What is a compensation plan?

Professionals expect more than a paycheck—they seek transparency, fairness, and rewards that reflect their contributions. When organizations take a thoughtful approach to pay and benefits, they can improve trust, boost engagement, and strengthen their employer brand.

Compensation plans are the backbone of attracting and keeping talented professionals. When designed thoughtfully, they do more than offer fair pay—they connect people’s efforts with the company’s goals and drive meaningful results.

Let’s explore how to build a compensation plan that works for both your people and the business.

What is a compensation plan?

A compensation plan is a payment package designed to attract and retain team members. A basic compensation package consists solely of a salary or wages. A more comprehensive compensation package could include additional benefits such as bonuses, perks, commissions, health insurance, or retirement investments. 

Compensation plans involve offering fair and competitive payments that simultaneously align with the company budget and promote business success.

<<Download this free compensation plan template.>>

Key insights

• A compensation plan is a structured payment package designed to attract, retain, and motivate employees. It includes direct compensation and indirect compensation.
• HR leaders prioritize compensation plans to ensure fair pay, reduce turnover, and align rewards with company goals and performance. A well-crafted plan enhances engagement and trust.
• A strong compensation plan is based on company philosophy, job structure, performance management guidelines, and incentive programs. 
• Direct vs. indirect compensation: Direct compensation covers salaries, bonuses, and equity, while indirect compensation includes health insurance, paid time off, and flexible work arrangements.
• HR best practices for compensation planning involve market research, pay equity audits, transparent salary structures, and regular plan reviews to ensure fairness and competitiveness.
• HR technology like HRMS simplifies compensation management by tracking pay structures, market trends, and equity distribution, improving efficiency and objectivity.

Why HR leaders care about compensation plans 

Compensation packages that adequately reward people for their hard work can drive business profit. Proper compensation management: 

• Illustrates company integrity and transparency
• Assists in attracting and retaining top talent
• Boosts employee motivation and loyalty
• Reduces turnover and hiring expenses

<<Learn more about how to simplify compensation management with Bob.>>

The pillars of a strong compensation plan foundation

A strong compensation plan is built on a solid foundation of key elements that ensure fairness, transparency, and alignment with organizational goals. These elements provide the structure needed to create a plan that attracts, motivates, and retains top talent.

Company philosophy

A clear compensation philosophy helps people understand how pay decisions are made. It explains the company’s approach to fairness, competitive pay, and aligning compensation with business goals. 

For example, some companies focus on offering consistent, market-aligned salary ranges, while others prioritize additional perks or performance bonuses. Whatever the focus, having a well-communicated philosophy builds trust and sets expectations.

Job structure (or job architecture)

Job structure organizes roles into levels and categories, giving everyone clarity about where they fit. Defined job titles, responsibilities, and pay ranges can create consistency across teams. This structure also helps people envision career opportunities and how they can grow within the organization.

For example, a company might establish clear levels for roles like junior, mid-level, and senior software engineer, each with defined responsibilities and salary bands. This ensures fair compensation and also provides a transparent path for growth, helping professionals understand what skills and achievements are needed to progress.

Performance management guidelines

Performance management guidelines connect individual effort to pay. They clarify how evaluations, goals, and achievements influence raises, bonuses, or promotions. When people know how their performance impacts their compensation, they’re more likely to stay motivated and engaged.

For example, a company might implement a structured review process where employees set quarterly goals with their managers. At the end of the year, performance is assessed based on these goals, with top performers receiving merit-based salary increases or bonuses. This transparency helps people understand how their contributions are valued and what they need to do to advance.

Team member incentives

Incentives keep people excited about reaching goals. They include bonuses, stock options, commission plans, or profit-sharing. The best incentives are tied directly to clear, measurable achievements. They recognize hard work and give people something extra to work toward.

