Understanding the difference between nondiscretionary and discretionary bonuses can help you decide whether to include an incentive pay plan for nonexempt employees. Choosing the right option for your business can save you significant time and money at the end of the year and allow you to avoid any unnecessary challenges regarding overtime pay.
Identifying which type of bonus is best for your organization can take some time and research. In this article, we explain the difference between discretionary and nondiscretionary bonuses, why understanding the difference is important for employers and some tips for reducing the burden of recalculating overtime pay.
What is a discretionary bonus?
A discretionary bonus is one given at the sole discretion of the employer and is not expected by the employee. The key to discretionary bonuses is that the employer has not set an expectation that a bonus will be paid if certain goals are met and the amount and timing of the bonus are not given in advance.
Difference between a discretionary and nondiscretionary bonus
Unlike a discretionary bonus, the nondiscretionary bonus does have specific criteria the employee must meet to qualify for the bonus. The employer predetermines the criteria and the employees expect to earn the bonus if they meet the criteria. An example of this is an incentive pay plan, which provides bonuses for employees who exceed productivity or performance goals.
Why discretionary and non-discretionary bonus pay matters
The Fair Labor Standards Act (FLSA) is a federal law that establishes overtime pay eligibility for employees. Under the FLSA, certain types of bonus payments to nonexempt employees can retroactively raise their “regular rate” of pay, resulting in additional overtime pay due. Exempt employees are given a salary and are expected to complete the tasks required for their job, regardless of how many hours it takes. Nonexempt employees must be paid one and a half times their hourly rate for hours worked beyond 40.
This means that if a nonexempt employee receives a nondiscretionary bonus during a pay period and the hourly rate is raised, this type of payment must be factored into the overtime pay calculations for the period of time covered by the bonus. Even if the amount of a bonus being paid is left to the employer’s discretion, if the employer sets goals or standards in advance of the payout, the bonus is considered nondiscretionary pay.
Even if the nonexempt employee received a year-end bonus, it must be apportioned back into the workweeks in which it was earned to re-calculate any additional overtime pay that is owed to the employee for the period the bonus covers.
On the other hand, discretionary bonuses do not need to be factored into overtime pay.
Examples of nondiscretionary bonuses
To make it easier to understand which commonly awarded bonuses are considered nondiscretionary, here is a list to consider:
- Hiring bonuses
- Attendance bonuses
- Bonuses for quality of work
- Bonuses for accuracy of work
- Longevity pay for retention bonuses
- Profitability bonuses
- Individual or group production bonuses
Tips to simplify bonuses
It’s best to continue forward with your current bonus plan and process if you have already communicated to employees how bonuses will be calculated and paid. Changes should be made and communicated before earning periods. When you are ready to make changes, here are some suggestions for how you can simplify the process and reduce the burden of recalculating bonuses and overtime pay.
Shorter bonus measurement periods
Consider shortening the bonus measurement periods. This means that instead of giving one large bonus at the end of the year that could require you to recalculate overtime pay for all of your nonexempt employees, consider giving smaller bonuses throughout the year. For example, you could give quarterly or even monthly bonuses based on performance or profitability. This would mean you would have a much smaller time frame in which you had to recalculate overtime.
If you give bonuses based on the percentage of earnings—wages and the overtime pay they received during the bonus period combined—you would meet the FLSA requirement for nonexempt employees because the percentage would already be weighted in proportion to their straight-time and overtime hours worked.
For example, assume that a $25,000 annual-bonus pool is established for employees whose earnings—both straight-time and overtime wages—equals exactly $500,000. Assume that a particular employee’s total wages, including overtime, are exactly $45,000. This person’s portion would be five percent, which you can calculate by dividing the $25,000 total pool by the total wages.
You then multiply their five percent by the total wages of $45,000 and get a bonus of $2,250.
Only give discretionary bonuses
Another option is to be careful to only give discretionary bonuses. In this case, employees can’t anticipate that it’s coming and it can’t be tied to any advanced criteria. While this can in many ways be the simplest option, it does eliminate the option of using incentive pay to motivate employee performance.