Compensation Plans & Package Strategies

Creating a Strong Compensation Plan

The business of employment is ever-changing. The labor market ebbs and flows, workplace laws evolve and business needs fluctuate—sometimes from one extreme to another. Still, some things have remained constant. Among them is the significance of employee compensation.

Compensation plays a significant role throughout the employment life cycle. It’s a draw for attracting and securing qualified candidates during the hiring process. And it’s key for helping employers keep high performers on board by remaining competitive within the talent marketplace. To achieve these outcomes for your company, you’ll need an intelligently designed, well-built compensation plan. In this guide, we’ll help to support you in developing one.

What is a compensation plan?

A compensation plan is a formal written document describing the company’s position on total rewards provided to employees for services rendered. A good plan addresses the following:

• Who (i.e., which employees) is/are to be compensated under any particular set of terms
• What types of compensation will be provided (e.g., salaries, benefits, bonuses, etc.)
• Why the compensation is offered (e.g., standard pay package, employee incentives)
• How much (i.e., the amount and/or value of each type of compensation)
• How often (i.e., the frequency of the specific compensation)

Once implemented, a strong and competitive compensation plan should:

• Support your business strategy and your operational and workforce needs
• Keep you competitive within your industry
• Attract and retain high-performing, qualified talent
• Enhance employee performance and job satisfaction
• Help define your competitive market position in terms of base pay, incentives and benefits
• Help establish a total rewards plan based on your compensation budget, competition and business conditions

Types of compensation

Before you develop your compensation plan, be sure you understand the different types of compensation. Categorically, there are two overarching types: direct and indirect.

Direct compensation

Direct compensation refers to salaries and wages paid by employers to employees for work performed. It is monetary—such as base pay, variable pay and differential pay.

Direct compensation can be broken down into the following categories:

• Base pay—This is the employee’s hourly rate or an annual salary, without additional pay like overtime or incentives. It’s the foundational amount that you offer new hires. Generally, this amount increases or decreases over time based on the employee’s performance. Base pay can be a solid indicator of the value your company places on an employee’s role and contributions. Moreover, a few factors must align for base pay rates to be effective. The organization must view them as sustainable, externally competitive, internally equitable, legal and defensible, and easy to understand by employees.
• Variable pay—This is pay that isn’t automatically set for the same amount every time. Variable pay may hinge on various factors and is usually based on reaching desired outcomes. An individual’s, team’s or company’s performance is typically the basis for variable compensation. This type of pay is often used as part of a sales compensation plan, such as with commission. Variable payment can increase employee engagement, productivity and earning potential while risking less of the payroll budget. It can take the form of short- and/or long-term incentives, including commission plans, profit sharing, stock options, deferred compensation, signing bonuses and cash recognition awards.
• Differential pay—Also called “premium pay,” differential pay is extra wages paid to employees for working undesirable shifts (e.g., nights or weekends). It can also apply to employees working under adverse conditions (such as unusually cold weather in an outdoor job). Differential pay is typical in the manufacturing industry.

Indirect compensation

Indirect compensation refers to the benefits an employer offers employees, whether voluntarily or as required by law. These often include:

• Health insurance, health savings accounts (HSAs), and flexible spending accounts (FSAs)
• Employee assistance programs;
• Wellness benefits
• Retirement plans, including with matching contributions
• Paid holidays, vacation time and other time off
• Educational and development programs, including with tuition assistance
• Disability, life and supplemental insurances
• Fringe benefits and perks, such as discount programs and company-provided equipment, vehicle or lunches

Now that you know what constitutes “compensation,” let’s move on to creating your compensation plan.

8 steps to consider for developing your compensation plan

1. Define your underlying compensation philosophy

Your company’s compensation philosophy is its moral position on pay and benefits based on your company values. Its consistent framework helps guide your principles about how you dole out money. It also informs what compensation represents  at your company.

Your compensation philosophy will be unique to your company. Best practice dictates adopting a fair compensation policy indicating that one’s pay should match their merits, tenure and skill sets. It remains unbiased in terms of age, gender, race, religion or protected categories. It should stay competitive with other similar roles in similar geographic areas. A practice of fair pay also ensures compliance with employment laws on the issue.

2. Know what you want to achieve

This helps you figure out what skills you need on staff and how to prioritize new hires accordingly. It also helps inform incentive strategies to drive intended outcomes among current employees.

For example, if you need to plug talent gaps, you may take the following steps:

• Note your business goals and rank them based on priority. What objectives must you achieve vs. those you’d like to achieve?
• Define what’s or who’s needed to achieve those goals. Who are the people and what skills and experience levels are required to achieve the goals?
• Document your “people gaps.” Wherever you’re missing talent, record the gap—you’ll need to identify where your business is missing key hires. This demonstrates your ability to anticipate human capital needs.
• Devise a compensation strategy for each gap. You can utilize compensation benchmarking tools to inform your talent costs. Also, you may want to offer higher pay rates for more urgent roles.
• Share your results with your leadership team. Let’s assume you’ve defined your talent gaps and estimated the costs to fill them. The final step is to make strategic recommendations on filling the roles. This could be an internal change in roles and responsibilities. It could also entail attracting, recruiting and hiring new people.

