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by Lee Ann Obringer
Introduction to How Employee Compensation Works
If you own your own business, your employee compensation and benefits package
can be the deciding factor for many potential employees. And it's not just the
money. To make your company competitive and attractive to job candidates, you
have to offer an exceptional total benefits package. That makes it a very
important part of your business planning and management process if you hope to
hire (and keep) top employees.
So how do you make your benefits package attractive and competitive without
financially jeopardizing the success of your business? How do you get the best
deals on insurance? What perks can you offer that won't cost you additional
money, but will mean a lot to your employees? Are stock options the way to go?
How do you set salaries? What benefit costs are tax deductible? There are
probably 100 more questions popping into your head as you start thinking about
how to set up and manage these policies.
In this article, we will answer some of those questions and direct you to
resources to help you find answers to the ones we don't get to here.
Setting Up Your Compensation Structure
Although money isn't everything, it certainly is one of the top issues
potential employees look at when interviewing new companies. (Yes, face it,
they are interviewing YOU.) Whether you're offering a straight basic salary
structure or an incentive-based pay structure may make or break you in the eyes
of top job candidates. Let's look at how each system works.
A standard base pay program offers fixed salary ranges for each position type
for employees performing the standard duties of their jobs. Set up minimum and
maximum levels within those pay ranges to account for variations in experience
and skill levels. When setting the base pay structure, determine where your
company falls within your own industry as well as competing industries that may
also offer job opportunities for your employees. Set up your pay levels to be
competitive, or else you risk losing employees. You can use the Internet to
find industry-standard salary levels for specific jobs in specific geographical
areas. Click here to search for Web sites with free-access databases of salary
information.
Once your base pay structure is in place, most companies then set up a merit
pay program that will take the employee through the salary range for their
position at a performance-driven speed. This comes into play when the
employee's managers do annual employee performance reviews. The downside of
this is that employees may begin to see it as a given that they will get a
salary increase after each evaluation, and it ceases to be a motivation to
perform better in their jobs. For this reason, more companies are moving toward
more of a reward-based compensation style, also called Incentive Compensation.
Incentive-based compensation is becoming much more common because of the
increased emphasis on performance and competition for talent. This type of
compensation structure significantly helps motivate employees to perform well.
Hiring bonuses are also frequently used now, even for new college graduates.
However, you might want to tie in a specific time period prior to the employee
collecting this bonus -- for example, one-half after six months and the
remainder after one year of employment. Otherwise, you could run the risk of
the employee departing after that first check, which would defeat your purpose.
So does that mean incentive compensation is the way to go? Maybe so, if your
business is in an industry where you really have to compete to get good
employees.
Setting up an incentive-based compensation program requires the same research
into your industry as the base pay program. You'll still establish base pay
levels, but it may be slightly lower and you will build into that base the
annual or quarterly (or any other interval) bonuses, commissions, or other
types of shared cash compensation.
In the next section we'll talk about other forms of compensation, including
bonuses, commissions, and vacations.
Forms of Compensation
Your bonuses should be based on achievement, and should include all of your
employees. Don't limit your incentive program to certain employees, or you'll
limit your company's potential. You'll also lose the benefit of the
team-building effects of incentive-based compensation. If everyone is going
after the same goal, they'll have a better chance -- and your company will have
a better chance -- of succeeding.
Your rewards should also be based on results and not simply the activity level
of the employee. Just because they try doesn't mean they should get the bonus
that those who actually produce results get.
Don't put a limit on the amount of the bonus; you'll only limit the effort your
employees put into the job. Once they reach the limit, they'll feel they can
kick back and relax. Keep it open and they'll continue to produce.
Tying your employees' compensation to the results they produce will help them
focus on the company's bottom line. You can also tie in long-term incentive
compensation in the form of stock options and deferred compensation plans (more
about stock options later in this article). These types of plans not only
compensate your employees for good work, but also help retain them.
For your sales staff, an incentive-based pay structure will almost always
produce better results than a straight pay structure. Although your customers
may experience a less-pressured sales pitch from a salaried sales rep, they
probably won't purchase as much, either. Putting in place a commission-based
pay structure for your sales staff can directly affect your sales numbers. If
their income is directly related to their performance and no ceiling is placed
in their way, then the sky really can be the limit. If you have talented sales
staff, they will thrive in this type of environment; if you don't, then they
usually won't. You can easily detect who is producing and who isn't and weed
out accordingly -- or at least know who requires some additional sales
training.