For example, a sales team might earn commission using an on-target earnings (OTE) structure, where a portion of a team member’s pay is tied to their performance. If team members exceed their targets, they can earn beyond their OTE through higher commission rates or performance bonuses. This can motivate them to push for better results, knowing their extra effort will lead to greater financial rewards.

What are the different types of compensation?

It’s critical to build your compensation plan according to your budget and resources. This is especially important when structuring a competitive compensation program with direct and indirect compensation components. Let’s unpack the differences between the two.

Direct compensation

Direct compensation refers to the financial payments given to people in exchange for time worked or results obtained. Examples of direct compensation include salaries, bonuses, and equity.

• Salary. Salaries are the bedrock of your company’s compensation plan. They’re the fixed, regular pay someone earns for their work, regardless of fluctuations in work hours or performance. Effective compensation plans keep geography, job responsibilities, cost of living, and external market data in mind when calculating base salaries.
• Hourly pay. Hourly pay is straightforward. It compensates people based on the time they work, making it a great fit for flexible or variable schedules. When deciding on hourly rates, think about factors like local labor laws, industry benchmarks, and the specific responsibilities of the role.
• Commissions. Commissions are a performance-driven way to reward people, especially in sales roles. They’re calculated as a percentage of revenue or based on completed deals. To keep things clear and effective, set measurable goals and a transparent payout structure to motivate your team.
• Bonuses. Bonuses are additional compensation often used to reward team members for high performance. When calculating bonuses, it’s useful to consider the following three questions: Who is eligible for a bonus? Which targets should they hit to earn a bonus? What should our payment structure look like?
• Equity. Equity compensation offers people a stake, or partial ownership, in the company. This benefits an organization by incentivizing talented members of the team to remain with the company. It also encourages high performance—if the company succeeds, everyone succeeds.

Indirect compensation

To keep pace with today’s work landscape, many companies have adopted holistic, people-driven strategies to improve their company culture and attract and retain talent. Many companies now offer a variety of indirect compensation benefits and development opportunities. 

Indirect compensation varies from company to company and often includes:

• Medical insurance
• Dental and vision coverage
• Retirement benefits
• Wellness programs (e.g., gym memberships)
• Educational incentives
• Mental health services (e.g., therapy or counseling)
• Volunteer opportunities
• Flexible spending accounts (FSA)
• Hybrid working arrangements
• Paid time off (PTO)
• Disability insurance (DI)
• Paid holidays
• Childcare initiatives
• Relocation stipends or housing options
• Reimbursement for work-from-home costs
• Commuter benefits

How to create and implement a competitive compensation plan

HR professionals can incorporate these practices to develop a compensation plan that attracts talent and boosts retention.

1. Do the research

HR professionals should build a fair compensation plan based on external market analysis and internal company data. Through benchmarking with similar organizations, HR can determine how to create an appealing payment package and maintain a competitive edge in recruitment and retention. 

2. Design a compensation philosophy

HR leaders should outline the company’s underlying approach towards compensation. Outlining the purpose of the compensation plan places the program in context, promoting alignment with objectives and company values. The written philosophy usually includes crucial factors such as a pay-for-performance strategy, a method for the establishment, maintenance, management, and the compensation framework.

A company that prioritizes innovation and collaboration may emphasize team-based bonuses and equity incentives in its compensation philosophy. HR can ensure alignment with company culture and long-term business goals by clearly stating that rewards are tied to both individual and team achievements. 

3. Outline the compensation plan with specific targets and seniority grades

Breaking down the compensation plan into clear targets and seniority levels ensures transparency and consistency. Define salary bands, bonus eligibility, and benefits by role or level so everyone understands how pay decisions are made. This structure helps eliminate ambiguity and promotes fairness, ensuring that compensation reflects experience, responsibilities, and performance.

A marketing associate, for instance, may start with a base salary and become eligible for performance bonuses after their first year. As they advance to a senior marketing manager role, they could gain access to higher bonuses, stock options, or leadership incentives. 

