Discretionary vs Non-Discretionary Bonuses Explained

As an employer, bonuses present the ideal opportunity to show your appreciation for your hardworking employees and retain your top achievers. After all, if you don't incentivize your team members, they could go in search of companies that do!

While bonuses are a powerful tool to reward employee performance, not all bonuses are created equal. Understanding the differences between discretionary and non-discretionary bonuses is essential for employers to remain compliant and for employees to know their rights.

Here at ShareWillow, we're passionate about sharing employee incentive ideas and how to implement them. In this article, we'll outline the key differences between discretionary and non-discretionary bonuses so that you gain a better understanding of these bonus structures' benefits and potential drawbacks.

What Is A Discretionary Bonus?

A discretionary bonus is a reward given entirely at the employer's discretion, without any prior promise or obligation. Discretionary bonuses can take place at any time of the year, and there are plenty of factors that may be considered, including things like exceptional performance and company profits.

Characteristics

• No predetermined formula
• Given irregularly or as a surprise
• Often used to boost morale or reward exceptional work
• Given at the sole discretion of the employer (beyond the scope of an employee's contract)
• The amount or type of compensation given will also be based on the employer's discretion

Examples

When it comes to discretionary bonuses, a popular example is holiday bonuses, which are often given out to employees during festive periods as a token of gratitude. In 2024, 7% of private industry workers received a holiday bonus in the US.

An employer may also decide to reward an employee for outstanding leadership during a specific project or implement a sign-on bonus for new starts.

As there aren't any rules to follow, employers can give out discretionary bonuses whenever they think an employee is deserving of one.

Google is a well-known company for its generous use of discretionary bonuses, often awarding its employees with random cash bonuses of $1,000 or more!

Legal Considerations

• These bonuses are not usually included in calculations for overtime pay.
• It must be genuinely discretionary to avoid any legal issues. This means that the employment contract should state that the employer has the sole discretion when it comes to awarding bonuses. There cannot be any predetermined criteria in place.
• Employers are not obligated to pay discretionary bonuses.
• Employers need to award bonuses fairly so that they are not accused of discrimination.

What Is A Non-Discretionary Bonus?

Non-discretionary bonuses have contractual obligations and are based on specific criteria, such as performance goals. Employees expect this bonus if they meet the stipulated requirements, so employers cannot decide to randomly withhold the bonus.

Characteristics Of A Non-Discretionary Bonus

• Tied to measurable metrics such as sales targets.
• Paid on a regular schedule (e.g. monthly, quarterly, or annually).
• Employees understand the requirements attached to the bonus.
• Details of these bonuses are usually specified in the employee's contract.
• Employers are contractually obligated to pay the bonus if an employee meets the requirements.

Examples

Some of the most common examples of non-discretionary bonuses include:

• Quarterly performance bonuses based on meeting sales quotas.
• Retention bonuses for staying with the company for a defined period.

Legal Considerations

• The bonus must be included in the calculation of overtime pay under the Fair Labor Standards Act (FLSA).
• Requires careful documentation to ensure compliance.
• Employers cannot withhold the bonus if an employee meets the requirements.
• Performance metrics need to be clearly laid out in the employee's contract.

Key Differences Between Discretionary And Non-Discretionary Bonuses

While there can be certain overlaps when it comes to discretionary and non-discretionary bonuses, there are many differences employers should be aware of.

Let's take a closer look at some of the most important differences.

Criteria For Issuance:

• Discretionary: Based on employer judgment with no prior agreement. These bonuses can be given out randomly as the employer sees fit.
• Non-Discretionary: Pre-determined and legally obligated if criteria are met. If an employee meets the bonus requirements, which are usually stipulated in their contract, the employer needs to issue the bonus.

Legal Requirements:

• Discretionary: Not bound by FLSA rules for overtime pay inclusion. Bonuses need to be genuinely discretionary, and employers need to practice fairness to avoid accusations of discrimination.
• Non-Discretionary: Must be included in regular rate calculations for overtime pay. Bonus requirements need to be clearly stipulated in a detailed bonus program document. Employers are legally obligated to pay these bonuses if employees meet the requirements.

Employee Expectations:

• Discretionary: Since these bonuses are never guaranteed, they usually happen somewhat randomly and can surprise employees.
• Non-Discretionary: The practice creates clear expectations as employees know if and when they will be paid these bonuses.

Use Cases:

• Discretionary: Generally rewarded based on exceptional performance or unexpected company success. They can also be used to reward specific circumstances like project leadership.
• Non-Discretionary: Structured incentives tied to goals like attendance, productivity, or meeting certain standards.

Payment Schedule

• Discretionary: Paid randomly throughout the year at the employer's discretion.
• Non-discretionary: Typically paid at regular intervals, either quarterly or annually. The payment schedule is outlined in the bonus program and/or employee contracts.

Advantages And Disadvantages Of Each Type

Looking at the benefits and potential drawbacks of discretionary and non-discretionary bonuses will help you better understand which type may be best suited to your company and employees.

