What is Variable pay?
Variable pay is additional compensation delivered to employees who have performed exceptionally or achieved specific company targets. It is usually gifted quarterly, half-yearly, or annually, either as a bonus, a yearly incentive, or a calendar-year monetary reward in addition to their monthly salary.
In short, variable pay is a payment in addition to an employee’s base salary. One primary focus of variable pay is to motivate employees to improve their work performance and increase retention. Organisations often use a performance management system and add a KPI or OKR sheet to track employee performance
Examples of Variable Pay
Let’s briefly understand how variable pay is calculated in the real world using the examples of variable pay.
Suppose a company plans to provide sales professionals with incentives of about 2.5 % of their fixed salary, often along with the variable pay amount. To increase engagement, the company may offer some good tips, like vacation packages, or arrange luxurious employee benefits.
| Employees | Sales achieved | Variable pay |
| Emp 1 | Rs. 10 lakhs | Rs. 25,000 |
| Emp 2 | Rs. 30 lakhs | Rs. 65,000 (2.5% of Rs. 20 lakhs + 4.5% of Rs. 10 lakhs) |
| Emp 3 | Rs. 50 lakhs | Rs. 1,70,000 (2.5% of Rs. 30 lakhs + 4.5% of Rs. 10 lakhs + 7.5% of Rs. 10 lakhs) |
Suppose an employee’s yearly wages are 10 lakhs. In that case, they will get a variable pay of 25000. On the other hand, if an employee gets 30 lakh as LPA, they will receive 65000. If their wages range from approximately 50 lakhs per annum, an employee receives an immense amount of 170000 as variable pay. The payroll management system and the automated process handle the entire transaction.
How is Variable Pay calculated in Salary?
The basic formula of the Variable Pay is,
Your package = Fixed Pay (X% of total package) + Variable Pay (100-X% of total package)
If your CTC is ₹10,00,000 and the variable pay is 10%, the variable pay is ₹1,00,000 annually.
For example, your monthly salary is 40000 and variable pay is 10000, provided every quarter.
So, the salary will be [ (₹40000*2) + (₹40000 + ₹10000)] = ₹ 130000 every three months or every quarter.
And the yearly salary will be (₹ 130000 * 4) = ₹ 520000.
If income tax applies to the acquired amount, then a tax percentage will be levied on the entire taxable amount.
During the calculation of the variable pay. Tips to remember always are,
- Variable pay is often expressed as a percentage of your annual **CTC (Cost to Company) or implemented as a fixed amount.
- Variable pay may depend on performance reviews or tenure within the organisation.
- Variable pay can be chosen based on specific goals (e.g., achieving sales targets or project milestones).
- Variable pay can be delivered monthly, half-yearly, yearly, etc.
Types of Variable Pay
Variable pay is categorised into multiple types based on different programs or organisation categories.
1. Based on the Program
As per the program, employers ensure an incentive, bonus, or recognition program in the variable plan. The details are highlighted below.
➔ Incentive Plan
This is the primary type of variable pay program. In it, specific performance targets are assigned to every employee at the beginning of each task. Variable payments are made only if the criteria are met. This incentive plan includes profit sharing, gain sharing, stock options, and sales incentives.
➔ Bonus Program
This is another variable pay option in which employees are paid a salary after completing a dedicated task or fulfilling related conditions. Examples of bonus programs include referrals, project bonuses, and retention bonuses.
➔ Recognition Program
A recognition program rewards employees for their hard work. It includes employee spot rewards, a nomination program, and managerial recognition.
2. Based on the Organisation
As per the organisation’s requirement, the variable pay is categorised into several sections, those are
➔ Incentive for every individual
This type of variable pay is for the individual employees who achieve their target within the estimated timeline. The employees receive a bonus or compensation with their monthly or yearly bonus. This type of individual incentive includes,
- sales commission
- Special Recognition
- Safety Rewards
- Target Achievement Rewards
- Best Performance Award
- Problem-Solving Award
3. Team/Group Incentives
Employees who achieve the work target or complete the project within the estimated timeline receive the group or team incentive at the end of the financial or calendar year. A stream of incentives enhances teamwork enthusiasm and builds employee engagement.
