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.

Stock Options/Profit Sharing

Often used as a tool to retain employees, stock options have a growing appeal in today's job market. Depending on the business and industry, stock options can be a very valuable and enticing benefit to offer employees and potential employees. Deciding to offer stock options is a no-brainer; deciding on the type of option plan is another story.

There are three classes of stock options: incentive stock options (ISO), employee stock purchase plan options, and nonqualified options.

The most popular plans are ISOs and nonqualified plans. With both of these plans, the employee is offered a specific number of shares that they can purchase (exercise) on a specified date. The shares can be purchased at the value of the stock at the time the option was granted. So, if the stock's value has increased when the employees exercise their option, then they get a good deal; if not, then the stock options are worth nothing.

These two plans differ in the way the money is taxed. With ISOs, the employees pay no taxes until they later sell the shares they have bought (exercised). At that time, any money they made off of the transaction is subject to capital gains tax instead of income tax. They must, however, make sure they don't sell the shares for at least two years after the time the option was granted or within one year after they exercised their option (bought the stock). Another thing to consider is that there is no corporate deduction when the employee exercises the option.

With nonqualified plans, the tax situation is different. Employees will have to pay income tax on any gains they made when they exercised their options (assuming the employee is making a profit based on the current value of the stock). For example, if the stock was valued at $2 per share when the options were granted and is valued at $5 when the options are exercised, then ordinary income tax must be paid on the gain of $3 per share. There can also be a corporate deduction on the same amount. Later, if the employee keeps the stock and it increases more in value, then they will only owe capital gains tax on the additional increase in value when they sell.

Employee stock purchase plans are another option for employers who want to lure new recruits. Unlike the ISOs and nonqualified plans, employee stock purchase plans are usually offered to all eligible employees. Employees can purchase the stock at usually about 85% of its market value. Most companies allow employees to purchase stock amounts up to 10% of total pay, and offer payroll deductions for payment.

Another lesser-known option particularly appealing for small and private companies is the phantom-stock plan. Phantom-stock plans operate in a similar manner as the other stock options, but the risk of sharing equity in the company isn't there. You can issue shares to your employees at a set price based on your company's current value, then on a specified future date reevaluate the company's value. If the stock has risen and the employee wants to sell, then you cut a check to the employee for the increased amount. Your employee will pay tax on the additional "wages," and your company can take a tax deduction.

Profit Sharing Plans

About 40% of companies offer profit sharing plans. Profit sharing programs require setting up a formula for distribution of company profits. The formula is usually based on 5% to 6% of the employee's salary. They usually include a vesting period of up to seven years. The good thing about profit sharing plans is that they allow you to decide if and how much your company contributes to the plan. During less profitable years, you may opt to not contribute. It also lets you control how the money is invested and is not as expensive to administer as other plans.

Employee Stock Ownership Plans (ESOPs)

ESOPs are the most common form of employee ownership in the United States. They allow your employees to own a part of the company without requiring them to purchase stock. Your company can be either public or private, and stock is usually transferred to the employees through annual contributions. ESOPs, like the other employee stock ownership methods, can improve your bottom line through employees' heightened awareness and vested interest in helping the company be successful. If you are interested in transferring some or all ownership to your employees, then this might be a good option for your company. The contributions are tax deductible, you can borrow against the ESOP, and stock owners can sell their shares back to the company when they leave and escape paying taxes if the money from the sale is transferred into another security. ESOP accounts are tax deferred until retirement.

Next, we'll talk about retirement plans.

Retirement Plans

Your company's retirement (or pension) plan is not only good for your employees, but it's also one of the best tax shelters available -- both for your company and your employees. You can deduct contributions, and the contributions are tax deferred to the employee.

Pension plans fall into two categories: defined-contribution pension plans, and defined-benefit pension plans.

Defined-benefit pension plans are plans that have a set benefit, and contributions that a company makes to the plan are based on actuarial assumptions. Your employee will know what their retirement amount will be and can plan accordingly.

