Salary negotiation

Should I sign a retention agreement? Taxes and legal loopholes

Crucial facts to consider before signing a retention agreement, including legal ramifications, taxes, and more.

What Is a Retention Bonus?

A retention bonus is a one time payment made to an employee in hopes of retaining them. This financial incentive usually comes with the expectation that, upon receiving the bonus, the employee will stay with the company for a predetermined period of time.

How much will it be?

A retention bonus amount is usually 10-25% of an employee's base salary.

The percentage of base salary offered is determined by any number of factors, from competitor salaries to the sheer amount of funding a company has available.

Why am I getting one?

While the primary goal of retention bonuses is to keep key employees on board, the motivating factors behind them may vary:

  1. They may be offered during a stressful time for the employer, when retaining key employees is essential for the company's survival. They often want top talent to help them through transitional periods such as a change in leadership, a merger or acquisition, the undertaking of a new project, or other large scale changes.
  2. Retention bonuses may also be offered during times of growth, both for the company and the economy. Offering retention bonuses has become a relatively common strategy to combat poaching of top talent. Many companies believe that retention bonuses work to prevent employees from seeking new jobs.

Since a retention bonus may come your way during times of prosperity or uncertainty, how do you know whether accepting one is the right move?

Should I Accept My Retention Bonus?

Before you accept a retention bonus, there are a number of factors you'll want to consider. Here are a few of them:

Why you're getting the bonus

Companies have different motivations for giving out retention bonuses. Consider whether the company is facing a time or turmoil or prosperity (and competition). Reflect on how you feel about those motivations: do you feel flattered to be deemed a valuable employee? Or do you feel like your employer is trying to buy your loyalty rather than earn it?

How you feel about staying on board

If you had already planned on staying with the company for the duration of the retention agreement, accepting the bonus should be a no-brainer. It may even provide a degree of job security you didn't have before.

If you aren't happy with your position, you already started browsing for other jobs, or better opportunities are coming your way, you have to ask yourself if the retention bonus is worth sticking around for. 

How it will be taxed

Retention bonuses are deemed supplemental wages and they are taxed. It's important to consider the tax rate and method before moving forward-- sometimes, you'll end up forfeiting 40% of your bonus to the IRS!

Here are the two potential taxation methods you need to be aware of. If you're unsure about which method will be used and how much tax will be taken out, consult a tax professional:

Aggregate Tax Method
This method combines the retention bonus and the employee's yearly salary. The sum of these two components is used to determine the tax rate. There is a special section on the employee's W-4 form that is used to calculate the rate.
Percentage Tax Method
This method considers the bonus separately from the employee's yearly salary. It is taxed at a flat rate of 25% up to one million dollars, and any amount over that is taxed at a rate of 39.6%. Here's an example: let's say that your bonus was 1.5 million dollars. $1 million would be taxed at 25% ($250,000 in taxes) and $500,000 would be taxed at 39.6% (another $198,000 in taxes).

Red Flags to Look Out For

Some employers will use language in a retention bonus agreement that is designed to trap an employee. Pay attention to these clauses and conditions to avoid getting screwed over:

"Actively Employed" condition

this condition stipulates that an employee will only receive the retention bonus if they are actively employed by a specific date. Actively employed can mean different things to different employers: for some, it simply means you're on their payroll. For others, it means you are on the job, performing your duties as normal. This meaning is the one you have to look out for-- employers could try to penalize you for being out sick, taking a leave of absence, or otherwise taking a break from your duties.

We recommend that you:

  1. Clarify your employer's definition of actively employed and get it in writing
  2. Ask that they change the language of the contract to reflect that you'll receive the bonus if you don't resign by the specified date. 

"Sole Discretion" condition

this condition stipulates that an employee's receipt of the retention bonus will be determined solely by the employer (at their "sole discretion"). It leaves room for employers to withhold bonuses for any number of reasons-- for example, they could deem performance that's only slightly worse than normal "unsatisfactory" and withhold your bonus, even if an external factor hindered your progress.

We recommend that you request language that places more power in your hands. "Reasonable discretion" can be a comfortable term, as long as "reasonable" is defined in a way you and your employer both agree with. A performance-based condition is also common, where you agree upon minimum standards of achievement.

An employer's commitment to you

Look out for any language that reflects an employer's commitment to keeping you on board for the duration of the bonus agreement, and how that will impact your bonus.

If this language is absent or "implied", make sure to ask your employer to clarify and incorporate the commitment into the agreement.

In an ideal situation, your employer would agree to give you the retention bonus if they choose to let you go before the retention period ends. This is also a great opportunity to request advanced notice or severance, if you are terminated while the bonus agreement is still in place.

Other potential red flags

Keep an eye out for anything else that may leave room for an employer to take advantage of you. Unfortunately, this can happen in a number of ways. Employers could make retention bonuses contingent on things you can't control (i.e. "you'll receive it when the merger goes through"), or they could begin picking away at the quality of your job after you sign (i.e. cutting other benefits, giving you more work, etc). To gain a complete understanding of your retention bonus agreement, it's best to consult a professional.

I Changed My Mind! What Do I Do?

What if you already accepted a retention bonus but now you're having second thoughts? Maybe you received a better offer, or maybe you just fell out of love with your current role. Regardless, we're here to help. These tips will help you figure whether getting out of the agreement is the best decision for you.

Re-examine the terms of the retention bonus agreement

Look out for the things we outlined above and identify any other ways an employer could come after you, should you choose to leave. More likely than not, the bonus money is the only thing at stake, but it's always good to re-familiarize yourself with the contract before proceeding.

The most important term: What happens to the money? This information should be available in your contract. There are two important factors to consider:

  1. When you received payments: If you received a lump sum at the beginning of the agreement, or installments throughout, you have already profited. If you were set to receive a lump sum at the end of the agreement, you have not yet profited (and the agreement may be easier to walk away from).
  2. Whether you lose the bonus: If you already received the bonus, some companies will allow you to keep it, even if you terminate the agreement. Other companies will require that you give it back. If you have already received and spent your bonus, this can present an issue. If you don't have enough funds readily available to pay your employer back, you may want to reconsider leaving the company.

Here's one example of how to introduce this conversation:

Consider your relationship with the company

Is the relationship you have with this company, your bosses, and even your coworkers worth risking? Backing out of a retention bonus agreement may not be taken kindly-- you're rolling back on a promise to be loyal to an employer. Consider the potential impacts on your network and future prospects before making the decision to leave.

Ask yourself why you're leaving, and whether it's worth it

Are you leaving to take a once-in-a-lifetime opportunity, or are you just sick of your job? Will you have to pay back the bonus, and if so, do you have the funds to do so? There are a lot of factors to take into consideration, between the terms of the contract and the host of personal reasons that can influence this kind of decision. Take some time to reflect on how leaving will impact you and whether you should hold on to your position a little longer.

Retention Bonuses Can Be Negotiated

How to negotiate a retention bonus

Two things are negotiable here: the dollar amount and the terms.

Here is an example email template for asking to increase the amount:

In other cases, the terms may be more pertinent. Here is an example of an email discussing terms:

If you have multiple issues and would like to further negotiate over email, here's how to tackle the discussion:

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