There are different types of team incentives, which are,
- Gain sharing
- Quality improvement
- Labor-cost reduction
4. Organizational Incentives
This group incentive can be offered to the entire organisation or all project members. An organisational commission helps employees improve productivity, enhance morale, and build engagement with the office environment. What will be included in the organisational incentives?
- Company Yealy’s profit sharing
- Provided Stock Options
- Deferred Compensation
Who gets the Variable Pay?
Target-oriented domains need to receive variable pay as an incentive to achieve the target within their estimated time. In a company, sales and marketing professionals should get variable pay; on the other hand, employees in high and demanding positions receive variable pay for their extraordinary performance and effort in the company’s business profit.
The choice ultimately depends on the organisation’s culture and budget. When a start-up or mid-range company has funds, employers can arrange a short outdoor trip or a dinner party instead of the employees’ variable pay. For the MNC or big industry, it is a piece of cake.
Is the variable pay Taxable?
In India, variable pay is taxable. After including bonuses, commissions, incentives, or performance-based rewards, variable pay becomes a considerable amount that can be included under the Indian tax regime. Companies often integrate the payroll management system, through which employees easily get a brief on tax-related updates.
How does the tax amount count in the variable tax?
According to the Income Tax Act, if the income rate exceeds a specific limit, it is considered taxable. If the variable amount is added to the particular wage amount, the monthly wages and the added variable pay will determine the tax rate.
➔ Allowances and Exemptions
Depending on local tax laws, specific variable pay components, such as allowances or reimbursements, may be partially or fully tax-exempt.
➔ Other Deductions
Contributions to social security, provident fund, or professional taxes may also apply to variable pay and income tax.
➔ Some Tips Before Consideration
- Keeping track of your variable pay, as it directly impacts your taxable income.
- Ensuring employers provide proper documentation, such as pay slips or Form 16 (or equivalent), showing the breakdown of your pay and deductions.
- Exploring tax-saving investments or exemptions allowed under your region’s tax laws to reduce the tax burden.
How to Create a Variable Pay Plan?
For start-ups or mid-range companies, an initial variable pay plan is pretty confusing, and employers face challenges when calculating variable pay percentages as incentives. Here’s a guide to creating an effective plan:
1. Define Objectives
First, employers should clarify the incentive plan’s purpose, whether it would be effective for productivity, and whether they want to focus on individual, team, or company-wide performance. For example, a sales team may have revenue targets, while a tech team might aim for project delivery timelines.
2. Identify Eligibility
Before planning for the variable pay amount, it will be essential to determine the roles and eligibility of employees. Variable pay is typically offered to roles directly tied to measurable results, like sales, marketing, or project management.
3. Creating Smooth Variable Pay
An employer should consider a smooth variable plan in which the employees can easily understand how the extra amount is calculated in addition to their salary. Complicated variable pay plans confuse the employees regarding rate calculation and percentage understanding.
4. Maintain Update
Employers should update their quarterly variable pay plans according to the recent tax regime and company policies. Incentives and bonuses must also reflect current market trends.
5. Review and Adjust
Review the plan periodically to ensure it remains relevant and effective in driving results. Update KPIs or pay structures as goals evolve.
Advantages of Variable Pay
Ensuring variable pay provides several benefits for employees and organisations. Monetary rewards motivate employees to stay in the company for an extended period. Conversely, employers can achieve a results-oriented culture by retaining talent. Here are the following advantages,
➔ Brilliancy in Performance
Employees empowered by the prospect of receiving variable payment and salary for their hard work or dedication are encouraged to exceed expectations and achieve specific targets. Variable payment is a powerful motivator, especially for roles tied to measurable outcomes like sales or project delivery.