Defined-contribution pension plans base your employees' benefits on the amount of money contributed to the account. Some of the types of accounts that fall into this category include: profit-sharing pension plans, money-purchase pension plans, target-benefit pension plans, stock-bonus pension plans, ESOPs, Thrift savings pension plans, and 401(k) pension plans.

401(k) Plans

The most popular of the defined-contribution pension plans is the 401(k). It has been around since 1978, and allows employees to contribute up to $12,000 of pre-tax money ($12,000 as of 2003; this increases by $1,000 each year until it reaches $15,000 in 2006), which is the highest of any of the pension plans. The employee and employer combined cannot contribute over $40,000 annually (or an amount equal to the employee's salary, whichever is less) to the employee's account.

401(k) plans let your employees save for retirement easily and conveniently through pre-tax automatic payroll deductions. It's money they don't see, so they don't miss it. Implementing a 401(k) plan can improve employee morale and help in luring in new employees. The money your employees contribute, as well as your contributions and their account earnings, are all tax deferred until they actually withdraw the money when they retire. Employees have full control over their investments. Withdrawals are also permitted at termination of employment or during financial hardship, but a 10% penalty tax is charged if they are younger than 59 1/2 years old. Many companies allow terminated employees or employees who elect to leave the company the option to keep their 401(k) account, but they can no longer contribute to it.

As an employer, you are not required to match contributions or contribute at all to your company's 401(k) plan; however, to be competitive, most employers do. You do have the flexibility to alter your contributions year to year based on the profitability of your company. You even have the option of contributing on behalf of employees who aren't participating as long as they are eligible. Your contributions are tax deductible, like with the other plans. You can also set up a vesting schedule for the contributions you make to your employees' accounts. This is just another way to help motivate employees to stay with the company longer.

The down side of 401(k) plans is that they are usually expensive to administer.

In the next section, we'll learn about money purchase plans.

Money Purchase Plans

Money-purchase plans are like profit sharing plans that require a set amount (usually a percentage of the employee's salary) be contributed by the employer each year, even in years where there is no profit. Employees can contribute up to 25% of their salaries or a maximum of $40,000 per year. On the flip side, money-purchase plans give employers the maximum tax advantage possible.

SIMPLE IRA

If you have 100 or fewer employees and offer no other retirement pension plan, the Savings Incentive Match Plan for Employees (SIMPLE) IRA provides a simplified way to make contributions to a retirement plan either for yourself if you're a sole proprietor, or for your employees. With this plan, your employees can make monthly contributions (salary deferrals), and you, as the employer, have the option of two types of contribution methods. You can either match the first 3% of the employee's contribution dollar for dollar, which by the way does help encourage participation by your employees, or you can opt to make a non-elective contribution equal to 2% of your employees' pay. If you choose to match your employees' contributions, you do have the option of altering the amount to fall somewhere between 1% and 3% for two out of every five years.

Your employees can contribute up to $8,000 in 2003, and no other contributions -- other than your employer match or non-elective contributions -- can be made. If the employee is less than 59 1/2 years old and hasn't contributed to the plan for at least two years, then withdrawn funds may face a 25% penalty tax.

The SIMPLE IRA has lower administrative costs than other plans. The plan is simple with regard to reporting requirements, and it isn't subject to nondiscrimination and top-heavy rules that limit the benefits provided to your highest paid employees. Your contributions are tax deductible. Your employees will be immediately 100% vested. They can set up their investment portfolios to suit their own goals and situations. They can also roll the account over to another SIMPLE IRA account with no tax penalty.

SIMPLE 401(k)

The SIMPLE 401(k) plan has many of the same requirements and features as the SIMPLE IRA, but it allows your employees to contribute a pre-tax portion of their salary. This plan will give your company a leg up in more competitive job markets. As with the SIMPLE IRA, you must have fewer than 100 employees and offer no other employer-sponsored retirement plan. Your contributions are tax deductible for your business, and you can contribute up to 15% of your eligible employees' salaries. Employees can invest up to $8,000 in 2003, can tailor their own investments, can borrow from their accounts, and earnings are tax-deferred until they are withdrawn.

