Employees often think of their salary and benefits as two separate things. But for employers, it’s more helpful to think in terms of total compensation.
So what is total compensation? How can you make sure that you’re providing a competitive compensation package to your employees?
Let’s find out.
What is Total Compensation?
Total compensation is the wages and benefits your employees receive as payment for working at your company. It can be split into two categories: direct and indirect compensation.
Wages, overtime pay, commissions, and bonuses count as an employee’s direct compensation. That’s because they receive this pay in the form of a paycheck.
Benefits like medical insurance, retirement savings, and paid time off (PTO), on the other hand, aren’t given to employees in cash. Employees can’t pay rent with their PTO, after all. But PTO and other benefits still cost you money to provide and offer tangible value to your employees.
Because of this, these benefits count as indirect compensation.
So to sum it up, direct + indirect compensation = total compensation.
How to Calculate Total Compensation
You might be groaning right now. Realizing that you must figure out direct and indirect compensation for each employee can feel downright overwhelming.
But we’ve got you covered. All you need to do is understand what factors play a role in direct and indirect compensation. From there, you can choose which types of pay and benefits make sense for your team.
Total Direct Compensation
There are eight key elements that factor into direct compensation. You might provide your employees with some or all of these. It all depends on your company’s size and structure.
A base salary is the total amount of money a salaried employee earns in each paycheck before any additions or deductions. In things like job descriptions, you’ll find it written as the sum total of a year’s worth of paychecks.
For example, a base salary could be written out as $60,000 a year—or $5,000 a month—before any deductions or additions.
Employers determine base salary on a range of factors. These might include the employee’s role in the company, education level, and relevant experience.
An easy way to determine a base salary for a role is to look at what your competitors are paying for similar roles. Check job descriptions for this information or ask your industry connections.
You can use this number as a starting point and make adjustments as you create your payroll budget.
If you pay employees by the hour instead of a salary, you’ll set a base hourly wage. This is the amount of money you pay for each hour of work the team member does. As with base salary, the number excludes any additions or deductions like taxes and insurance premiums.
Like base salary, the base hourly wage can vary depending on a person’s experience level, job title, education, and the average base wage in your industry.
A base wage for a medical technician might be $25 an hour. IT consultants, on the other hand, could expect to rake in as much as $200 an hour.
Have you ever wondered why nurses would choose to work the night shift? Or why some people seem to love working during holidays?
Many employers recognize that working at night or on holidays is less than ideal. But companies may still need employees to work these undesirable shifts anyway. To encourage their team members to step up for these shifts, employers pay them more money.
This extra money is called a pay differential.
Let’s look at nurses, for example. During daytime hours, Anna the emergency room nurse might make a base wage of $40 an hour.
If Anna works at all during the hours of 7 p.m. to 7 a.m., she gets a differential of $5 per hour. On weekend nights, a $10 differential is added to this.
This bumps Anna’s pay during those hours to $55 an hour. Take a look at the overall pay difference between the day shift and the weekend night shift:
- 12-hour day shift (7 a.m. to 7 p.m.): $480
- 12-hour weekend night shift (7 p.m. to 7 a.m.): $660
Anna loves this pay differential and takes on as many weekend night shifts as she can.
Overtime is another type of pay differential. Under the Fair Labor Standards Act (FLSA), employers must provide overtime pay when an employee works more than 40 hours per week. The minimum overtime pay is time and a half.
This means that if Anna works 45 hours during a week of Monday through Friday day shifts, she’ll receive $60 an hour for those five extra hours. That’s because $40 x 1.5 (time and a half) = $60.
As you can probably tell, pay differentials can significantly increase an employee’s paycheck.
As the name suggests, variable pay is, well, variable. Most of the time, variable pay is based on employee performance. If an employee meets a challenging goal and you reward her with a bonus, that’s variable pay.
Commissions are another type of variable pay. Car salespeople often get paid on commission. Let’s say a car salesman receives a base wage of $15 an hour plus a 25% commission on the front-end profit of each car he sells.
