According to compensation programs, the benefits such as retirement

A defined-benefit plan is an employer-sponsored retirement plan where employee benefits are computed using a formula that considers several factors, such as length of employment and salary history. The company is responsible for managing the plan's investments and risk and will usually hire an outside investment manager to do this.

Typically an employee cannot just withdraw funds as with a 401(k) plan. Rather, they become eligible to take their benefit as a lifetime annuity or in some cases as a lump sum at an age defined by the plan's rules.

Also known as pension plans or qualified-benefit plans, this type of plan is called "defined benefit" because employees and employers know the formula for calculating retirement benefits ahead of time, and they use it to define and set the benefit paid out. This fund is different from other retirement funds, like retirement savings accounts, where the payout amounts depend on investment returns.

Poor investment returns or faulty assumptions and calculations can result in a funding shortfall, where employers are legally obligated to make up the difference with a cash contribution.

• A defined-benefit plan is an employer-based program that pays benefits based on factors such as length of employment and salary history.
• Pensions are defined-benefit plans.
• In contrast to defined-contribution plans, the employer, not the employee, is responsible for all of the planning and investment risk of a defined-benefit plan.
• Benefits can be distributed as fixed-monthly payments like an annuity or in one lump-sum payment.
• The surviving spouse is often entitled to the benefits if the employee passes away.

Since the employer is responsible for making investment decisions and managing the plan's investments, the employer assumes all the investment and planning risks.

A defined-benefit plan guarantees a specific benefit or payout upon retirement. The employer may opt for a fixed benefit or one calculated according to a formula that factors in years of service, age, and average salary. The employer typically funds the plan by contributing a regular amount, usually a percentage of the employee's pay, into a tax-deferred account. However, depending on the plan, employees may also make contributions. The employer contribution is, in effect, deferred compensation.

Upon retirement, the plan may pay monthly payments throughout the employee’s lifetime or as a lump-sum payment. For example, a plan for a retiree with 30 years of service at retirement may state the benefit as an exact dollar amount, such as $150 per month per year of the employee's service. This plan would pay the employee $4,500 per month in retirement. If the employee dies, some plans distribute any remaining benefits to the employee's beneficiaries.

Payment options commonly include a single-life annuity, which provides a fixed monthly benefit until death; a qualified joint and survivor annuity, which offers a fixed monthly benefit until death and allows the surviving spouse to continue receiving benefits thereafter; or a lump-sum payment, which pays the entire value of the plan in a single payment.

Selecting the right payment option is important because it can affect the benefit amount the employee receives. It is best to discuss benefit options with a financial advisor.

Working an additional year increases the employee's benefits, as it increases the years of service used in the benefit formula. This extra year may also increase the final salary the employer uses to calculate the benefit. In addition, there may be a stipulation that says working past the plan's normal retirement age automatically increases an employee's benefits.

Compensation and benefits refer to the benefits a firm provides to its employees in exchange for their labor. Compensation and benefits are thus a key part of Human Resource Management. In this article, we will provide you with a full guide about compensation and benefits. 

Contents
What are compensation and benefits?
Why are compensation and benefits important?
Compensation and benefits and employee motivation
How do HR Departments calculate compensation and benefits?
3 Models to Explain Compensation and Benefits
Compensation and benefits package example
Frequently Asked Questions

What are compensation and benefits?

When you receive a job offer, the first thing you look at is the salary. Whether the recruiter lists the wage as an hourly, weekly, monthly, or hourly rate, candidates see it as the most critical part of any job offer. Typically, when employees think about compensation, the salary is what they think of. But, for many employees (especially senior employees) compensation is far more than just the regular paycheck.

Benefits cover indirect pay. This can be health insurance, stock options, or any myriad of things offered to employees. All of these things are critical in any job offer. Two jobs that offer identical salaries may vary wildly in the benefits category, making one a better financial proposition than the other.

Overtime pay, stock options, 401k matches, pension plans, days off, and even free lunches make up an essential part of the compensation and benefits package. 

Some benefits are country-specific. In the United States, health insurance makes up a key component of benefits. Who your employer is, determines your health care options – even down to which doctors you can see and which medications are covered.