4. Consider indirect compensation

Think beyond paychecks. Indirect compensation, like wellness programs or flexible work arrangements, adds value to people’s overall experience. Highlight benefits that align with your company’s culture and your team’s needs. Offering meaningful perks shows you’re invested in supporting people’s wellbeing—something they’ll notice and appreciate.

An organization that values work-life balance might offer unlimited PTO, remote work options, or a four-day workweek. Meanwhile, an organization focused on professional growth could provide tuition reimbursement, mentorship programs, or learning stipends. Tailoring benefits to reflect company values helps HR leaders create a more engaged and satisfied workforce.

5. Calculate the costs of your compensation plan

Before rolling out a plan, evaluate its financial impact. Add up direct costs like salaries and bonuses, and include indirect compensation like benefits or stipends. Balancing competitive pay with your company’s budget ensures you’re creating a plan that works for both your people and your bottom line.

For example, a growing startup might analyze how offering performance-based bonuses affect its annual budget while ensuring salaries remain competitive. Modeling different scenarios—such as adjusting commission rates or introducing equity grants—will help the company create a sustainable compensation plan that attracts talent without straining resources.

6. Seek buy-in from leadership and stakeholders

Gaining support from leadership and stakeholders starts with clear communication about the value of a strong compensation plan. Explain how it aligns with organizational goals, improves team performance, and reduces turnover. 

Let’s say an HR leader is preparing to roll out a new performance-based bonus structure. They might present data showing how incentive programs increase productivity and retention. They can also help executives understand the long-term benefits by sharing insights on how competitive pay reduces turnover costs and attracts top talent. 

7. Explain the compensation plan to your people

Communicating the components of the compensation plan to personnel demonstrates integrity and nurtures trust in the employer. When people understand the breakdown of their payment plan, they can feel comfortable and confident investing their full efforts into their work. For example, a company implementing a new bonus structure might hold a town hall meeting or create a detailed FAQ document explaining how performance metrics influence payouts.

8. Draft a straightforward employment contract

The compensation plan’s terms and conditions should be simple and easy to understand, both for the employer and team members. A clear employment contract promotes respectful employee-employer relations while also helping avoid disagreements and legal misconduct. During the hiring process, HR leaders should ensure that both parties acknowledge the payment terms.

9. Approach each position holistically

Examine each job and its different components: What skills and educational levels does the job require? What are the job conditions? How does each job compare to others in value? Analyzing each position in relation to other roles can provide HR professionals with a broad perspective and deep understanding of each job’s overall worth.

10. Monitor key compensation metrics

Keep an eye on the numbers. Metrics like pay equity, salary-to-revenue ratios, or market competitiveness can reveal whether your plan is working. Regularly reviewing these benchmarks helps you spot gaps and make adjustments. 

<<Monitor your compensation plan with this compensation analysis template.>>

How to ensure equity and fairness in a compensation plan

Now that you understand how to build a compensation plan, here’s how HR leaders can ensure their plans are fair and equitable:

Conduct regular salary audits

Reviewing salaries on a regular basis helps spot and fix pay gaps within your organization. Analyze pay data across roles, departments, and demographics to ensure compensation aligns with contributions and market standards.

Incorporate pay transparency

Pay transparency creates trust. Being open about the factors that shape compensation decisions—such as experience, performance, and market trends—helps people feel valued and respected. When employees understand how pay is determined, they’re more likely to stay engaged and motivated, reducing uncertainty and fostering a culture of fairness.

Design salary bands with equity in mind

Assigning clear salary bands to roles and levels helps reduce bias, ensure fairness, and create transparency around compensation decisions. A well-defined structure prevents pay disparities, supports career growth, and strengthens trust. 

<<Conduct a pay equity audit with this free template.>>

Account for diverse needs

Different people have different priorities. Offering flexible benefits, such as childcare support, remote work options, or wellness programs, helps meet the unique needs of your team, making compensation feel more personalized and equitable. 