Discretionary Bonuses:

Advantages

• Flexible and can be adapted to specific situations.
• Boosts morale by surprising employees.
• Encourages employees to excel in all aspects of their work as they may receive a discretionary bonus for their excellence. Research suggests that, depending on the timing of the bonus, it can increase employee output and overall company earnings.
• Can be used as a tool to retain the top achievers.

Disadvantages

• Lack of predictability may reduce employee motivation.
• Not tied to measurable goals.
• Employers may be accused of discrimination if they don't give these bonuses out fairly.
• No transparency in how and why employers give out these bonuses.

Non-Discretionary Bonuses:

Advantages

• Clear and predictable, motivating employees to meet goals.
• Can align with many company objectives.
• Employees know what to expect, creating a sense of stability in their work life.
• Creates a perception of fairness amongst employees as everyone has the same opportunities to receive bonuses.

Disadvantages

• Less flexibility; tied to pre-determined criteria.
• Requires detailed record-keeping for legal compliance.
• May no longer be relevant if your business undergoes rapid transformation. For example, if your business had to grow very quickly, you may need to change the goal posts for performance-based non-discretionary bonuses in order to maintain their relevancy.
• Employees may become hyper-focused on reaching bonus criteria instead of focusing on other company-wide goals.

How To Choose The Right Bonus Structure

Choosing the right bonus structure for your company is essential for employee retention and overall morale. Remember that you can choose to have a mixed structure or you can opt for one type of bonus structure.

Let's discuss a few points that may help you decide.

Factors To Consider:

• Company goals: Discretionary bonuses give you short-term flexibility, while non-discretionary bonuses are typically better for fostering long-term company goals. To determine which is better for your company, ask yourself: "What are the specific goals you want your business to achieve, and how can bonuses motivate your employees to reach these goals?"
• Budget: Ensure sustainable bonus policies that your company can actually afford. If every employee reached the requirements for a non-discretionary bonus, would you be able to pay them?
• Employee preferences: Some employees value surprise rewards, while others prefer guaranteed bonuses. You may want to ask your employees for their opinions before deciding on a bonus structure.
• Look at competitors: Do some market research to determine how other businesses within your industry handle their bonus structures. You can learn a lot from those who have been in the industry longer than you, especially businesses that are known for having high levels of employee satisfaction. While you don't have to copy their bonus structure, you can always look to them for inspiration.
• Transparency: Think about the bonus structure that will offer transparency and fairness. If you value transparency, it may be better to opt for a non-discretionary bonus as all the requirements are clearly laid out for your employees.

Our takeaways

Bonus policies should always closely align with your company culture and business objectives. As many different aspects of your business can change from year to year, it's a good idea to regularly review and adjust your bonus strategies to stay competitive.

In most cases, it's usually best to go with non-discretionary bonuses. While discretionary bonuses can offer flexibility and excitement, they can often lead to disappointments by employees who may feel left out. Employees may also feel frustrated by not knowing exactly how to reach bonus goals.

FAQs

What are some of the types of discretionary bonuses?

Some of the most common types of discretionary bonuses include:

• Referral bonuses: Bonus payment awarded to employees for referring successful candidates.
• Profit sharing bonuses: Used to share company profits with employees.
• Group production bonuses: Awarded to teams within your business for reaching certain goals.
• Holiday bonuses: Given to employees during the festive season.
• Spot bonuses: Awarded directly after exceptional contributions by a specific employee or team.
• Performance bonuses: Awarded to employees for excellent performance.
• Safety bonuses: Used to incentivize employees to maintain high levels of safety in the workplace.

What does the Fair Labor Standards Act say about bonuses?

Under the FLSA, employers can exclude discretionary bonuses when calculating the regular rate of pay for their employees. However, non-discretionary bonuses must be included in employee's regular rate of pay calculations.

What is discretionary allowance?

Discretionary allowance refers to a range of additional compensation benefits that employers offer their employees. These benefits go beyond what is legally required and can include things like discretionary bonuses, wellness programs, family benefits, and other discretionary rewards.

Are businesses legally required to give out bonuses?

No, it's up to the employer whether they want to give out any type of bonus. However, employee bonuses offer a wide range of benefits and are common across all sorts of different industries.

Ensure You Have An Effective Bonus Structure In Place

Discretionary and non-discretionary bonuses serve different purposes, each with its own unique benefits and challenges. By understanding the distinctions and legal implications, employers can create effective bonus structures that motivate employees and align with organizational goals.

Whether you're rewarding exceptional performance or setting structured incentives, choosing the right approach is key to fostering engagement and compliance. In most cases, a mixed bonus structure can work well but non-discretionary bonuses tend to be the most straightforward and transparent.

Are you looking for better ways to implement and manage incentive plans? Here at ShareWillow, we can curate a customized plan that meets all your criteria. When it comes to incentives like profit sharing and bonus plans, we offer streamlined solutions to help you retain your top employees. Book a demo to learn more about the best compensation plans based on your specific industry.