Pay Incentive Programs

Incentive Pay and Cautions for Non-Exempt Employees

Above and beyond base pay is the option of incentive pay. The critical point to make about any plan for a pay incentive program is to watch your messaging. Your communication should focus on the notion that incentive pay is for results above and beyond normal expectations. You want to avoid any one thinking their incentive pay is an entitlement. Look what that thinking has done in the financial industry.

Where Pay Incentive Programs Can Be Targeted

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Incentive pay may be targeted within the company at three different levels. The first is a company-wide incentive pay program.

1. Company-wide. You can have all employees participate, or have it across the whole company for FLSA exempt employees only. This is sometimes called a Team Award.

2. Group. The second option is to offer a pay incentive at a group or division level. This makes a lot of sense if you are in an organization that has many different locations, each with some unique challenges in its competitive environment.

3. Individual. The third option is to have incentive targets at the individual level.

You have the choice to have one, two, or all three of these options within your incentive pay program. You also get to decide what weight each component should carry as well as the timing of the payouts. Most organizations choose annually, semi-annually, or quarterly incentive payouts. In making the payout decision, you must balance what optimally supports your strategic plan versus the administrative burden.

FLSA Incentive Pay Rules – Take Caution with Non-Exempt Employees

Let me share one major cautionary note regarding a company-wide incentive program that includes non-exempt employees. While I philosophically support an incentive to promote an all-for-one and one-for-all approach with everyone tied to a common incentive, it’s important to recognize that if you decide to do this, you must commit to revisiting your non-exempt overtime costs once the incentive is paid out.

To stay in compliance with FLSA, the Fair Labor Standards Act, you must go back and do an additional calculation for overtime hours worked in the period over which your incentive applies. This new calculation takes into account the incentive into a newly calculated average hourly wage, which will result in awarding more over time pay. Let me give you an example.

Calculating Overtime Pay when Paid by Incentive

The following is an example of calculating non-exempt employees incentives:

Let’s say you have a company-wide Team Award for everyone that pays out twice a year. The firm does very well and you have a non-exempt employee, Chris, who qualifies for a $500 incentive award. Let’s also say Chris earns $15 per hour, worked 1,040 regular hours and worked 100 hours of overtime during the six months defined for the Team Award period. You do not owe Chris just the $500 incentive. You also owe Chris an additional $22. How can that be?

For FLSA compliance you must re-calculate Chris’ overtime pay. Prior to the payment of the Team Award, Chris had gross earning of $17,850, from his all his hours worked (1,040 regular and 100 overtime) plus the premium for his over time.

Chris’s original pay calculation:

Total hours worked at base pay [$15 x (1,040 +100)] = $17,100
+ OT Premium ($15 x 0.5 x 100) = $750
Total Gross Pay = $17,100 + $750 = $17,850

Once an incentive award is paid to a non-exempt employee who has worked overtime, a new Average Straight Time Hourly Earnings (ASTHE) must be calculated. The math is the base pay for all hours worked, plus any non-discretionary incentive pay, divided by the number of hours worked. The prior ASTHE was $15. Now it has shifted up by forty-four cents.

Chris’s revised pay calculation:

Total hours worked at base pay [$15 x (1,040 +100)] = $17,100
+ Team Award = $17,100 + $500 = $17,600
ASTHE = $17,600/1,140 = $15.44 per hour
Overtime premium = $15.44 x 0.5 = $7.72 per hour x 100 hours = $772
Total Gross Pay = $17,100 + $500 + $772 = $18,372.
Moneys already paid to Chris = $17,850 plus the $500 incentive = $18,350.
Additional money owed to Chris for his overtime = $18372 – $18,350 = $22.

This is the most challenging compensation calculation you will ever need to do. The Department of Labor does have an on-line calculator that can help:

Note on Non-Discretionary Pay

The last note on this has to do with the adjective used above: non-discretionary. The incentives I’ve described in this article are non-discretionary. That is they are clearly communicated and employees know what they can expect in exchange for performance against pre-defined goals.

All non-discretionary incentives must apply the ASTHE calculation for overtime worked in the applicable work time frame. Attendance or safety bonuses are examples of non-discretionary incentives. Discretionary bonuses are not defined, not communicated ahead of time, and are at the whim of management. Discretionary bonuses do not affect prior overtime pay as described above.


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