COMPENSATION & BENEFITS CHEAT SHEET

12 Key Compensation Metrics

Download our free cheat sheet to gain access to key compensation metrics and learn how to create insightful C&B charts in Excel

In Europe, there is often a focus on more social benefits, including parental leave, severance pay, and termination notice. In countries like France and Finland, it is not uncommon for employers to pay for restaurant vouchers that cover part of the employee’s lunch. 

Most often, compensation and benefits (commonly referred to as comp & benefits) fall under the responsibility of the Human Resources department. In a small company, an HR generalist would handle all aspects of this process, while in a large company, there would be dedicated departments to manage these.

Why are compensation and benefits important?

Compensation and benefits are important for two reasons.

First, people won’t work for you without pay. And unless you’re a non-profit organization, it’s illegal to ask them to work for you for free. There is a social contract between the employer and employee, where the employee puts in the work and the employer rewards this. Compensation and benefits are an important part of that equation.

Other things play a role too – and we’ll discuss them later – but what the employee receives is central. In addition to salary, benefits remain a crucial motivator for job candidates.

Second, as of June 2019, benefits make up 31.4 percent of the cost of employing someone. It is a significant expense with a clear goal so it’s not something businesses can overlook. This is why paying careful attention to a fair compensation and benefits structure is so important.

But, how does compensation motivate employees and do increases make a difference?

Compensation and benefits and employee motivation

Glassdoor found that a 10 percent increase in base pay resulted in a 1.5 percent increase in the chance that the employee would stay at the company for their next role, rather than moving on. While their findings were statistically significant and turnover is expensive, it’s probably not enough to convince a boss to give someone a 10 percent raise. 

This same research found that a higher company rating on Glassdoor resulted in a four percent increase in the chance that someone would stay at the company. Salary is clearly important, but there is something other than money going on.

A Payscale study gives some insight into the influence of salary. They found a strong correlation between pay and engagement (and engagement profoundly influences retention), but what was stronger is pay clarity. When employees understood that their compensation was fair, it increased their engagement.

Do you have the competencies needed to remain relevant? Take the 5 minute assessment to find out!

Procedural and distributive fairness

Compensation fairness consists out of two elements: procedural fairness and distributive fairness.

1. Distributive fairness refers to the perceived fairness of the amount of compensation the employee receives.
2. Procedural fairness refers to the perceived fairness of the means used to determine those amounts.

Research shows that both distributive fairness and procedural fairness lead to higher employee retention.

However, when it comes to employee engagement (or motivation), procedural fairness seems more important than distributive fairness. A study in the UK showed a link between procedural fairness and engagement. Another study among Chinese compulsory school teachers showed that procedural fairness, not distributive fairness, predicted employee motivation. 

In other words, it’s not so much about money as it is about communication and honesty. Traditionally, many companies keep salary information confidential. Some managers even punish employees for sharing their salaries with co-workers, even though the National Labor Relations Act protects employees’ rights to discuss their working conditions, including salary. Secrecy can backfire, though, as employees are concerned that their pay is not fair. 

When an employee clearly understands that their compensation is commensurate with their skills, position in the company, and broader job market, they are more likely to be engaged in their work.

Benefits and motivation

Salary is only a part of compensation, though. Other benefits, such as pensions, 401ks, and stock options, also help increase employee retention. Many of these benefits require a period before the employee is vested. That is, you don’t receive the money or benefit from these forms of compensation until you’ve worked a minimum amount of time. If you quit before this date, you give up the stock or 401k match or other benefits.

Researchers at the University of Pennsylvania found that delayed compensation did decrease turnover overall, but it also resulted in employees quitting just after they did vest. In other words, employees are acting strategically when choosing to leave their jobs. They wish to move on but also want to maximize their compensation.

The Society for Human Resource Management (SHRM) found that 62 percent of U.S. employees rated their health care benefits as very important to them, meaning that this is an area that companies can focus on to increase engagement and retention. 

The same SHRM study also found that indirect compensation benefits also strongly influenced employee happiness. Things such as paid time off (63 percent said it was very important), flexibility (53 percent), and family-friendly benefits (35 percent) strongly influenced employee satisfaction with their jobs. The traditional money-based programs, such as retirement benefits, were also important. Still, at 48 percent saying retirement benefits were important, you can see how flexibility and vacation may cost you less and increase happiness overall.