3. Conduct a job analysis for all positions in your company

A job analysis gives you the knowledge to set appropriate pay ranges for each position. The analysis involves carefully observing the role to determine the following:

• Its duties and responsibilities
• Its importance compared to other positions
• The qualifications required to execute the role
• The working conditions for performing the job

4. Obtain market pay rates for all positions and develop pay ranges

You’ll need to understand the going rates for all roles, including salaried employees, hourly employees and any open positions. You can reach out to your personal network or research information with online resources. Either way, you will likely need to dig further for more meaningful data.

A possible more reliable solution is to leverage compensation benchmarking tools offered from various vendors. Salary benchmarking tools can generally provide tailored compensation data for specific jobs in specific geographic regions. In addition, they can provide median wages and salary ranges based on quartiles and estimate salary changes. This info can help project whether demand for the role will increase or decrease.

5. Decide which benefits to offer

This decision of which benefits to provide as part of your compensation plan is driven by several variables, including:

• Full-time vs. part-time employment
• Exempt vs. nonexempt employees
• What benefits your competitors offer
• Which benefits you’re required to provide or offer
• The benefit needs of your workforce
• What benefits you can afford to provide

6. Do not overlook the power of incentives as part of your total compensation plan

Incentives are the perks (typically monetary, but not always) used to motivate existing employees. Examples include bonuses, company stocks, paid holidays and gifts or vouchers. They should tie as closely to performance as possible.

Take note that not all incentives are created equal. Poor incentives fail to motivate staff and may put your company at risk at employee turnover. Conversely, employers who leverage strong incentives can see an increase in revenue, profits, productivity and employee retention.

A soundly constructed incentive compensation plan covers the following:

• Determining the target employees
• The requirements for earning an incentive
• The rewards employees can expect for achieving the goals or standards
• All related timelines for earning and payment of the rewards

Your incentive compensation plan should support efforts that move the business closer to its goals. It should be clear and potentially achievable by all without favoring any particular subgroup. Finally, it should make sense fiscally and within your business’s infrastructure.

7. Stay in tune with your compensation budget

Your compensation budget can give you a sense of how many people you can bring on and level experience you can support. It can also help guide decisions around employees’ raises, promotions, and compensation adjustments.

Your budget helps define the following:

• The total number of people your budget can support on payroll
• The extent of and types of incentive strategies you can use
• Pay ranges for various positions
• The overall compensation package (salary, benefits and perks) you can offer to each worker
• The optimal mix of worker types to retain (contract, full-time, part-time, etc.)

8. Take applicable laws into account

Consider the federal, state and local laws relevant to your business when drafting a strong compensation plan. Some of the most common compensation-related laws include the following:

• Title VII of the Civil Rights Act
• Americans with Disabilities Act (ADA)
• Age Discrimination in Employment Act (ADEA)
• Fair Labor Standards Act (FLSA)
• Equal Pay Act (EPA)
• Affordable Care Act (ACA)
• Employee Retirement Income Security Act (ERISA)
• Family and Medical Leave Act (FMLA)
• State and local wage and benefits laws

Specialized compensation plans

Depending on how your business is structured, you may need to create specialized compensation plans. Let’s look at the different considerations for executives and salespeople.

Considerations for executive compensation plans:

• The organization’s long-term and short-term goals
• What your direct compensation will be, typically based on industry, organization size and sales revenue
• Annual incentives and bonuses, typically based on executive performance and a percentage of profits
• Long-term incentives—these are typically offered to select leaders who directly influence organizational performance and success
• Incentive stock options and restricted stock grants
• Special benefits and additional compensation, such as supplemental health and wellness benefits, non-qualified retirement plan and company-provided vehicle

Considerations for sales compensation plans:

• Will you offer salary and commission or only commission?
• Will the plan consist of salary and incentive or only salary?
• Will incentive earnings be allocated as a dollar amount or a percentage of base pay or sales generated?
• Does the plan meet both your organizational needs and your budget?
• Does the plan facilitate ongoing corporate growth and increased profits?

What if your budget doesn’t fully align with your compensation plan?

When you calculate total compensation, you may be surprised at the cost of offering your ideal compensation package. Don’t panic if you are unable to offer competitive pay (or even median rates) for critical positions. This doesn’t necessarily mean you won’t be able to hire top talent or keep employees. It just means you may need to get more creative.

For example, let’s consider a smaller business that may have a more limited budget. They may have the strategic advantage of being more agile than large corporations. They can be more flexible in incentivizing work from both monetary and non-monetary means. Financial perks (like performance-based bonuses, profit sharing or earning equity in the company) and non-monetary incentives or perks (like flexible work hours or career opportunities) can add value for employees. Lean into that flexibility and develop a total compensation package that delivers real value to your ideal workers. To define its value, you can even allocate a dollar amount to each non-monetary benefit.