There are also disadvantages to commission-based pay structures for sales
staff. Often, employees focus entirely on the sale of items that give them the
highest return for their time and don't really take into consideration the
actual needs of the client. Customer service may also suffer because the sales
rep has moved on to the next high-dollar sale. What you have to do is make sure
you have a good combination of both a base salary and sales commission. Your
base salary has to be sufficient to attract good candidates, but not so good
that you'll get reps satisfied with the base amount even if they don't make any
sales!
It's a delicate balance. Your type of business will also play a part in
determining the type of pay structure you offer your sales staff. If you offer
a single product with few variations, then a straight commission structure may
work for you. If you offer several products or services or a combination of
products and services, then your sales approach is going to require more of a
relationship-building technique and probably more continued customer service if
you want to make additional sales to your existing customer base. In this case,
your base salary may be more important. Also keep in mind that this pay
structure can evolve over time. If something isn't working, then you can adjust
it. Just make sure your staff understands that when you hire them.
In addition to regular benefits packages that include health insurance,
vacation, and retirement plans, employees seem to be actively seeking companies
who offer more of the things they value. Balancing their lives is becoming more
important than ever. Because of this, other benefits like flexible schedules,
relaxed atmospheres, childcare and other lifestyle benefits are becoming almost
as important as salaries. In fact, according to data compiled by WorkLife
Benefits, 90% of 1,000+ employees polled by the Gallup Organization in 1998
said that work/life balance is as important as health insurance. More than
one-fourth of surveyed workers said that balancing work and family is more
important than a competitive salary, job security or support for an advanced
degree. But these other perks, as well as other intrinsic rewards, can
definitely have a strong effect on how employees feel about their employer and
their work environment, and can help retain employees who might otherwise
leave. We'll talk more about fringe and other added benefits throughout this
article.
If you're a small employer and doing your own payroll, you'll also need to stay
on top of changes in employment taxes. As of January 2001, Social Security tax
was 6.2% and Medicare tax was 1.45%. Each requires you, as the employer, to
match the amounts withheld for a total of 15.3% to be paid to the IRS. You must
also pay unemployment taxes if your employees earned at least $1500 in one
calendar quarter. Visit the U.S. Treasury Web site for up-to-date information
about income-tax withholding, Social Security and Medicare withholding, as well
as rules about when and how you should be depositing these taxes (more on this
later in the article).
If you have hired independent contractors, you are not required to withhold
taxes or match amounts. You do, however, have to be certain that the worker
would be classified as an independent contractor. As a rule of thumb, whether
workers are contractors or not is determined by who controls their time and how
and where they do the job. Again, visit the U.S. Treasury Web site for
up-to-date information.
Each individual state also has withholding requirements. A Website like this
Tax and Accounting Site Directory can provide you with links to an individual
state's treasury office, which will provide up-to-date information regarding
unemployment insurance, income-tax withholding, and any additional taxes that
might be required.
Now, let's move on and talk about the "I" word: Insurance.
Health Insurance
Insurance premiums will probably cost you about 8% to 10% of your payroll
amount. The majority of this will be your health insurance premiums. So what
are your options and how do you find the best deal? There are currently three
main types of health coverage you can offer to your employees: traditional
coverage (fee-for-service), HMO (health maintenance organization), or PPO
(preferred provider organization).
With a traditional health coverage plan, your employees will have the most
flexibility. They can see the doctors they want to see, go to hospitals all
over the country, and change doctors whenever they want to. These plans are,
however, more expensive and usually don't cover preventive health care like
physicals, immunizations, and well-child care. There are three variations of
traditional fee-for-service coverage: basic, major medical, and comprehensive.
Basic covers some of the costs of a hospital room and care, but not everything.
Major Medical begins where Basic leaves off, and Comprehensive is a combination
of the two.
With traditional health coverage, employees will have to pay a deductible
(usually $250 to $500 per year) before the insurance begins paying anything. At
that point, the insurance company begins paying 80% and the employee is
responsible for the remaining 20% of all medical bills. They do usually have a
"cap," which is a limit on the amount the employee will have to pay in one
year. Once the cap is reached, the insurance company pays the excess.
There may also be limitations on how much the plan will pay for particular
services. These are called "customary fees." If an employee's doctor charges
more than the average amount for a particular procedure, then that employee is
responsible for the remainder of the bill.
One of the most loved and hated types of plans is the health maintenance
organization (HMO). HMOs are basically prepaid health plans. With an HMO,
employees can only go to specific groups of doctors that are either owned by or
have contracted with the health maintenance organization.
Small co-payments of $5 to $25 dollars are made by employees for office or
emergency room visits, and the services are sometimes limited. Usually
employees are required to select a primary care physician (PCP) who will
monitor their health and make any necessary referrals to specialists. They
typically can't see a specialist unless the PCP approves and makes the referral
(unless they want to pay for it themselves).