Of course, because compensation and benefits can vary across companies and geographic regions, it’s important to benchmark your programs to ensure you’re maximizing the benefits from your programs.

How do HR Departments calculate compensation and benefits?

While governments set the floor for pay, known as a minimum wage, businesses are generally free to set their own wages. However, you’d be hard-pressed to hire an accountant for minimum wage. Instead, you’ll need to pay a market rate.

A market-rate can also be defined as a “going rate” and is the amount people are willing to pay for a particular good or service. Employees are offering their services and fall under this definition. There are market rates for each position, but because people are rarely transparent about salaries, this can be difficult to ascertain.

A compensation specialist will use salary surveys to help her determine a market rate. A salary survey asks many businesses to share their compensation data for positions. The data is then anonymized and sold back to businesses. In this way, a company can determine that the average rate for a junior accountant is $X, while the average rate for a marketing manager is $Y.

Because positions vary from company to company, you cannot just look at the salary survey and base all your salaries on the average salary for someone with that title. A marketing manager at a Fortune 500 company will have a very different job description than a marketing manager at a 25-person business.

Compensation managers will determine not only an ideal salary for a position but a salary range. Because candidates vary wildly, it doesn’t always make sense to pay different people the same amount. One person may have more experience and better skills than another and deserves a higher salary. Each range has a mid-point, which you may hear as a compa-ratio. If you have a compa-ratio of 100 percent, that means you are at the midpoint of the salary range.

Determining where someone fits within that salary range can also be complicated. Compensation managers often use statistical tools, such as regression analysis, to establish a proper salary position. The variables that the regression use can include

• Highest degree earned (and type and degree area)
• Years of experience
• Tenure with the company
• Position tenure
• Current salary
• Full-time equivalent status
• Exempt vs. non-exempt status
• Grade level or salary band classification
• Employee location (if you have multiple locations)
• Job performance ratings

In addition to salaries, stocks, retirement benefits, health insurance, and any other benefit are included in compensation figures. 

3 Models to explain compensation and benefits

While compensation and benefits is a flat model to explain differences in pay, there are two scientific models that enable us to understand compensation and benefits in a better way.

Compensation and benefits vs. total rewards

As discussed, compensation and benefits are not the only aspects of employee happiness, engagement, and retention. The Total Rewards Model demonstrates the interplay between the organization and compensation. 

The Total Rewards Model, coined by WorldatWork, proposes that total rewards are made up out of two elements:

1. Direct compensation. This consists of:
   1. Salary. This is the base and variable pay for work.
   2. Rewards. Other monetary benefits from working at the company, including health care, retirement pay, and allowances. 
2. Indirect compensation. This consists of:
   1. Work-life balance. A good work-life balance is crucial for a happy career. 
   2. Recognition. Recognition by colleagues and supervisors, as well as external recognition for your job.
   3. Development & career. Training and development, mentor programs, talent (mobility) programs.

If you only look at compensation when determining what makes employees happy, you’ll fall short. Total rewards look at how all aspects of an employee’s work-life impact their satisfaction. Research shows that Total Rewards offers a valid framework to reduce employee turnover. 

For years, Gallup tracked employee engagement daily and found that engagement generally stayed between 30 and 35 percent of employees. This means there is a lot of work to be done in this area.

As established above, pay and benefits are not the only things that make employees happy. Management practices have significant impacts on employee happiness and profitability and even reduced workplace accidents. Ignoring the culture part of an employees’ total rewards can reduce company performance and increase turnover.

Warr’s Vitamin model

Another approach to compensation and benefits is Warr’s vitamin model. A vitamin deficiency produces bodily impairment and may lead to physical illness. Normal vitamin intake improves health. However, an excess of vitamins can have different effects. According to Warr, an overdose of vitamins C and E neither improve nor impair the individual’s health. However, excess of vitamins A and D lead to toxic concentrations, which causes ill health.

Warr grouped job characteristics in these two categories, CE and AD.

