What is Compensation?

Compensation is the total remuneration an employee receives in exchange for their work. The term refers to an employee’s base salary, as well as any additional payments and benefits such as bonuses, paid vacation, flexible work, and health insurance. 

Compensation refers to pay for both employees and independent contractors such as freelancers. However, independent contractors usually only receive pay in the form of a consultancy rate or fee rather than benefits. 

While there are some legal requirements around minimum compensation standards, you can adjust your approach to suit your organization’s business strategy, goals, and resources, as well as the industry it operates in and the broader job market. 

Types of Compensation

A compensation package typically includes a combination of financial and non-financial benefits. 

Financial compensation

Also referred to as direct compensation, financial compensation is paid as cash or a cash equivalent. 

Forms of financial compensation include:

• Base pay. Base pay is the fixed amount an employee is paid for their work. Usually calculated from an annual salary or hourly rate, an employee’s base pay is set out in their employment contract and doesn’t vary.
• Additional pay. Additional pay is irregular pay of varying amounts that an employee receives on top of their base salary. Examples of additional pay include commissions, overtime, bonuses, incentive pay, accrued leave, and severance pay. 
• Tips. Common in the food service industry, tips are discretionary amounts given directly to an employee by a customer. 

Non-financial compensation

Also referred to as indirect compensation, non-financial pay offers benefits with a non-monetary value, for example, a better work-life balance or improved working conditions. 

Forms of non-financial pay include:

• Insurance plans, such as life, health, and dental insurance
• Paid leave, including vacation and sick leave
• Gym memberships, lunchtime exercise classes, or other health and wellness benefits
• Retirement plans
• Flexible hours
• Remote work
• Employee assistance programs offering services such as counseling or legal advice
• Health savings accounts (HSAs) or flexible spending accounts (FSAs) for healthcare expenses not covered by insurance
• Child care assistance
• Meal vouchers, travel, or housing allowances
• Training allowances or reimbursements
• Student loan repayment assistance
• Job-related subscriptions
• Company car or mobile phone
• Equity, allowing an employee to own a percentage of the organization via an employee stock purchase plan or stock option

Why is Compensation Important?

There are several reasons why you should spend time developing your organization’s compensation philosophy and strategy. 

It is important for:

• Attracting top talent. Your approach to compensation can distinguish you from other employers and attract high-quality candidates. Even if you can’t offer the most competitive base pay, offering employees attractive and unique benefits can be an effective strategy. 
• Improving employee job satisfaction. 60% of employees in one survey said that pay was very important to their job satisfaction. Appropriate compensation is essential to maintaining morale by demonstrating how you value your employees. 
• Increasing employee retention rates. A Pew Research survey found that low pay was one of the top reasons why American employees quit their job in 2021. Addressing this avoids the need to rehire and onboard new employees regularly, keeping costs down. 
• Managing your budget. Compensation is one of the most significant expenses for an organization. By assessing what types you can offer, you can account for it in your budget accordingly. 

Laws Around Compensation

There are many laws around pay, setting minimum standards and regulating the financial and non-financial compensation organizations offer their employees. 

In the US, for example, an employer needs to consider several pieces of federal legislation when designing a compensation package including:

• The Fair Labor Standards Act: covers employee status, overtime pay, and minimum wages.
• The Equal Pay Act: prohibits pay discrimination based on sex.
• Title VII of the Civil Rights Act: prohibits pay discrimination based on race, color, sex, religion, or national origin.
• The Americans with Disabilities Act: prohibits pay discrimination based on disability.
• The Age Discrimination in Employment Act: prohibits pay discrimination based on age.
• The Family Medical Leave Act: requires certain employers to provide eligible employees with unpaid leave while maintaining their health benefits.
• The National Labor Relations Act: facilitates collective bargaining by giving employees the right to discuss wages with other employees. 

In addition to these federal laws, there are also laws at the state level. Employment contracts, as well as any collective bargaining agreements, may also affect how you compensate employees. 

As an employer, you also need to understand the tax regime, in particular the taxes you need to withhold on different types of compensation. 

Deciding How to Compensate Your Employees

When designing a compensation package, there are several factors to take into account. 

• Competitor research. To ensure you’re offering competitive compensation packages, research the compensation packages your local competitors are offering for the same roles. You can do this by looking at job advertisements or checking aggregate information, for example, via the US Bureau of Labor Statistics. 
• Check any legal requirements. It’s essential to understand your legal obligations as an employer and should seek legal advice when setting employee compensation. 
• Consider your budget. You must have the resources to provide employees with their promised compensation. When designing a compensation package, you should forecast anticipated bonuses, commissions, and raises and factor them into your budget.  
• Use a combination of salary and benefits. Benefits can be just as important to employees as their base salary. Offering benefits such as child care, remote work, and health insurance may allow you to adjust the base salary you offer employees. To strike the right balance, you need to understand how your employees and potential employees want to be compensated. It’s also worth highlighting the benefits you offer in job advertisements to make you stand out from other employers. 
• Align employee compensation with your business strategy, mission, and organizational values. For example, if your organization works in the sustainability sector, you may offer to cover the carbon offset component of any flights your employees take. 
• Communicate your compensation strategy to your employees. Employees need to know what they are entitled to. Transparency and equality around salary and benefits ensure your employees know their contributions are valued. It’s especially important to promote the non-financial benefits available to employees to ensure they take advantage of them. 

Conclusion

Compensation is the total remuneration; both financial and non-financial, your employees receive in return for their work. It includes salary, additional pay, and benefits such as insurance, flexible work arrangements, child care, and employee assistance programs. 

Compensating your employees properly is essential to attracting and retaining talent in your organization. s