HMOs operate on the premise that if they keep you healthy and take care of
small problems before they become large ones, then they'll make more money over
time and people will be healthier. Because of this, they usually do cover
preventive care like physicals, well-child check-ups, etc. They also usually
have less paperwork for patients to fill out.
The last health insurance option is the preferred provider organization (PPO).
PPOs combine the best of both the traditional insurance and HMO worlds. Like
the HMO, there is a list of providers that your employees have to choose from
(a network) and they must select a primary care physician. They don't have to
fill out much paperwork when they go for a visit, just pay a small co-pay, and
most preventive care is covered. The difference is that they can also go
outside of the list of approved physicians to any doctor they want. They just
have to pay more and fill out claims forms.
Most employers also include dental coverage and vision coverage. Typically,
dental coverage pays 100% of preventive services, 80% of procedures such as
fillings, and 50% of major procedures such as crowns. Vision coverage will
usually pay for one vision exam per year and one pair of glasses.
It pays to find a good broker when looking for health insurance policies. The
broker may represent plans from up to 15 different insurers, allowing you to
get a better feel for what is available and do more comparison shopping. Be
aware, though, that most insurer's will only prepare a quote for your company
once, so be sure you have selected a good broker before you have them get
quotes.
When you're evaluating the plans, check the deductibles and co-insurance rates.
If a policy requires a co-payment that is more than 25% of the procedure
amount, then look elsewhere. Make sure there is a good range of services
offered and that long-term illnesses and pre-existing conditions are covered.
There should also be at least $1 million in coverage. Also check on typical
charges from local doctors to make sure the maximum reimbursement for a
particular procedure is not too low.
Next, you'll need to check out the insurers. You can find out about their
financial health at Standard and Poor's. In addition to their financial health,
you'll also need to investigate their claim payment history. You don't want an
insurer who doesn't want to pay claims. Your broker should be able to help you
in this area.
Compare their pricing, their services, their service areas and lists of
physicians (if HMOs or PPOs), and remember, your employees (and you) will have
to live with your choice -- so do your homework! You can get a list of
registered health underwriter brokers in your area by contacting the National
Association of Health Underwriters.
If yours is a small business, you can call your state department of insurance
to find small business group health providers in your area, or else look into a
health purchasing alliance or association plan. These plans allow small
businesses to purchase insurance as part of a larger group.
Health purchasing alliances provide a needed service for small businesses by
providing a way for them to purchase group insurance at lower fees than they
normally could. The alliance purchases the health plan for its members (small
businesses) and has a third-party administrator manage the plan. Be prepared
for the underwriting process with this type of group coverage. It will often
involve all employees filling out a questionnaire regarding their health as
well as their family's health. Also, check into the operations of the alliance
to ensure that all of the funds are managed correctly.
You can also check with trade, professional and other associations to see if
they offer group health coverage.
Read on to learn about other types of insurance.
Disability and Life Insurance
Long and Short-Term Disability
In the United States, short-term disability (STD) is not provided by many
employers, however, some states do require it for up to 26 weeks. It is
designed to replace an employee's income on a short-term basis as a result of a
disability, and is usually equal to about 60% of the employee's gross weekly
pay. This way, the amount the employees draw is closer to the amount of lost
income that the employee actually took home (net) prior to the disability.
Long-term disability (LTD) is not required by law, but some companies do offer
it as a standard benefit. Long-term disability is lost-income coverage that
kicks in as a result of a disability. It is also based on about 60% of the
employee's gross income. There is usually an elimination period of 30 to 180
days before the benefits will begin, so it typically picks up where short-term
disability ends (if STD is offered). LTD benefits can continue on for life,
although most terminate at age 65 when social security kicks in. Many employers
pay all of the long-term disability premiums.
Some companies pay for short-term disability and make the long-term optional,
sometimes at a reduced cost to the employee. The logic behind this is that you
want the employee to come back to work after a short, unforeseen accident or
injury -- employers rarely see an employee come back from a long-term
disability. Also, there are many variables in selecting the policies,
everything from the exclusion period, which can be based on different time
periods if it's an injury or illness, to pre-existing condition limitations,
self-reported claim limitations, own-occupation protection, and rate guarantee.
And, if the company pays for the benefit, it is considered taxable income; if
the employee pays for the benefit, it is considered insurance and is
non-taxable.
Think about your workplace and consider the types of accidents that could
possibly occur to help decide what types and levels of disability insurance you
should cover. Also, remember to go through a reputable broker to get the best
deal.