Simplified Employee Pension (SEP) Plan

An SEP plan is basically individual IRAs set up for all of your employees that aren't subject to the $2,000 per year IRA limit. As an employer, you can contribute up to 25% tax deferred of your employees' annual salaries (up to $40,000), and can set the plan up at any time during the year. Your employees can control how their accounts are invested, and are full-owners (there is no vesting period) from the very beginning. Your employees do, however, have to be at least 21 years old, and have to have worked for your company for at least three of the past five years.

There are several benefits of an SEP plan. They are simple to set up and administer, and you have no government filings to maintain because the employees are responsible for their own accounts. You can change your contributions at any time, and the contributions are still tax-deductible for your business. To set one up, you have to implement a written agreement to provide benefits to your eligible employees, give the eligible employees information about the SEP and have them set up SEP-IRA accounts (or you can set up the accounts for them).

Aside from these most common benefits discussed so far, there are many other forms of benefits you can offer your employees.

Other Benefits and Policies

There are many other benefits you can offer your employees that will both give your company an edge in recruiting and retaining talent, and provide your employees with some of the things that make work a little more rewarding. Added benefits make your organization more effective on many levels. Issues like childcare, education assistance, adoption assistance and flexible schedules can help your company gain an advantage over the competition and find and retain your most important resource. Good benefits and company perks can improve employee morale and, in turn, have a very positive affect on your bottom line. Let's go over some of the other benefits you can offer your employees that will give your company a competitive edge in recruiting.

Dependent Care Assistance

According to a study by WorkLife Benefits in Cyprus, California, 20 percent of non-working mothers of young children do not work because they see quality childcare as unaffordable or unavailable. Dependent Care Assistance is not limited to childcare. It can be elder care, or care for any family member. Employers can offer flexible working arrangements, care resources and referrals, financial-planning assistance, long-term care insurance, and dependent-care assistance accounts. You can also provide educational services for your employees to help them learn more about their options.

You may also consider opening a company-sponsored childcare center. There are many benefits, including a boost in your company's ability to recruit and retain employees. Company productivity will be increased because your employees have reliable childcare and fewer absences. It also helps give your company more of a family-oriented reputation, which in today's workplace is a definite plus. The downside to a company-owned childcare center is the fact that you have to keep the center going even if your employees have few children. You'll also be paying up to one-third of the expenses of the center if you want it to be affordable for your employees. For some companies, this is the perfect solution; for others it isn't. But most who have existing centers believe they have definitely saved money over the long run.

Adoption Assistance Programs

An adoption-assistance program for your employees can range from simply providing resources and recommendations, to paid maternity or paternity leave, to providing financial assistance for your workers who are trying to build families through adoption. Many companies are now beginning to provide adoption assistance services.

You can set it up in any number of ways. You can offer paid or unpaid leave, contract out for referral services, or pay a lump sum or a percentage of the actual cost of the adoption and related fees. For many employees, just having the leave available and the emotional support of the company is the most important thing. There are also many families who could never hope to adopt if it weren't for the financial assistance and support of their employers.

Think of your adoption assistance as simply an equitable alternative for employees who choose adoption. If you've always provided good maternity benefits, then this evens out the score for everyone. It is also not an expensive benefit to offer simply because there aren't that many employees who will take advantage of it. But, for the employees who do, it is priceless.

Once again, this is another way of building a stronger, more loyal workforce. You'll reap the benefits as a company through lower turnover and higher productivity.

Outplacement Services

Outplacement services are services a company offers to assist their employees quickly find new job opportunities when drops in revenue, reorganizations, and other reasons force a cut back in staff. This assistance can come in the form of group programs, support programs and one-on-one consulting with an external consulting group. Fees for these outside services range about 15% to 20% of the terminated employee's salary (plus bonus).

