A study conducted by Zippia showed that year-end bonuses are the most common type of bonus used by companies with 100 employees or less. The same study also found that approximately 33% of companies in the United States provide year-end bonuses to staff – a number that continues to rise – making annual incentive plans an important part of keeping an organization’s pay competitive. A competitive pay structure is an essential part of attracting and retaining top talent.

As we approach the holiday season, many companies are preparing to distribute their year-end bonuses to their team members. While this occurs, companies are also finalizing their goals for the upcoming year. As your organization’s annual goals become more concrete, it’s a great time to start planning how you will incorporate an annual incentive plan into those goals.

What is an Annual Incentive Plan?

An annual incentive plan is a performance-based incentive plan designed to motivate and reward employees for achieving specific goals or performance targets on an annual basis. It’s a way of recognizing your team for all of the effort they put forth throughout the year and showing your appreciation for the work that they do by giving them a piece of the pie – so to speak.

How to Create an Effective Annual Incentive Plan

An effective annual incentive pay plan works to inspire and motivate your team, because when they feel recognized for their efforts, they’ll likely work harder to achieve company goals. Here’s how to create an annual incentive plan:

Determine Your Goals: As with any incentive pay plan, the first step is identifying what the company’s goals are for implementing the plan. Are you trying to achieve certain revenue goals? Or perhaps you want to focus on upselling to current clients? Isolating these factors will help when it comes to determining what types of incentives you want to offer to team members when they actually achieve them. Whatever your goals are, make sure that they are measurable and attainable for your staff.

Tie an Incentive to Your Goals: Once your goals have been established, you will need to tie an incentive to the goal. This step is two-fold. First and foremost, you need to determine the company’s budget for annual incentives. A combination of historical data, expense reports, and revenue forecast reports will help you gauge what will be financially feasible for the company. Additionally, part of this step includes research to make sure that what you are offering to your team is competitive with other companies within your industry.

Second, determine whether you will be offering a flat amount or if it will be based on a percentage. When it comes to percentage-based incentives, this can be handled in a couple of ways. You could do a percentage of the employee’s annual salary or a percentage of annual revenue. Some of this may be dependent on an employee’s role in the company and can vary between positions – which is covered in more detail below. Either way, think again about the goals you are trying to achieve and what you can afford. These two guiding factors will help you make sense of what would work best.

Determine Eligibility & Tailor Incentives to Roles: Not all roles within a company are created equal and this should be accounted for when developing your incentive plans. Ultimately, it is the work of the collective that makes the goals happen, but at the same time you should recognize that certain team members will contribute more to achieving your outlined goals. As such, they should receive a commensurate amount of the incentive being offered. Identify which team members are more directly responsible for the goal at hand, as well as the impact of each position contributing to the goal. What makes sense for the amount of effort that they will put forth? Tailor your incentive structure to align with how each role will impact the goal.

For example, it may make more sense for sales reps to receive a percentage of the revenue they help generate. In this same scenario, it may make more sense to give your supporting and administrative staff a flat bonus for their efforts to assist your sales team.

Make it Transparent: Your employees should have a clear understanding of how their annual incentive pay works. While some of the components of their annual incentive plan may be unavailable, especially in cases contingent on reaching a specific revenue milestone, your employees should still understand what needs to be accomplished to earn the incentive pay and how their incentive will be calculated once the goal is achieved. This system of transparency ensures that every employee understands how their efforts contribute to the overall success of the organization.

Make Adjustments as Needed: A lot can change in a year and your goals for the following year may be very different than your goals for the current year. Your organization’s financial situation and budget for annual incentives may also be very different from year to year. Business operations fluctuate and your annual incentive plan may need to be tweaked on occasion. With this in mind, organizations should leave ample time for planning in case adjustments need to be made, so you can communicate the plan before your employees ask questions about it.

Along with considering the organization’s goals and budgets, it’s a good idea to check-in with your employees and make sure that what you are offering is actually fair and satisfactory. A flexible approach ensures that your incentive plan stays relevant and continues to motivate your team members.