Life Insurance
Depending on the size of your company, you can offer group life insurance to
your employees for as little as 5 cents per $1,000 worth of coverage. Not a bad
deal! Your employees and prospective employees will appreciate it because it
means they won't have to get physicals before they're covered, and usually they
can convert the plan to an individual life insurance plan if/when they leave
the company.
The most common coverage for employees is a policy equal to their salary. In
most cases, the employer pays the entire premium. Some companies also allow the
employee to purchase additional coverage for family members or themselves at a
low monthly cost. The insurance rates will be evaluated every five years to
account for rising (or falling) average ages of employees, so rates may
fluctuate depending on the demographics of the business.
If your business has fewer than 10 employees, you probably won't be able to
purchase group life insurance.
Next, let's go over paid leave. Not only do you have to pay your employees when
they work, but you sometimes have to pay them when they don't...
Paid Time Off
You'll spend about 10% of your payroll on paid time off. Paid time off is a
very highly rated benefit, especially with so many workers trying harder to
balance work and family life.
Most companies provide paid holidays for all of their employees. The national
average is 10 1/2 paid holidays per year. These are typically New Years day,
President's day, Memorial day, Independence day, Labor day, Thanksgiving day,
the day after Thanksgiving day, Christmas Eve, and Christmas day. In addition
to standard holidays, some companies also provide one to two floating holidays
or personal days. These days can be used whenever the employee would like to
use them and often make up for religious holidays that are not part of the
company's standard paid holiday schedule.
The average number of vacation days provided for new employees is 10 per year,
with increases to 15 after five years and 20 after 10 to 15 years. Vacation
time is accrued on a monthly or quarterly basis, and most companies use a
calendar year to make their recordkeeping easier.
When cold and flu season strikes, your employees will begin taking advantage of
the paid sick days you're offering. Most companies provide 6 to 9 sick days.
Unlike vacation time, the number of sick days companies offer typically doesn't
increase as the years go by, and if you set a policy of not carrying over
unused sick leave to the following year, be prepared for a lot of sniffles in
December. Some companies allow employees to use their paid sick days to also
take care of family members who are ill. Make sure you set a policy and stick
to it.
Some companies (about 25%) offer one larger lump of paid time off (PTO) that
can be used however the employee sees fit. A typical scenario might be to
provide three weeks of paid time off for the first five years, then step up the
amount to four weeks after 10 years, and so on.
In either the paid vacation or PTO situations, employees would have to request
the time off in advance, except for emergencies. The time can typically be
taken in half-day increments. The time is accrued on a monthly or quarterly
basis and banked until the employee uses it. If the employee leaves the job,
the employee is usually paid for the banked time.
Whether you allow unused vacation days or PTO to carry over to the following
year is up to you. Some companies allow a certain number of days to carry over,
but any days over that number are lost. Others allow employees to get special
permission from their managers to carry over days with the stipulation that
they be used by a certain date the following year. Carrying over sick days from
one year to the next is another issue to wrestle with. Take into consideration
the impact it would have on your company to have employees out for extended
periods of time with full pay because of stored sick or vacation pay, this in
addition to having to cover for the loss of their productivity. Also remember
that carrying forward these banked days to another year can create headaches
for your bookkeeper, accountant, or controller.
Read on to learn about other benefits.
Other Leave and Benefits
Jury Duty, Military Leave, and Bereavement
Don't forget to include policies on jury duty, military leave, and bereavement.
These situations may come up more often than you think, and even if yours is a
small company, you need to have policies in place to address these so that you
know you're handling them consistently. Typically, companies allow up to two
weeks per year for jury duty or military leave and up to three days per year
for bereavement.
You'll also need a policy on maternity and/or paternity leave. Whether this
leave is paid or unpaid is up to you (more on this later).
Domestic Partner Benefits
The very controversial subject of employment benefits for domestic partners has
become more commonplace over the past few years. If yours is a very diverse
workforce, you may want to consider covering domestic partners in your benefits
program. The focus of most domestic partner benefits seems to be health care,
but many also cross over into life insurance, family leave, and other areas.
While you may think the reasons for including domestic partner coverage in your
benefit program are simply a commitment to diversity and public image, also
remember that your closest competitors may be offering this. If you don't offer
it as well, you may be hindering your own efforts to attract talent to your
workforce. Your company's values, beliefs, and your labor market will all be
deciding factors in whether you offer domestic partner coverage.
Check with regulations in your state's insurance laws and also with your
insurer, because there are still a few restrictions that may affect your
ability to offer the benefit even if you want to.