1. CE is short for Constant Effects. Once an optimum is reached, any additional resources don’t add anything to employee well-being. Examples include 
   1. Pay level
   2. Pleasant environment
   3. Safe work practices
   4. Adequate equipment
   5. Value to society
   6. Supportive and considerate supervision
   7. Job security
2. AD is short for Additional Decrement. Once the optimum is reached, any additional resources hurt employee well-being. Examples include 
   1. Task discretion
   2. Influence
   3. Skill use
   4. Number of job demands
   5. Difficulty of job demands
   6. Range of different tasks
   7. Future predictability
   8. Availability of feedback
   9. Amount of social contact.

It is key to identify the optimum level for employees when it comes to compensation and benefits. Too much will either cost the organization resources (time, money, administration) in the case of CE, or will decrease employee well-being in the case of AD.

Researchers in Germany found that Warr’s theories did have a correlation with employee happiness and engagement and business success, at least in the German Horticulture business. While that may be a very specific area, it’s worth noting that these ideas do have merit, and looking at the total picture (or making sure employees receive all their vitamins) has a positive impact on your business.

Simon Sinek’s Why model

Simon Sinek’s Why model can also apply to compensation and benefits. As Warr’s Vitamins and the Total Rewards Matrix demonstrate, employees want to know the why and understanding that influences their performance. Sinek says that the best and most influential communicators begin with the why – why we do this. And the answer to the question, “Why?” cannot be to achieve shareholder value. That does not inspire.

Inspiration and understanding of underlying company culture and values increase engagement, especially among Millennials and Gen Z. The oldest Millennials are now in their late 30s (defining the millennials as those born between 1981 and 1996), but they still behave differently than prior generations. They prefer to meet with their managers one on one–and finding the why in their job is part of this. Millennials want to see companies benefiting society, not just shareholders. If you can explain why your company exists, it can impact your millennial turnover and engagement.

Your compensation packages and your total rewards models should not remain static. There are generational differences. As Gen Z enters the workforce, you’ll note that they (generally speaking) behave differently than prior generations, and compensation needs to adjust.

Compensation and benefits package example

What should a compensation and benefits package look like? There is no one answer for that as the package for a grocery store clerk will have little in common with the CEO’s package. However, here are some standard items that companies often include in a job offer. You’ll need to adjust for your organization, local laws, and employee level. 

• Salary
• Overtime pay
• Bonuses and commissions (discretionary and non-discretionary)
• Retirement (defined benefit and defined contribution plans)
• Stock options
• Restricted stock
• Vacation
• Profit-sharing
• Merit pay
• Sign-on bonuses
• Relocation bonuses
• Housing, school, and meal reimbursement
• Healthcare benefits (medical, dental, vision, etc.)

Salespeople, for instance, will need a commission plan that details what their commission is, and under what circumstances they receive it (is it when the paperwork for the sale is signed or is it when the customer pays?). Profit-sharing plans need to define what constitutes a profit, and when such, the company pays the bonuses (yearly, quarterly?). 

Companies must operate within the confines of laws. Summary Plan Descriptions should define everything legally, and you should provide these to employees, so they know precisely what their compensation and benefits are. While all these things are, generally, negotiable, you must maintain equity with similarly situated employees, to prevent illegal or immoral discrimination. 

Compensation packages cannot detail the total rewards aspect of any job offer. But, understand that your job candidates look for that. Websites such as Glassdoor give insights into your total rewards, whether you like it or not. It’s important to remember that candidates consider all that information when deciding to accept or reject a job offer.

You can no longer hide behind a large salary offer and hope that everyone ignores the culture your office has to offer.

Compensation and benefits are key components for company success, employee engagement, and turnover. You should evaluate your plans and programs regularly (at least yearly) to ensure that you meet both employee expectations and remain competitive in the marketplace.

FAQ

What are compensation and benefits?

Typically, when employees think about compensation, the salary is what they think of. Benefits cover indirect pay. Think of health insurance, stock options, or various other things offered to employees.

What is the difference between compensation and benefits?

Put simply, compensation covers people’s direct pay, their salary. Benefits cover employees’ indirect pay, things like health insurance and stock options but also social benefits such as parental leave.

Why are compensation and benefits important?

Compensation and benefits are important for two reasons. First, people won’t work for you without pay. Second, benefits are a significant expense with a clear goal and thus not something businesses can overlook.