Education Assistance Programs

Many employers offer assistance for employees who want to gain additional education or degrees. If you think about it, your employees' skill levels are what make your business successful -- or not. Investing in job related training and education for your employees will not only improve the abilities of your employees to do their jobs, but -- as we've mentioned a few times already -- it will improve their morale and perhaps make them stick around a little longer.

But, you're probably now saying, "What if they get the training or degree and then leave anyway!" That may happen too, but most likely you'll experience just the opposite. In fact, by acting as a mentor to your employees and supporting their efforts to gain more education, you'll probably see a large payback for your efforts.

If you decide to implement an education assistance program, take some time to think through what you want to offer. Some questions you should ask yourself include:

  • How much money will the company offer in assistance? (The IRS will allow you to contribute a maximum of $5,250 tax-free.)
  • Will you pay varying percentages of the tuition based on the grades the employee gets for the course?
  • Should it be limited to courses related to the employee's current position, or other positions within your company? (Usually, this is required by most employers.)
  • Will all of your employees be eligible? (Will it be offered to part-time employees as well as full-time?)
  • Will you have a contract in place that the employee must sign guaranteeing they will stay with your company for X months after they complete the training?

Employee Achievement/Merit Awards

Honoring your employees who have high achievements is not only a good way to improve morale and loyalty, it's just a nice thing to do. Often all employees really want is just a verbal acknowledgement of a job well done. Of course, throwing in some monetary thanks is also appreciated.

Golden Parachutes

Golden parachutes are not for when your executives go on that skydiving retreat that costs the company thousands! They are contracts you set up with your top executives that will provide them with special benefits in the event they lose their jobs due to takeovers or acquisitions by another company. These benefits are typically quite generous and come in the form of a large severance package, a large one-time bonus that only comes when employment is terminated, and/or stock options.

Now, your executives won't be rolling in the dough forever, remember they have to get back out there and pound the pavement. They just might not have to pound it as quickly as they might have before. Some more generous hearts also use some of their funds to help others. They will, however, have to pay a 20% tax on the total amount of their payment.

Cafeteria Plans and other Flexible Benefit Plans

No, we're not talking about banana pudding specials and Meatloaf Mondays. Cafeteria plans are a type of flexible benefit plan that let your employees choose from a list of benefits they wish to participate in. Choosing to participate will often allow the employee to reduce their taxable income because they are paying or contributing with pre-tax dollars.

There are five main types of these flexible benefit plans. They include:

  • Premium-Only Plans - With this type of plan, employees can pay their portions of the insurance premiums with pre-tax dollars.
  • Spending Accounts - This plan allows your employees to put aside pretax money into accounts to be used for dependent care or medical bills.
  • Full Flexible Benefit Plans - These plans give employees both a choice in selecting from the menu of benefits, as well as an allowance to spend on those benefits. Any benefits they want to add that will be more than their allowance would be paid for with pre-tax dollars in some cases and post-tax in others.
  • Variable Credits - This option allows you to base the employee's allowance on their performance or certain health aspects such as smoker vs. nonsmoker, seat belt use, and other criteria. Credits are given based on these factors.
  • Modular Plans - This type of plan puts your employee's choices into packages. Usually the packages are set up with specific groups in mind so they can target their needs. They are divided into groups based on demographics such as young single workers, families, and older couples.

Employee Assistance Programs

Employee Assistance Programs are provided by many employers. These programs provide your employees with somewhere to turn in the event of a personal problem that affects all aspects of their lives, including their jobs. If you, as the employer, ignore these types of problems then you may find less loyalty and more employee burnout.

These programs have a large counseling element, although their goals are to maintain and even improve your company's production. The EAP can help your employee determine the problem and find the right kind of help. They can also help management have a better understanding of the types of problems their employees may be facing, both personal and work-related. Some of these problems may be stress that is related to job security, conflicts with others in the workplace, divorce or other family problems, substance abuse, or financial problems.