Crafting or updating a compensation plan can be especially daunting for small to midsize businesses. Regardless of your business size, it’s essential to align with prevailing conditions. When the goal is attracting and retaining talent in a tight applicant market, creating a structured compensation strategy or updating your current plan to meet demand is crucial.

Aligning your compensation plan with market conditions

If you experience high turnover and exit interviews net a consistent theme—leaving for higher wages—you already know you need to adjust to the market. Even without attrition, periodically verifying you’re in line with the market is advisable. Turnover is expensive. You want your talent that you rely on to be satisfied and not considering other options.

Accessing pay data

There are many resources for businesses to determine market conditions. The U.S. Department of Labor publishes pay data by occupation annually. They list virtually every job category in the country. If employees work under a collective bargaining agreement (CBA), the local union can advise on prevailing wages. But geography and local conditions can significantly affect compensation and benefits variances.

Many businesses feel increased pressure to refrain from discussions about pay history, whether or not it’s prohibited in the employee’s jurisdiction. Numerous companies publish pay ranges in job postings and on their websites, sometimes to comply with state or local laws requiring pay ranges in postings, but sometimes simply for the sake of transparency. Many employers are publishing ranges to attract talent. Wondering what a specific role should be paying? A quick search of comparable openings in your area could give you the information you need.

Compensation in the age of pay history bans

Even if you’re not hiring in a jurisdiction that prohibits discussing pay history, there’s a good chance you will be soon. As of 2025, more than 40 states and local jurisdictions have banned salary history inquiries and legislation on the issue is pending around the country.

Salary history bans purportedly aim to create pay equity. They assume that if two new hires have the same job descriptions and perform the same work, they should receive the same pay. But let’s suppose one new hire has more qualifications, as in knowledge, experience, skills, etc. Shouldn’t that person be compensated at a higher level even though they do the same job?

If previous qualifications factor into performance, they may. An example may be an inexperienced retail associate compared to someone with several years of customer care experience. It might be advisable to create a compensation program with position levels and promote staff as they meet milestones.

Forecasting compensation costs

Remember to include future wages and benefit costs as you craft your compensation plan. Think in terms of total compensation vs. pay alone. Factor in annual wage increases, overtime, incentives, or bonuses planned at the top of the range. As employees meet goals, you’ll be ready to reward them accordingly.

In a good market, a structured compensation plan is necessary to attract and retain the best talent that is aligned with your budget. In a tight market, a comprehensive plan may be mission-critical. You must offer competitive wages and benefits in today’s tight labor market. Whether recruiting new employees or bolstering employee retention, a solid compensation plan is critical to finding and keeping top talent.

Employees today seek a good work-life balance and job security. Regardless, pay and benefits are often communicated as the top motivator. That means a regular review of your compensation package should be a top priority. But how do you do it? Let’s take a look.

When is it time to evaluate your company’s compensation package?

If you haven’t examined your compensation package in several years, it’s probably past due. A lot can change with perpetual shifts in compensation trends. What might have been effective two years ago may be outdated compared to what your competitors are doing. To remain competitive amid the flux, most companies are performing an annual review of their own compensation plans. Typically, this would occur around the time you’re planning next year’s budget so you can discuss and incorporate any necessary adjustments.

In a tight labor market with wage inflation, you may need to review your company’s compensation package more often. This could be the case if, for example, you have a high employee turnover rate. Exit interviews may reveal that compensation is a significant reason workers are leaving. If your job offers are getting turned down regularly, it may be another sign to evaluate your compensation plans. Consider making it part of your business strategy to schedule important compensation conversations with new, seasoned and exiting employees for the insights you otherwise wouldn’t receive.

Key areas to review when evaluating your compensation plan

Often, employees think primarily about base pay when assessing compensation. In business, though, compensation goes far beyond the base pay. When reviewing your compensation plan, you must assess total compensation and working arrangements.

Total compensation

Remember that total compensation, or “compensation packages,” may include any combination of the following:

• Pay—Base wages, commissions, bonus payments, stock awards, and other financial incentives and rewards
• Benefits—Paid leave, sick days, holidays, and health insurance, and other benefits coverage
• Retirement savings—401(k), matching contributions, pensions, etc.
• Programs and perks—Employee assistance, gym memberships, childcare assistance and more

Many employers provide workers with an annual total compensation statement outlining the company’s contribution beyond the base pay employees receive.

Working arrangements

While not directly a type of compensation, you may also want to examine your working arrangements, particularly regarding remote work. Employees are placing a high priority on flexible work schedules or arrangements. They may be willing to trade higher pay for flexible work arrangements. It’s worth considering how this added “benefit” might fit into your larger compensation plan.

Creating and maintaining a compensation plan that works for your business

A strong compensation plan is the backbone of a healthy and thriving business. Your compensation plan as a whole should be reflective of your company’s values, company culture and strategy. Establishing and sustaining a compensation plan that helps recruit and retain talent also requires regular evaluation and monitoring. It’s important to remain competitive within your industry and with other companies vying for the talent you seek.

This communication is for informational purposes only, is not legal, tax or accounting advice, and is not an offer to sell, buy or procure insurance.