If you see the words fixed comp and variable comp get thrown around all the time but feel lost when it comes to understanding what they mean, we’ve got you. They’re actually pretty simple.
Fixed comp, short for fixed compensation, is the set salary or hourly wage you give an employee. It stays the same unless you give the person a raise or yearly salary increase.
Variable comp is compensation that changes from pay period to pay period. This could mean things like bonuses, commissions, tips, and profit sharing. Variable compensation is usually performance-based.
Some companies pay their employees fixed comp more than variable comp. Others do the opposite. Let’s take a look at what fixed comp vs. variable comp looks like for both salaried and hourly employees.
Fixed Comp vs Variable Comp for Salaried Employees
When you offer an employee a salaried position, you’re guaranteeing that you’ll pay them a set salary for a specific time period—usually one year.
Let’s say you run an architecture firm. You’ve recently landed a contract to design an office building for a large local nonprofit. You need to hire two more licensed architects to join your team, and you want to offer them salaried roles.
You decide to offer a starting salary of $80,000 to $100,000 a year depending on the candidate’s education level and experience. Since the scale and complexity of your firm’s projects can vary, you decide to offer the opportunity for three types of bonuses:
- A signing bonus of $5,000 for each new hire
- A retention bonus of $7,000 for the 30 days right before a project deadline
- An extra $3,000 performance bonus on top of the $7,000 retention bonus for employees who exceed your expectations
These incentives are an example of what variable pay could look like for a salaried employee. They’re not a core part of the employee’s direct compensation, even though they’re great to have.
Salaried employees can usually depend on a fixed monthly income to see them through. Everything else is icing on the cake.
Fixed Comp vs Variable Comp for Hourly Employees
Hourly employees are far more likely to depend more on variable comp than their salaried peers.
Employees who earn tips are the perfect example of this.
In the United States, federal law says that employers only have to pay a fixed comp rate of $2.13 an hour if the person’s monthly tips make up the difference and equal the minimum wage of $7.25 an hour.
(Do you know anyone who could survive on this type of wage? We don’t.)
Many states have different laws for tips. In California, for instance, employers cannot use tips to make up the difference between a low, fixed hourly wage and the state minimum wage of $15.50. They must simply pay their employees $15.50. Any tips the employees receive is theirs to keep as variable pay on top of that fixed minimum wage rate.
Other states don’t have these laws. Because of this, they default to that embarrassing federal minimum wage of $2.13 an hour for tipped employees.
One such state is Tennessee. If an employee named Sally works as a restaurant server in Nashville, her employer only has to pay her a fixed compensation rate of $2.13.
And he can take a tip credit of $5.12 for each hour of work Sally does to meet the federal minimum wage law of $7.25 an hour.
So let’s say Sally works a double shift, which is two 4-hour shifts back to back in the restaurant world. She will earn a fixed wage of $2.13 an hour, giving her a base pay of $17.04 for the entire day’s work.
It was a slow day at the restaurant, and Sally waited 6 tables during her shifts.
Here’s what the tips looked like for each table:
- Table 1: 4 people, one bill of $133, one 15% tip of $19.95
- Table 2: 6 people, an automatic gratuity of 18% applied to the table total of $200 for a tip of $36
- Table 3: 2 people, one bill of $40, one 10% tip of $4
- Table 4: 1 person, one bill of $35, one 20% tip of $7
- Table 5: 5 people with two separate bills equalling $201 with a 10% tip of $20.10 and $183 with a 15% tip of $27.45
- Table 6: 1 person with one bill of $30 and a 10% tip equalling $3
Sally’s total tips equal $117.50.
Sally’s employer can deduct a tip credit of $5.12 x 8 hours, or $40.96, to meet the minimum wage requirement of $7.25 an hour for the 8-hour shift—a total of $58 paid by the employer.
Unlike with the rest of the tips, the employer will include this amount in Sally’s fixed pay and deduct taxes and any benefits from it.
That means Sally only brings home $76.54 in tips for that double shift. She’ll get the rest of her tips as part of her regular, minimum wage paycheck of $58 for 8 hours of work.
This means that for one full day of work, Sally earned $134.54—before deductions—or $16.82 per hour.
Even though this is above California’s minimum wage, Sally isn’t guaranteed to make that much money every time. Receiving fair compensation depends on how much variable pay she earns in tips.
What if she worked in California, earning a base fixed compensation of $15.50 an hour plus those same exact tips? She wouldn’t have to see $40.96 go to cover her minimum wage. Instead, she’d get to bring all $117.50 home on top of her base pay of $124, or $15.50 for 8 hours.
With a heavy variable comp factor in Tennessee, Sally earns less—$134.54 for eight hours of work. If Sally had a stable, fixed hourly comp of $15.50, she’d earn $241.50 for the same amount of work.