After a week, he sells a $100,000 Maserati that a buyer purchases with a $25,000 down payment. This down payment is the front-end profit, and our guy earns a whopping $6,250 for that single sale.
The next day, he might not sell anything, which is why being paid on commission counts as variable pay.
Holiday bonuses, hiring bonuses, and other incentives also fall into the variable pay category.
A 401(k) is an employer-sponsored retirement savings plan. It comes with the option for employers and employees to contribute money to the plan every month. Usually, an employer matches an employee’s contribution up to a certain percentage.
An employer might offer a 100% match on employee contributions up to a maximum of 5% of the employee’s annual income. This means that if an employee earns $70,000 a year, you’ll match their contributions up to $3,500 every year.
This means you’re paying out $3,500 a year for each employee who takes advantage of the 401(k) matching benefit. You don’t pay it directly to your employees, but they’ll definitely see that money when they retire.
Many employers pay cash allowances for things like food and lodging when they require employees to travel.
Or you might provide a childcare allowance to help the parents on your team afford daycare. If employees have to commute a long distance, you might offer an allowance to help with gas.
There’s really no limit on what you can provide as an allowance. Because allowances are often paid out in cash, they usually count as direct compensation.
One way to help employees feel—and literally be—personally invested in their role is to give them equity in your company.
Most companies that offer equity benefits require employees to work for the company for a set number of years before they can own company stock.
Let’s say you offer 1,600 shares to your employees over the course of five years. You wouldn’t give these shares to an employee up front. Instead, you could award 320 shares after one year of service, add another 320 following another year of service, and so on until the employee has 1,600 shares.
Some companies give employees the option to receive these shares as cash payouts instead of as stock units. If your company is thriving, equity compensation can be a big boon to your employees.
Other companies give equity compensation solely in the form of discounted stock purchases.
Total Indirect Compensation
Indirect compensation may not be as exciting as direct compensation, but it’s pretty darn important. Can you imagine working for a company that paid a decent salary but didn’t offer any paid time off, health benefits, or retirement plans?
Let’s take a look at the main types of indirect compensation.
Paid Time Off
Paid time off provides employees with the option to take vacations while still being paid their regular rate.
And vacations from work are vital to the well-being of humans everywhere. When you take time off work, your body and mind can relax, unwind, and recharge. Employees who use their paid time off (PTO) are often healthier, better rested, and more productive than those who don’t.
In a way, PTO feels like direct compensation because your employees receive payment for days or hours they didn’t work.
But the pay isn’t the point of PTO. The point is that you’re giving employees much-needed time to rest without worrying about losing income.
That’s why PTO is considered indirect compensation. Find out how to set up a PTO policy your employees will love.
Some companies ask their employees to use PTO for unforeseen circumstances. This might include illnesses, caring for a sick family member, or bereavement. Technically, paid sick leave is a form of PTO. But other companies put PTO in one bucket and paid leave for unexpected circumstances in another bucket.
This type of paid leave only applies if an employee experiences a qualifying event. Because of this, it’s considered indirect compensation.
Having separate PTO and paid leave policies means your employees can take time off to recover from an illness or care for a family member. And they can do it without spending their vacation days.
If you offer paid leave, make sure you comply with your state’s sick time and PTO laws. States like California, Arizona, and Vermont require employers to provide paid sick leave.
If I had to choose between working for a company that:
- Pays well but doesn’t offer health insurance
- Pays slightly less than I’d like but offers a great health insurance plan
…I’d choose #2 every time.
Healthcare premiums vary wildly from state to state and plan type to plan type. But in general, Americans can expect to pay an average of $22,000 per year on health insurance premiums. That’s over $1,800 a month.
Employers cover about 70% of this cost, lowering the employee’s burden to about $6,600 per year, or $550 per month.
That’s a big difference.
And we all know what can happen if a person experiences a medical emergency without any insurance coverage. (Hello, bankruptcy.)
That’s why providing your employees with affordable healthcare is one of the most important indirect benefits of all.
