A bonus and a salary increase both represent an increase in an employee’s compensation. The difference between them is that a bonus is a one-time payment, while a salary increase is a permanent change in compensation, putting more money in the employee’s pocket every payday for the entire duration of his employment.
Employers may award salary increases for exceptional performance, to correct internal salary inconsistencies, bring employees' pay up to current market standards or retain a particularly valuable or hard-to-replace employee. Employers generally expect that a salary increase will encourage the employee to be more productive, thereby covering much of the cost of the pay raise. Some companies may prefer rewarding employees with bonuses.
Unlike a salary increase, a bonus doesn't become part of the company’s permanent fixed costs and doesn't change the base pay level for figuring any future salary increases. A bonus also won't raise the employer’s costs for benefits that are based on a percentage of an employee's base salary, such as disability insurance, 401k contributions and employee life insurance. Additionally, a bonus system allows employers to reward exceptional employees who are already at the top of the salary scale for their rank, or pay a reward when budget limits bar salary raises. The psychological boost of a lump-sum performance bonus may provide a bigger productivity increase than a raise in base salary.
Most bonuses are linked to performance. Profit-sharing and gain-sharing bonuses reward employees for their efforts to boost company profits or meet improvement targets. They typically are paid across the board to all employees or to everyone in a particular department or business unit. Spot bonuses reward individual employees for achievements that deserve special recognition. Task bonuses go to individuals or teams that complete important projects on time and within budget.
Sign-on bonuses are paid to new employees to keep them financially whole as they trade out their old employer’s pension plan or stock options for those of the new employer. Sign-on bonuses are common when qualified top talent is hard to find. Referral bonuses go to employees who refer friends or acquaintances who are hired for company job openings. Retention bonuses go to critical employees needed to conduct transitions or complete projects during acquisitions and mergers. There also are holiday bonuses paid as a “13th month’s salary” and not tied to performance.