When it comes to rewarding employee performance, companies often choose between a merit bonus and an incentive bonus - or use both. Understanding the difference is essential to designing a compensation strategy that drives motivation, retains top talent, and aligns with business goals.
In this article, we’ll explore the definitions, purposes, and structures behind merit bonuses and incentive bonuses, explain key differences, along with practical examples and guidance on avoiding common pitfalls.
A merit bonus is a reward given to employees based on individual performance evaluations. Unlike a salary increase, it’s a one-time payment recognizing past achievements rather than future goals.
These bonuses are typically determined through performance reviews, where employees who exceed expectations receive an additional reward. Companies often use key performance indicators (KPIs), manager evaluations, and peer feedback to assess merit-based awards. Merit bonuses work well in organizations that want to reinforce a culture of excellence and recognize top performers without committing to long-term salary increases.
Reflects consistent, strong performance over time
Typically tied to manager evaluations and performance ratings
Paid annually or semi-annually
Does not require preset targets
An incentive bonus is performance-driven and often tied to specific targets or results. Incentive bonuses are designed to encourage future performance by linking rewards to predefined goals. Unlike merit bonuses, which recognize past achievements, incentive bonuses are forward-looking and contingent on specific results.
These bonuses can be structured at the individual, team, or company level, and they often align with strategic objectives such as revenue growth, customer satisfaction, or operational efficiency. Incentive bonuses can be short-term (monthly or quarterly) or long-term (annual performance targets).
Forward-looking and tied to specific KPIs
Often linked to sales, productivity, or project completion
Can be individual, team-based, or company-wide
| Feature | Merit Bonus | Incentive Bonus |
|---|---|---|
| Purpose | Recognize past performance | Motivate future performance |
| Timing | Awarded after performance reviews | Awarded upon meeting set targets |
| Criteria | Subjective manager evaluation | Objective KPIs and metrics |
| Frequency | Annual or semi-annual | Can be quarterly, annual, or project-based |
| Flexibility | More discretionary | Requires pre-defined bonus plans |
The company wants to drive specific business outcomes in the future.
Performance can be measured objectively (e.g., revenue growth, cost savings, productivity increases).
Driving specific behaviors (e.g., sales, efficiency)
Aligning compensation with business results
Many organizations use both merit and bonus systems in tandem, tailoring rewards based on role and level.
While bonuses can be powerful motivators, poor implementation can lead to unintended consequences. Here are some challenges to watch for when structuring effective bonus programs.
Subjectivity: Relying too heavily on manager discretion can introduce bias. Use standardized review frameworks.
Lack of clarity: Ensure employees understand how bonuses are determined.
Unrealistic goals: If targets are too ambitious, they can demotivate rather than inspire.
Misaligned KPIs: Incentives should match company priorities, or they may encourage the wrong behaviors.
Lack of Transparency: Employees should clearly understand the criteria for earning a bonus.
A SaaS firm uses merit bonuses for engineering roles and an incentive bonus plan for sales. Top engineers get annual LTI bonuses for innovation, while account managers receive monthly bonuses tied to new ARR.
Front-line staff receive STIP bonuses (Short-Term Incentive Plan) for night shifts and patient care metrics (incentive bonuses), while department heads receive merit based bonuses aligned with quality reviews.
Understanding the differences between merit bonuses and incentive bonuses allows businesses to reward employees in ways that are fair, strategic, and motivating. By blending both approaches—and avoiding common mistakes—companies can create bonus plans that support growth and performance.
Looking to build smarter bonus incentive programs? Bentega helps companies design effective merit bonuses, incentive bonuses, short-term incentive plans and long-term LTI bonus strategies. Explore customized bonus solutions at Bentega.io.