➔ Alignment between Employee and Company
Employees love staying at a company where their hard work is recognized. Besides, the monetary compensation makes the employees more enthusiastic. Moreover, variable pay ensures that individual efforts align with the company’s vision and mission.
➔ Attracts and Retains Talent
Offering a variable pay component makes a company’s compensation package more competitive. High performers talents stay for long years when they experience comfort in their organization.
➔ Flexible for Employers
Employers benefit from the flexibility and cost efficiency that variable pay offers. It allows companies to adjust payouts based on profitability and performance, reducing the financial burden during lean periods and giving them more control over their financial management.
➔ Promotes a Results-Oriented Culture
A well-designed variable pay plan nurtures a culture where employees are motivated to innovate, solve problems, and achieve measurable outcomes.
Challenges of Variable Pay
Some companies plan to offer variable pay to all employees, yet others only to a few who directly perform the target-related tasks. Hence, inter-office discrimination occurs. Employees feel undervalued and less engaged, which hampers productivity.
1. Complexity in Design and Implementation
Planning for the variable pay requires a proper organisational goal, defined KPIs, and ensured fairness in employee roles and responsibilities. Inter-workplace micromanagement, misaligned metrics, and poorly structured plans can result in miscommunication, leading to work-related perturbations and dissatisfaction. Tailoring the plan to fit diverse job functions while maintaining consistency adds complexity.
2. Uncertainty in Earnings for Employees
Let’s consider a scenario where employees of the same domain receive different salaries due to variable pay. Compensation can be unpredictable if employees’ efforts go unrecognised while their co-workers achieve variable income.
Variable pay creates stress in employees’ minds. They feel undervalued when their income depends on achieving specific targets. This uncertainty can negatively impact morale, particularly during underperformance or economic downturns when achieving targets is challenging.
3. Influence of External Factors
External factors like market conditions, economic slowdowns, or supply chain issues can impact performance metrics. Employees might feel penalised for outcomes beyond their control, leading to resentment and a perception of unfairness in the variable pay system.
4. Risk to Team Collaboration
When variable pay is tied to individual performance, it can create unhealthy employee competition. This focus on personal achievements might reduce collaboration and teamwork, harming organisational culture and productivity in team-dependent roles.
5. Administrative and Communication Challenges
Managing variable pay and tracking employees eligible for the extra payment is challenging for the company. For a large workforce, the entire compensation process becomes time-consuming and error-prone. Even employers face complaints against them for inadequate communication about the plan’s structure, evaluation process, payout timelines or the wrong selection of candidates for variable payment. This may lead to misunderstandings, mistrust, and dissatisfaction among employees.
FAQs on Variable Pay
1. What is Variable Pay in salary?
Some bonuses, incentives, or commissions added to eligible employees’ salaries are known as variable Pay in salary.
2. Is Variable Pay in CTC good or bad?
Variable Pay is good for employees with target-oriented tasks and responsibilities, as they feel valued and recognised.
3. What is 80% Variable Pay?
Employees will receive a performance-based bonus or incentive equal to 80% of their potential variable pay amount.
4. How do you find the Variable Pay in the payslip?
The payslip must have a separate section for ‘variable pay’, ‘incentives’, and a performance-based pay section. Employees can find the variable pay amount there.
5. Is Variable Pay mandatory?
No, variable Pay is mandatory for employees who work hard for the target achievement and the company’s productivity.
6. Why do Employers use Variable Pay?
Employers utilise variable pay to incentivise employees and align their performance with company objectives, boosting motivation, engagement, and profitability.
It allows for rewards based on individual or team success, fostering a performance-driven culture. Additionally, variable pay can create flexibility in compensation, enabling companies to adjust payouts based on financial performance or market conditions
7. Will I get Variable Pay in the Notice Period?
Variable Pay is usually not applicable during the notice period. However, according to company policy, many organisations compensate employees with monthly wages.
8. Is Variable Pay taxable?
If the salary amount and the added variable Pay exceed the taxable amount limit, the employee must pay tax accordingly.