Depending on the size of your company you can opt to have an on-site certified employee assistance professional, or you can contract with someone outside. Things to remember include checking with your medical insurance and making sure whomever you use for your EAP knows the limitations of your medical insurance. (In fact, some medical insurers offer varying forms of EAPs in their total insurance package, so make sure you check with them first.) Try to find an EAP who is familiar with your type of business and the types of problems you see most often in your workforce. The business of the EAP is a relationship business, so make sure you choose someone you and your employees will feel good about talking to. If you don't, it's not the benefit you want it to be.

Other Benefits to Think About

  • Paid moving expenses
  • Transportation discounts
  • Leave sharing plans
  • Scholarships
  • Low-interest or interest-free loans for employees

You may be asking if there is anything you can offer your employees that they will like that doesn't cost you anything? Well, you're in luck. Read on and find out about some great perks that are almost entirely free.

Cost-free Benefits and Perks

Sweetening the pot with some additional perks may swing a job candidate your way and cost your company next to nothing. We're talking about flex time, direct deposit of paychecks, having good policies on personal leave that fit in with employees' goals, employee recognition programs, holiday parties, etc.

Flex Time

Allowing flexible work schedules in your business is very often the most strategic thing you can do from a hiring standpoint. Often companies that offer flex time find that their employees are more productive, motivated, and loyal. And why wouldn't they be? Employees can alleviate quite a bit of stress from life just by coming in to work an hour earlier and leaving an hour earlier to miss the interstate parking lot scene, and it can also give them more time with their families.

But how do you structure it so that you don't have disgruntled employees whose jobs really can't be flexible? There are ways you can adjust to make the majority of your employees happy. For instance, let your employees come up with creative ways to do it themselves. If they are more empowered to find a solution then they'll probably come up with one they would like. If it's agreeable to management then everyone is happy and more productive. Try out the flex solutions your employees come up with on a limited basis and try to measure your results. Also, make sure your employees keep your clients in mind when they devise their plans. Any plan that hinders client contact probably isn't one you want to adopt.

Telecommuting

As I sit here with my laptop on my screened-in porch with the birds singing and early spring sun shining, I would be hard pressed to come up with a reason for why telecommuting couldn't work for your company. But of course there are always situations where telecommuting simply won't work. You obviously can't let your receptionist telecommute, because who would be there to receive! And, chances are that many of your employees aren't even interested in telecommuting. For those that are, however, think about the benefits to both them personally and to the company. The company can use the office space for other employees, storage, equipment, or a break room. You can simply set aside an area to be used by your telecommuters when they do venture into the office. You can experience the benefit of added productivity by your telecommuters. Lack of interruptions is one of the biggest perks of telecommuting. How many times have you had a tight deadline and an endless parade of co-workers stopping by your office to tell you the latest joke from the water cooler? More than you can count probably. You'll also benefit from the increased loyalty and boosted morale of your telecommuting workforce. Face time in an office is way overrated. Today, you have to measure an employee's worth by what they produce, not by how many hours you see them sitting at their computers (or in the break room, or at their co-worker's desk).

The benefits for your employees who telecommute can also be quite substantial. They can save time since their commute is only a brief stroll to their home office (or porch). They also benefit from a quieter and less interrupted environment. They can work whenever the inspiration hits them, too. Or if they have an appointment in the afternoon they can make up the time later that night.

It is quite possible you'll get more work out of employees that you allow to telecommute than the ones that you don't. You do need to investigate potential problems such as liability insurance, workers' compensation issues, office equipment, and confidentiality issues. These may bring to light problems for telecommuting in your line of business. You also need to make sure you have a written policy about how your telecommuters need to operate. For instance, you may make it a policy that your telecommuters have to be accessible during regular office hours even if they're working schedule is slightly different. You may also want to set up a reporting schedule to replace your usual eyeball-to-eyeball meetings to make sure you know at regular intervals where your employees are with projects, or other work. Some other key issues to consider are the relationships you have with your telecommuting employees. Make sure you're not leaving them out of meetings and decisions they should be involved in just because they didn't happen to be in the office at the time. Continued communication is crucial. Think through the process and make sure you cover all bases. If you have to get a proposed telecommuting program approved by upper management, it also helps to have statistics from similar companies that have successful telecommuting programs.