Many employers help their employees save for the future by offering tax-advantaged retirement plans. The most popular retirement benefit is a 401(k) plan where employers can match the contributions made by employees.
And yes, we did say 401(k) matching plans fall under the direct compensation umbrella. So what’s the deal?
Here’s the thing: sometimes, one form of compensation can be both direct and indirect. Since you don’t directly pay employees what you contribute to a 401(k), you can think of this retirement plan as indirect compensation.
But your employees will receive the money later on when they retire. So in a way, a 401(k) match still functions as direct compensation.
Offering childcare benefits is a huge help to the parents on your team. Daycare can cost as much as a mortgage and force employees—especially women—to leave the workforce when they have children. Employers can help by:
- Providing a licensed onsite daycare facility at a reduced price
- Contracting with a licensed daycare and footing some of the costs of childcare
- Contracting with a reputable childcare referral service to help employees find quality care for their children
Even though you don’t pay your employees directly for these services, you’re giving the parents on your team a major leg up. The federal Employer-Provided Child Care Credit gives employers a tax break on a portion of these costs, so there’s a benefit in there for you, too.
The most successful employees (and employers!) never stop learning new things.
Professional development doesn’t just boost a person’s skill set—and confidence in their abilities.
It can also prepare them for the future. Think about what your industry looked like twenty years ago. How much have things changed since then? And what might your industry look like in the next 20 years?
Offering professional development means that you, the employer:
- Pay for courses, certificates, and other forms of relevant continuing education
- Provide employees with the work time they need to complete said courses
- Offer incentives to motivate team members to sign up for professional development
Again, you’re not paying employees directly for the extra learning. But you are providing an indirect benefit that helps everyone on your team retain core skills and gain new ones.
Do you offer employees PTO for volunteering? Flexible work hours? A paid hour for wellness and relaxation every week? These non-wage benefits can improve your employees’ quality of life.
They might cost you some money—and a little bit of convenience—but they aren’t monetary benefits for your team members. Instead, they help employees feel like you value their drive to help others, take breaks, and curate a meaningful work-life balance.
Fair Market Value of Total Compensation
Finally, one of the most important things to do is make sure you’re paying the fair market value (FMV) for your employees’ work. FMV means providing competitive salary and benefits packages.
This doesn’t necessarily mean paying more money or offering more benefits. It just means that you’ve done your research. You know what your competitors are offering for similar roles. And you’re offering a total compensation package of similar value.
You can determine FMV by looking up similar job postings, assessing the cost of living in your area, and factoring in the level of education and training the role requires. This is really just a starting point.
We recommend studying everything that goes into total compensation and creating a package from there.
If you can make FMV determinations accurately and keep track of what factors affect total compensation, you’re in good shape.
Total Compensation Statements
Total compensation statements have been rising in popularity. So what is it?
In some ways, a total compensation statement is like a pay stub in that it’s a summary of your employee’s compensation. But instead of sticking to the direct compensation you pay, it notes the value of the non-wage benefits you offer.
In other words, it includes indirect compensation.
For example, you’d include how much things like health insurance premiums, gym memberships, and childcare subsidies cost you.
These statements are usually prepared once a year, and like most things in life, they come with pros and cons.
Total compensation statements can help employees see how much they are valued. They also help boost transparency. Employees can compare their total comp statements with colleagues to see how their benefits stack up.
Whether or not an employer would view this as a positive thing is up in the air. Pay transparency is a big issue, though, and total comp statements help employees understand whether they’re being paid fairly.
But employees could also see a total compensation statement as a way for an employer to justify smaller yearly raises.
Avoid these problems by making it clear that the total comp statements are there to keep employees informed and close any lingering pay gaps.
Ready, Set, Payroll!
Now that you understand what factors make up total compensation, you’re ready to create your first payroll budget. With a budget in hand, you’ll be able to make smart decisions about how much direct and indirect compensation you can offer your employees.
Our guide to creating a payroll budget will help you get started.