Discretionary Bonuses: What Employers Need to Know Before Rewarding Staff

During high stress and peak periods in the workplace, employers may wish to find ways to show their appreciation for their employees’ hard work.

However, firm-wide or company bonuses are usually contractual and tend to be paid out once specific targets are hit. This means an employer has less flexibility around how much or who is entitled to one. Employees’ entitlement to a contractual bonus should be recorded in their written statement of employment particulars and the criteria for the employee to obtain a contractual bonus should be clearly explained and set out.

Employment Law Christmas Round Up

During the festive season at work spirits are heightened, Christmas jumpers are out in full force and tubs of celebrations and quality street litter the counterspace. While it is a joyous and fun occasion for those who celebrate, there are still a number of things employers should be wary of to ensure a smooth sailing festive season. Read more >

What is a discretionary bonus?

Discretionary bonuses are sometimes known as voluntary or non-contractual bonuses. Unlike contractual bonuses, they provide employers with greater flexibility, allowing a bonus to be awarded in one year but not necessarily the next, with the amount adjusted to reflect business circumstances.

This flexibility can make discretionary bonuses an attractive option for employers looking to recognise exceptional contribution, reward performance or provide additional support during periods of financial pressure.

However, whilst employers may retain discretion, that discretion is not unlimited. Employers should ensure decisions are reasonable, consistent and capable of being justified if challenged.

As a result, discretionary bonuses should form part of a considered reward strategy rather than being implemented on an ad hoc basis.

How employers can award discretionary bonuses fairly and legally

If an employer decides to award discretionary bonuses, several factors should be considered before making any decisions:

• Confidentiality: Employers should handle sensitive information about employees discreetly, especially if assessing personal circumstances that may influence bonus decisions.
• Fairness: Bonuses should be distributed fairly, ensuring that employees in similar roles or circumstances receive similar treatment.
• Awareness of employee needs: Employers and managers who are familiar with their teams can better understand who might need extra support, though this should be done respectfully and without making assumptions.
• Committee oversight: Forming a bonus committee can help mitigate unconscious bias and ensure that decisions are balanced and consistent.

A bonus committee or review panel may help mitigate unconscious bias and ensure decisions are balanced, objective and consistent across the organisation. Employers should also ensure employees understand whether a bonus is contractual or discretionary, helping to manage expectations and reduce potential disputes.

For further guidance on fair workplace reward arrangements, employers may find the ACAS guidance on bonuses helpful.

How should employers document discretionary bonus decisions?

Employers should keep a record of the decision-making process, including criteria considered, committee notes, and approvals.

Maintaining a documented audit trail can help protect against allegations of unfair treatment and provide evidence that decisions were made consistently. It can also serve as a useful reference point when considering future bonus awards and reviewing the effectiveness of reward strategies.

What are the alternatives to providing discretionary bonuses?

Discretionary bonuses might go a long way to help struggling employees, however, they are not the only method of assistance available. Employers may wish to consider other options available, such as providing short-term crisis loans that could then be paid back through salary deductions over a set period of time.

Employers may also wish to consider whether sustainable salary increases are achievable as part of a longer-term reward strategy. However, for businesses which are unable to provide salary increases, a one-time discretionary bonus could seem like the best way forward.

It is important for employers to seek professional advice, where necessary, to ensure that they have addressed factors such as fairness, unconscious bias and how to ensure the support will remain confidential before they go ahead and set up any discretionary bonus schemes.

What’s the difference between a contractual bonus and a discretionary bonus?

Understanding the distinction between contractual and discretionary bonuses is important.

A contractual bonus:

• is linked to specific performance measures or targets;
• is usually documented within employment contracts or bonus schemes; and
• becomes payable when the agreed criteria have been met.

A discretionary bonus:

• is not automatically payable;
• gives employers greater flexibility over whether a payment is made;
• allows the amount awarded to vary according to business circumstances; and
• should still be administered fairly and reasonably.

Employers should ensure employment documentation accurately reflects the type of bonus arrangement they intend to operate

Are employee bonuses taxable?

Yes, typically bonuses are considered taxable income. Certain types of gifts, such as non-cash items below a specific value threshold, may not be taxable, depending on the tax laws in each country. Employers should consult tax professionals to understand how to handle gifts and bonuses compliantly.

Understanding the tax position in advance can help avoid unexpected costs and ensure compliance with relevant reporting obligations. Employers can review the latest HMRC guidance on bonuses here.

Rewarding employees through discretionary bonuses

While financial rewards can play an important role in employee engagement, employers should also consider how their wider festive activities contribute to workplace culture. Our guide on how employers can create an inclusive workplace during the holiday season explores this in more detail.

Discretionary bonuses can be an effective way to recognise employees’ contributions, support retention and strengthen workplace engagement. However, employers should ensure bonus decisions are made fairly, consistently and in line with any contractual obligations, whilst also considering potential discrimination and tax risks. Taking time to establish a clear decision-making process and maintaining appropriate records can help reduce the likelihood of disputes and ensure employees understand how reward decisions are reached.

If you are considering introducing a discretionary bonus scheme, reviewing an existing approach or dealing with concerns arising from bonus payments, seeking specialist advice at an early stage can help minimise risk and support informed decision-making.

We advise employers on bonus arrangements, contractual entitlements, workplace policies and employee relations issues. If you would like guidance on implementing or reviewing a discretionary bonus scheme, get in touch with a member of our employment team.

This content is provided for general informational purposes only and does not constitute legal advice. It is not intended to address the circumstances of any individual or entity, nor should it be relied upon as a substitute for specific advice from a qualified solicitor. The information reflects the legal position as at the date specified and may be subject to change. If you require advice on a specific matter, please contact us directly.