More Cost-free Benefits & Perks

Discounts for Your Employees

If your business offers a commercial product or service that your employees would otherwise have to pay for, then it may make sense to allow them the perk of getting it for free, or at least at a reduced cost. Your company can get a tax break, the employee gets a good deal, and good will abounds for all.

Working Condition Benefit

Known as the working condition benefit by the IRS, you can also gain some mileage, benefit-wise, by allowing your employees to use their company cars, computers, PDAs, etc., for personal as well as company business. Make sure you have a written policy and have checked your insurance coverage before granting this benefit.

On-premises Exercise Facilities

A fit employee is a healthy employee, and a healthy employee is a productive employee. Or so it would seem. If you have on-site exercise facilities that your employees can have access to free of charge then you've got a good perk waiting to happen. If you don't already have the facilities as part of your business, then perhaps you should consider setting up a small workout room with some basic equipment, or put in a shower and set up some running/walking trails around your business's property. Exercise not only relieves stress and improves health, it helps clear the mind and fosters creativity. Your employees may even acquire some team building skills if you start a company softball team.

Read on to learn about even more types of cost-free benefits & perks.

Regulatory Issues and Government Requirements

The only thing the IRS requires is that business's withhold and match FICA (social security), pay unemployment insurance, and pay workers' compensation insurance. You are required by the state to pay unemployment insurance tax if you have one or more employees for at least 20 weeks during the calendar year, or if you paid at least $1500 in wages during the calendar year. If you have at least three employees you must carry workers' compensation insurance in case one of your employees is injured on the job. This is also administered through the state.

To better understand how FICA tax is set up, keep in mind that the FICA tax, also known as the Social Security tax, is paid equally by the employer and employee. In other words, it is the tax that you withhold from the employee's pay and match. The tax is composed of two elements:

  1. OASDI (6.2%) - Old Age, Survivor and Disability portion of the tax is paid on wages up to the maximum covered wage base for the year. This cap changes every year, so make sure you verify the current level. (For 2003 it is $87,000).
  2. HI (1.45%) - The hospital insurance or Medicare portion of the tax is paid on all wages, without limit (not like the $87k mentioned above).

IRS Form 5500

As an employer who offers benefits for your employees, you have to be in compliance with regulations of the IRS, the Department of Labor/ERISA, the Pension Benefit Guarantee Corporation, and the Social Security Administration. To communicate this information you have to fill out IRS Form 5500, which collects information about your plan qualification, financial condition, and operations. This form has to be filed by the last day of the seventh month following the end of the plan year. You'll have to include any plan audits, actuarial reports, and other documentation.

For more information go to the IRS Web site. The easiest way to find the forms and pubs is to go to the search page and click the link that says "Search for Form or Publication to Download."

Read on to learn more about government requirements.

Be Careful Of...

Americans with Disabilities Act

The Americans with Disabilities Act was passed in 1990 to make it illegal to discriminate against people with disabilities. The law is broken down into 5 sections.

  1. Fair employment practices
  2. Public services
  3. Public accommodations
  4. Telecommunications
  5. And Miscellaneous issues such as retaliation, insurance, construction, state immunity, etc.

As an employer, it is illegal for you to discriminate against someone with a disability in:

  • Recruiting
  • Wages
  • Hiring
  • Firing
  • Promotions
  • Job assignments
  • Training
  • Leave
  • Lay-offs
  • Benefits
  • Any other employment related activity

So, in a nutshell, don't discriminate in any way, shape or form against anyone.

