Key Compensation Components

Compensation has become a far more complicated issue than just deciding how much to pay your employees. In addition to salary, employers must consider many other components — 401(k) plans, stock options, bonuses, and vacation — these too have become part of current compensation packages.

Employees also have greater expectations of what should be included in their compensation packages, and they may demand specific benefits that can be costly for small businesses.

Costly or not, building a fair and attractive compensation package is critical for attracting and retaining employees. When setting up your compensation package, consider the following components:

Salary and wages. This is usually the single largest component of a compensation package, and not surprisingly, the most common point of comparison used by employees and potential employees. Salary should be tied to a person's skills and experience. Subsequent increases need to be based on an employee's performance, value, and contribution to an organization. For salespeople, it might be important to find a balance between salary and commission.

Check salary surveys and want ads, and scout out competitors to see if they are underpaying or overpaying their staff. Paying too much is an unnecessary drain on your resources, but paying too little will make it difficult to find and keep the best people. (Read How Do I Find Out Salary Ranges?)

Bonuses. Employee bonuses, which are usually paid in a single lump at the end of the year, are one way of providing performance incentives. Profit-sharing plans are a more formal way of doing this, but they're not as effective for rewarding individual performance and compensating employees for meeting their goals.

Long-term incentives. Stock options or stock grants not only provide long-term incentives to employees, but they can also help retain valuable team members through your organization's crucial startup phase.

Health insurance. Employer-sponsored health insurance is fairly standard among medium-size companies. Plus, it's a benefit that has great value to employees. An employer-sponsored plan saves employees money, and gives them peace of mind in knowing that they won't be denied coverage, even if they have existing health problems.

If you think you can't afford it, think again. Providing insurance to your employees sends the message that you care about their health and the health of their families. It can also be a vehicle for promoting productivity. To minimize costs, consider having employees pick up part of the tab. Employees who have coverage through a spouse may want to opt out of a plan, particularly if there's a cost associated with it.

Life and/or disability insurance. This is also a benefit that usually costs less when it's purchased by an employer rather than by an individual.

Retirement plans. 401(k) plans have become popular because they're relatively easy to administer and are less expensive than traditional pension plans. Many employees like these plans because they maintain some control over the amount of their contribution and how the money is invested. Most small companies try to put some kind of savings or 401(k) plan in place, even if they don't contribute money to them.

Time off and flexible schedules. This includes holidays, vacations, sick days, and personal days. An employer unable to offer competitive salaries may close part of the gap by offering more time off or flexible work hours. Some employers make no distinction between sick, vacation, or personal days, allowing employees a set number of days off each year to be used at their discretion. This prevents employees from abusing sick days, and keeps them from feeling that they need to lie when a child is ill or a personal emergency arises.

Miscellaneous compensation. Other forms of compensation to consider include employee assistance programs, which can provide everything from psychological counseling to legal assistance; discounts on company products; the use of a company cars; and any other incentives that motivate employees and give your company a competitive advantage. Read Unusual Perks for Employees.