Start by surveying your team to understand their top priorities. Implement a benefits portal or system that allows employees to select the perks that matter most to them. Communicating options clearly—in onboarding, internal newsletters, or manager check-ins—helps people fully utilize their benefits.

Train managers on equitable compensation practices

Provide targeted training on topics like unconscious bias, pay equity, and performance-based compensation to help managers make informed and objective decisions. Offer real-world scenarios and role-playing exercises to reinforce best practices. Implement ongoing coaching and resources, such as compensation guidelines and decision-making frameworks, to support managers in day-to-day pay discussions.

Review and adjust regularly

Compensation plans aren’t set in stone. Check in on pay structures and benefits to confirm they’re competitive and fair. Regular updates show your commitment to equity and help address any gaps before they grow.

Compensation plan template example

Compensation plans are as unique as the organizations that create them. Here’s an example:

Basic information
Company name and address
Employee name and ID
Employee position
Employee department

Direct compensation
Hourly rate
Hourly rate 1.5 overtime
Hourly rate double overtime
Salary
Non-exempt 1.5 overtime
Non-exempt double overtime
Commission basis
Commission rate (either percentage or fixed rate)
Overrides
Splits
Payment delay
Sign-on bonuses
Salary-based bonuses
Bonuses based on department goals
Referral bonuses
Holiday bonuses
Quarterly or annual bonuses
Retention bonuses

Benefits
Health insurance
PTO
Family and medical leave
Disability and workers’ compensation
Dental care plan
Hazard pay
Severance pay
Other benefits

<<Optimize your compensation plan with this free template.>>

How can an HRMS help with compensation planning?

Human resource management systems are an invaluable asset for HR leaders when creating a compensation plan. HRMS can help:

• Collate a vast amount of data in one place, streamlining the compensation planning process
• Analyze a variety of metrics, such as geography, cost of living, salary bands, bonus structures, equity grants, and benefits, to calculate salary targets
• Introduce impartiality and remove biases from the decision-making process
• Monitor types of stock, grant timing, and vesting schedules given to team members as equity compensation

Key takeaways

• A compensation plan is a comprehensive payment package designed to attract and retain talented team members by offering fair and competitive compensation
• Direct compensation includes financial payments like salaries, bonuses, and equity, rewarding people for their time and performance
• Indirect compensation encompasses various benefits such as health insurance, retirement plans, and wellness programs, contributing to job satisfaction and retention
• Effective compensation plans demonstrate company integrity and support a positive company culture, enhancing motivation and reducing turnover
• HR leaders can leverage HRMS technology to streamline compensation planning, ensuring fair and equitable pay structures

Benefits of a thorough compensation plan

An enticing, competitive compensation plan demonstrates that the organization values its people. When people know their employer appreciates them, they are more likely to feel motivated and engaged and exhibit higher levels of job satisfaction. A fair compensation plan can nurture respect between people and their employers, setting the foundation for a positive atmosphere and thriving company culture. 

<<Ensure fair compensation with this compensation plan template.>>

Compensation plan FAQs

What is a total compensation plan, and what is included?

A total compensation plan is everything a company provides to a team member in exchange for their work. A total compensation plan takes the full package into account to demonstrate the complete value of what people earn.

Total compensation plans include both direct and indirect forms of pay. On the direct side, this means salaries, hourly wages, bonuses, commissions, and equity.  Indirect components include benefits like medical and dental insurance, retirement savings plans, paid time off, and wellness programs. Companies may also offer perks such as childcare support and parental leave, professional development reimbursements, or commuter allowances. 

What is the difference between total compensation and total reward statements?

Total compensation refers to the combined financial and non-financial benefits a company provides to its people. It’s a broad term that covers everything from base pay to health benefits and perks. A total reward statement is a personalized document that breaks down the value a company provides to a team member, including both monetary and non-monetary rewards. It’s a way to show people exactly what they’re receiving, from their salary and bonuses to their benefits and additional perks.