People qualify as "disabled" under this act if they have, or have a record of, physical or mental impairment that substantially limits a major life activity. This includes hearing, sight, speech, breathing, performing manual tasks, walking, caring for themselves, learning, or working.

In order to be protected by the ADA they must be qualified and able to perform the essential duties of the job with or without reasonable accommodation. This means you should interview them and review their work histories just like you would anyone else you are considering for employment. This shouldn't have any affect on your ability to hire the best candidate for the job. You just have to make sure you're not disregarding them simply because of their disability.

Essential Duties

Take care defining the "essential duties" of the job. Use your best judgment in determining what those essential duties are. According to the ADA you must decide whether the job itself exists because of that particular duty. You must then determine if there are other employees that duty could be assigned to or distributed among. And finally, what is the degree of skill required to perform the duty? Make these determinations before writing your job descriptions.

Reasonable accommodations are another thing you need to be aware of. What is considered reasonable? Reasonable accommodation enables the disabled individual to take part in and enjoy the benefits that other non-disabled employees do. It may include buying or modifying equipment or devices that the person can use to do the job, restructuring the job, offering part-time or altered schedules as accommodation, and making the workplace accessible to the individual, or many other changes.

There is also a limit to what is considered reasonable. If it would cause undue hardship on your company to make the changes necessary to accommodate the individual then there are ways to work around it. For example, you can allow the person to pay a portion of the cost of the changes required to accommodate them.

This is a fairly complicated law, and certainly hasn't been addressed completely in this article. For additional information go to HR Next, the Americans with Disabilities Act Web site, the EEOC Web site, or the U.S. Department of Justice Web site.

Family and Medical Leave Act

If your business has at least 50 employees within a 75-mile radius then you must follow the requirements of the Family and Medical Leave Act. This means you have to allow all eligible employees to take up to 12 weeks of unpaid time off to be with family because of medical issues, births or adoptions. Eligible employees are those who have worked for your company for at least 12 months and 1,250 hours during those 12 months. You have to guarantee that employee that they will have their job (or a comparable job) when they return to work. Your employees are also allowed by the FMLA to take the 12 weeks of leave in smaller chunks if they need to.

With all of these great ideas for employee benefits, you feel certain your program will be the best on the block. But, maybe there are still some more things you can do to give your company an edge. What can you do to make sure you have that edge? Read on for some creative tips on making your workplace the very best!

The Competition

So, we've talked about a lot of ways to set up a good benefit program for your employees and how your benefits and perks are often more important than the salary, but what will really stand out to potential employees? What do they really look for? One of the most important things to keep in mind when planning or tweaking your benefits package is that there is a strong and growing trend toward helping employees balance their work with their family lives. People are no longer just wishing there was an alternative - they're making alternatives. If you make a concerted effort to allow your employees to not only do their jobs but to still have time to live their lives, you'll be rewarded with loyalty, productivity, and strong workforce.

Here are a few suggestions for creative benefits to add, but don't stop here. Poll your employees and see what they would like to see added to the benefit list. You may be surprised.

  • Special guest speakers (monthly, quarterly, whatever you can do)
  • On-site classes about topics that interest your employees, such as personal finance, yoga, home buying, childcare issues, etc.
  • Special company-sponsored meals (Like Pizza Fridays, or Days of Perpetual Eating!)
  • Office games
  • On-site massages
  • Special-recognition gift certificates
  • Set up a special Sunshine committee to come up with fun treats and activities for employees
  • Regular staff parties and get-togethers (on work time, not personal time!)
  • On-site dry cleaning pick ups
  • On-site film-processing pick ups
  • An employee Web site that features photos from staff parties, family photos, etc.
  • On-site stores offering items that employees typically have to go out at lunch for.
  • A company restaurant that also offers take-out meals for dinners.
  • An ATM machine

For more information on employee compensation, benefits packages and related topics, check out the links on the next page.

Related HowStuffWorks Articles

More Great Links