (not both). The employer owns the account. Dependent care FSAs are a separate type. |
| Health reimbursement arrangement (HRA) | Employer only | The employer decides whether unused funds roll over. Usually not portable. |
Retirement plans
| Type | Description | Who bears the risk? |
|---|---|---|
| Defined benefit (DB) / pension | Promises a specific monthly benefit at retirement, usually based on salary and years of service. Insured by the Pension Benefit Guaranty Corporation (PBGC). | Employer (investment risk) |
| Defined contribution (DC) | Specifies the contribution. The benefit depends on the account balance. Examples: 401(k), 403(b), 457, profit-sharing plans and ESOPs. | Employee |
| Cash balance plan | A hybrid: legally a DB plan, but each employee has a hypothetical account with pay credits and interest credits | Employer |
Vesting. Vesting is an employee's nonforfeitable right to employer contributions. Employees' own contributions are always 100% vested immediately.
| Plan type | Maximum vesting schedules under ERISA |
|---|---|
| Defined contribution (employer contributions) | 3-year cliff (0% until 3 years, then 100%) or 2-to-6-year graded (20% per year, starting at year 2) |
| Defined benefit | 5-year cliff or 3-to-7-year graded |
Other retirement terms:
- Qualified plans meet IRS and ERISA requirements for tax advantages and must pass nondiscrimination testing.
- Nonqualified plans (such as deferred compensation and SERPs) are for executives and don't have to meet nondiscrimination rules.
- Roth 401(k) is funded with after-tax contributions; qualified withdrawals are tax-free.
- Automatic enrollment: SECURE 2.0 Act of 2022 requires most new 401(k) and 403(b) plans established after Dec. 29, 2022, to auto-enroll (plan years after 2024).
Leave plans
These include paid and unpaid leave; PTO banks; open (unlimited) leave; vacation; holidays; sick leave; parental leave; bereavement; jury duty (federal law protects jobs, but no federal requirement to pay); and volunteer leave.
Other benefits and compensation
- Other benefits: disability insurance (short-term vs long-term), EAPs, wellness programs, life coaches, outplacement services.
- Other compensation: tuition assistance (up to $5,250 per year is tax-free under IRC Section 127).
Compensation for special workforce groups
- Expatriate compensation approaches:
| Approach | Description |
|---|---|
| Balance sheet (home-based) | Most common. Keeps the expatriate "whole": purchasing power matches home, via allowances. |
| Host-based (localization) | Pay matches the host-country market |
| Headquarters-based | Pay is based on the HQ country's scale |
| Lump sum / cafeteria | A fixed amount the expatriate allocates as they choose |
- Tax equalization: employee pays the same tax they would have paid at home; employer covers the rest.
- Totalization agreements: bilateral agreements that eliminate double social security taxation.
Pay practices and issues
- Pay equity: equal pay for equal or comparable work. Use regression analysis for audits.
- Pay transparency: many jurisdictions require pay ranges in postings and ban salary-history questions. NLRA protects rights to discuss pay.
Basic payroll and accounting
- Net Pay Formula: Gross pay − pre-tax deductions − taxes − post-tax deductions = net pay.
- Section 125 cafeteria plan: allows pre-tax payment for benefit premiums and FSA contributions.
Total rewards metrics
Includes insurance participation rates, compa-ratio, benefits cost as a percentage of payroll, total compensation per FTE, merit budget utilization and pay equity gaps.
Finished reading?