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Variable Pay – Options & Overview

As the name suggests, Variable Pay can fall into a number of different categories. Payments are related to employee performance over a given period of time, usually in addition to their fixed wage or salary. Dependent on the industry, you may come across commission-only positions as well.

Types of variable pay will fall into one of two categories:

  • Payments related to volume-based or output-based productivity (e.g., tips and commissions, per kilometer rates, production unit volumes); Or
  • Performance-based or incentive program amounts – generally related to performance management programs.

Fixed Pay vs. Variable Pay

Fixed Pay amounts are constant and seldom vary between pay cycles. This is assigned to the employee based on their rank and/or designation within the organization.

Variable Pay (also referred to as performance-based or incentive pay) is paid based on the employee’s performance within the period in which it is being paid.

Variable Pay has multiple benefits to being implemented:

  • Motivation for employee performance,
  • Aligning employee efforts with the goals of the organization,
  • Attracts top talent,
  • Boosts employee retention,
  • Gives the company competitive advantage in their field/industry, and
  • Helps align expenditure with income.

Types of Variable Pay

Management by Objectives (MBOs)

  • This is a program that lays out specific goals the employee must reach, in order to earn variable payments
  • Examples:
    • Piecework rates – payment per unit (e.g., number of goods produced, number of kilometers driven, number of fruits picked).
    • Reducing key metrics, such as how long each call lasts at a call centre, or how long a car is sitting at a drive-through window.

Commission Payments

  • Payment(s) to an employee calculated on the amount of business completed. For example:
    • Percentage of sales
    • Percentages of profits
    • Lump sum payments per transaction
  • Commissions are built into a company’s pay structure, and so they may take different forms across different companies. For example:
    • Straight Commission
    • Salary Plus Commission
    • Bonus Commission
    • Variable Commission
    • Graduated Commission
    • Residual Commission
    • Draw Against Commission
  • Commission payments are considered to be taxable income. As such, the commission amount is included in the employee’s income for the given tax year and becomes subject to regular income tax rates.

Profit-Sharing Plan

  • As the name suggests, this plan allows for sharing of company earnings/profits with employees, generally distributed on a quarterly or annual basis. How much an employee receives will be tied to a pre-determined formula, as established by the company. In general, higher company profits = a higher contribution.
  • You may also find this referred to as an Employee Profit-Sharing Plan (EPSP) or Deferred Profit-Sharing Plan (DPSP).
  • The plan is setup by the employer. There are usually restrictions on when and how employees can access these funds. There may also be restrictions on the type of accounts / investments that this money can be deposited into.
  • All of the employer’s contributions will be considered part of taxable income, meaning they will be included in the employee’s income for the given tax year and will be subject to regular tax rates. The same applies to any investment income earned on the contribution amounts.

Bonus Payments

  • Single installment payments (lump sum).
  • It is common to see bonuses referenced in the employment contract, but some employers do pay out bonuses at their discretion.
  • Some examples would be:
    • Performance-based Bonus
    • Sign-on Bonus
    • Retention Bonus
    • Referral Bonus
    • Holiday Bonus
  • Bonuses are considered to be taxable income. As such, the bonus amount is included in the employee’s income for the given tax year and becomes subject to the bonus tax method.

Employee Stock Options (ESOs)

  • ESOs are a chance for employees to purchase company shares at a predetermined price.
  • Non-Qualified Stock Options (NQSOs) are the most common ESOs in Canada.
    • When an employee exercises these stock options, they are required to report the income as a taxable benefit. The taxable benefit is included in the employee’s income for the given tax year and becomes subject to regular income tax rates.
  • Qualified Stock Options (QSOs) can offer a more favourable tax setup for employees. You may also hear them called incentive stock options (ISOs).

While each type of variable pay has its benefits, ultimately it is the choice of each business to determine how to align your compensation structure with your organization’s culture, strategy, and financial goals.

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