That’s a 79.5% increase.
Sally should probably move from Tennessee to California.
Another type of variable pay is commissions. Salaried workers don’t typically work on commission, but many hourly workers do. Car dealerships, for instance, often pay the minimum legal amount per hour, forcing employees to depend on commissions for most of their income.
One advantage hourly workers have is overtime. Salaried employees almost never get paid overtime wages. But hourly workers do—it’s the law.
If you work more than 40 hours per week, you’re entitled to overtime pay of 1.5 times your hourly rate for each hour of overtime worked.
Benefits of Fixed Compensation
There’s a lot to love about fixed compensation. For employees, it’s comforting to know they’ll make a set amount every pay period. On the employer’s end, paying fixed salaries is easier for your payroll department to sort out.
You can plan ahead for bonuses and provide them as a true cherry-on-top benefit for your employees.
Depending on a fair, fixed hourly wage over variables like tips and commissions can benefit employers, too.
Even if you live in a state with a low minimum wage requirement, payroll gets simpler if you just offer at least the minimum wage for tipped workers.
For example, what if you were Sally’s employer, but instead of paying the minimum wage of $7.25, you paid her $15 an hour? She’d make a decent fixed wage and get to keep all her tips.
And you wouldn’t have to hope that her tips made up that $5.12 difference every single time she worked.
Because if they didn’t, you’d have to figure out how to pay her the minimum wage anyway. And Sally would probably feel like you were paying her dirt, because…well…you would be.
She would probably start searching for another gig that paid more fairly, leaving you to repeat the cycle with another unfortunate soul.
Hello, unhealthy levels of turnover.
Besides, it’s no question that employees value their base pay more than anything else. And if you offer a competitive base salary or hourly rate plus other benefits like healthcare, tuition support, PTO, and paid holidays, you’re more likely to attract and retain good employees.
Benefits of Variable Compensation
I might have painted variable compensation in a poor light, but there are definite perks that come with variable compensation. Especially for salaried employees who don’t depend on tips or commissions to bulk up their compensation.
Performance bonuses, company-paid travel, retirement plans, and acquired skill bonuses are just a few of the types of variable compensation that make life better—not more stressful—for your team.
For hourly employees, commissions and tips can provide a strong incentive to perform well. If your compensation depends on you selling at least 10 cars per month at a dealership, you’ll work your bum off to do it.
But I’ll also argue that commissions and tips can give plenty of incentive even with a more robust fixed comp package. In California, for instance, some car dealerships pay a base rate of $300 plus commissions and bonuses. If a salesperson has a bad week with zero sales or customers just aren’t biting, they get paid California’s minimum wage for the week instead.
This type of structure incentivizes commissions and guarantees that employees will at least earn a base wage they can live on. Even if they don’t sell any cars.
Another variable comp strategy we love is team bonuses. If your entire team has a huge deadline or busy period that puts strain on everyone and they knock the work out of the park, you can reward everyone with a bonus.
This encourages your employees to work together for the company’s greater good instead of competing with one another for an individual performance bonus. A rat race like that can cause tension and jealousy in the workplace.
Finally, we also recommend considering management by objectives (MBO) as a variable pay strategy.
With MBOs, the management team spruces up the company-wide goals for the year and breaks them up into smaller benchmarks. The benchmarks are then assigned to each member of the team, and employees are invited to meet that goal in the best way they see fit.
Once an employee meets their goal, they receive a bonus. There’s healthy competition here as each team member works to meet the goal. But they will all be rewarded once they finish their individual objectives. No one loses out. Unless they don’t meet their goal, of course.
Fixed Compensation Shouldn’t Be Static
Inflation rose to 8.8% in 2022. In 2019, it was at 3.5%.
Everything is more expensive these days, and you cannot expect to pay 2019-style salaries in 2023, or 2024, or 2030, for that matter.
As the cost of living rises, so too should the average salary in just about every field.
So even though fixed compensation is fixed, it should rise every year. This doesn’t mean it’s variable compensation. Remember, fixed compensation is pay that remains the same for a set period of time, like a year.
If you paid an employee an annual salary of $70,000 in 2019, you should have upped that to $78,785 in 2023. That’s because a 3% increase is the very least you should offer each year. Businesses that really want to keep up with inflation should aim for a yearly increase of 4.5% to 5.0%.
You can always use compa-ratio to make sure you’re paying your hourly or salaried employees a fair wage. A compa-ratio compares an employee’s annual salary or hourly pay to the median wage in that industry. Learn more about how to calculate and use compa-ratio.
Beyond that, you should be identifying your top performers and giving them raises each year.