What Is Incentive Pay?

What Is Incentive Pay?

28 March 2024

Share this blog

Incentive pay is an additional element of pay above and beyond an employee’s basic salary. It’s designed to reward employees for achieving specific goals or performance milestones. Unlike an employee’s standard hourly rate of pay or their annual salary, incentive pay is directly linked to performance, encouraging employees to align their efforts with the company’s objectives. This approach is adopted by many companies as it can help to boost productivity, morale, and business outcomes.

In this blog, we’ll explore the various types of incentive pay, their benefits, and how businesses can implement this approach effectively.

What is incentive pay?

Incentive pay, also known as pay-for-performance or variable pay, is defined by salary.com as, “giving employees additional money when they achieve specific goals, reach targets, or excel in their work”. These incentives can be offered individually or as part of a team effort, depending on the organisation’s goals.

There are several forms of incentive pay, including:

  • Bonuses – usually paid for achieving targets, such as sales quotas or project deadlines.
  • Commission – this is common in sales roles where employees earn a percentage of the revenue they generate.
  • Profit-sharing – where employees receive a share of the company’s profits.
  • Stock options or equity – this is where employees are given ownership stakes in the business, aligning their success with the company’s financial growth.

What are the benefits of incentive pay?

One of the most notable benefits of incentive pay is the increase in productivity as it often motivates employees to perform at their best. Recent research shows that even a simple expression of thanks from a senior manager can lead employees to be 50% more productive. It can also encourage innovation as employees are more likely to propose and implement innovative ideas if there is an associated reward for successful initiatives

Many businesses often also notice an increase in employee retention. Recognising and rewarding achievements generates loyalty, which then leads to lower employee turnover rates. Again, research supports this with survey data showing that employee turnover was reduced by 31% in companies where there is a strong culture of employee recognition.

As well as this, incentive pay encourages employees to focus on priorities that drive organisational success. For example, a well-structured sales commission scheme ensures a direct link between effort and revenue generation.

What are some challenges of incentive pay?

While incentive pay can be effective, it’s not without challenges. For example, it could possibly lead to the risk of unhealthy competition. Overemphasis on individual incentives can create rivalry among employees, potentially harming team dynamics and employee morale. As well as that, a poorly designed incentive plan may encourage the wrong behaviour. For example, rewarding speed over quality can lead to potential errors as employees rush to get work done instead of focusing on quality. The knock on effect of this is then increased complaints and dissatisfaction from customers.

Another challenge is the administrative burden of designing, managing, and evaluating incentive schemes. These can be complex and time-consuming and can lead to increased queries and grievances if staff don’t understand them or if they’re poorly explained.

Key considerations around incentive pay

If you’re considering implementing incentive pay in your organisation, there are some key and legal considerations to keep in mind. For example, your incentive scheme must comply with the Equality Act 2010. Disparities in incentive distribution could lead to claims of unfair treatment. That’s why it’s good practice to carry out an equality impact assessment on any incentive pay proposal, so that you can take an informed and proactive approach.

There’s also tax implications to consider too. Some incentives can be subject to Income Tax and National Insurance Contributions, and with that in mind, businesses should take appropriate advice in order to maintain legal compliance and avoid penalties.

For SMEs, simpler schemes, such as spot bonuses or team-based incentives, can be easier to implement and administer and just can also be just as effective.

Our tips for designing an effective incentive pay scheme

As we’ve mentioned, creating and implementing an incentive pay scheme can be time-consuming. However, when you factor in the below considerations, it can enhance the effectiveness of your scheme. Some key factors to consider include:

  • Setting clear and achievable targets – setting unrealistic goals can be demotivating for employees as they feel like they are simply being set up to fail. There is nothing wrong with having ambitious targets, but they should be balanced with a degree of realism.
  • Ensuring fairness and transparency – you should clearly communicate the criteria for earning incentives to avoid confusion or mistrust.
  • Review and adjust your scheme regularly – be sure to regularly monitor the scheme’s impact and make any necessary changes to address any unintended consequences.

Learn how HRX can help with your incentive pay scheme

Incentive pay is a powerful tool for businesses looking to enhance performance and retain top talent. When implemented thoughtfully, this approach can align employee efforts with your organisations goals, creating a win-win scenario.

By using our HR software, businesses can share details of their incentive pay schemes with employees, and any associated documents can be saved on individual employee records so everyone is clear on what has been agreed. Find out more about how HRX can help with your scheme by booking a demo, or by signing up for your FREE 30 day trial.


Similar Blogs

employee-references

Our Ultimate Guide to Employee References

Employee references might seem straightforward, but they can be a legal and practical minefield for employers. Whether you’re writing a reference for a current employee or responding to a request for a former team member, there are important considerations to keep in mind. This guide will walk you through the do’s and don’ts of employee…
View Article

6 June 2024

what-is-tupe

What is TUPE?

For employers in the UK, navigating employment law can sometimes feel like a maze. One of the more complex areas is the Transfer of Undertakings (Protection of Employment) Regulations 2006, commonly known as TUPE. Understanding TUPE is crucial if your business is involved in acquisitions, mergers, or outsourcing arrangements. In this blog, we tell you…
View Article

23 May 2024

menopause-in-the-workplace

A Guide to Menopause in The Workplace

Menopause is a natural part of a women’s life, but for too long, it’s been something of a workplace taboo. Times and attitudes, though are changing for the better as more organisations recognise the importance of employee wellbeing. Menopause is finally becoming a subject that is spoken about more openly and with a greater level…
View Article

14 May 2024

Take it for a spin

It’s so easy to get started, join us on a quick demo and we’ll talk you through the system. We also provide free onboarding to get you started.

Call us on

01282 921000

Monday to Friday 9am - 5pm

30 days free No credit card required Quick & Easy

Book a demo

Contact Us
When is the best time to call