June 26, 2026
We are often asked, “When is the best time to start developing or revising our Variable Pay Plan for next year?” The answer is always “Right after mid-year.” But first, what exactly is “Variable Pay?” Typically, Variable Pay refers to incentives, bonuses, or commissions an employee can earn that are not guaranteed.
By mid-year you should already know how your current-year plans are performing. Don’t have an existing plan or plans? Then perhaps it’s simply time to develop a new plan for next year. Regardless, it is important to understand relevant Variable Pay Plan types, parameters, and the importance of communicating the plan. Let’s start with an overview of the types of Variable Pay Plans:
Types of Variable Pay Plans
There are basically three types of plans: Short-term, Long-term, and Sales Incentive.
Short-term plans are typically one year or less. These plans can be based on goal sharing or gain sharing, or they can be designed just for management, be a customer contact plan for call centers, or be a plan for sales employees.
Long-term plans commonly run for three years or longer. They can be stock options or cash plans and are typically reserved for senior management or very high-level individual contributors. Long-term plans have multi-year goals and may involve some vesting (percentage earned) each year.
Variable pay plans should be defined for a specific employee population and encompass no more than three to five parameters. They should incorporate goals connected to each parameter. These should include stretch goals and should impact business processes or results.
Plan Parameters
Variable pay plans include many parameters. These include the following:
Plan Design and Eligibility
The main challenges in variable pay plan design are being able to forecast company performance, setting goals at the right level, and motivating employees to achieve desired results. These should be addressed upfront. Then eligibility must be determined: Who will be eligible? Certain groups of employees? Full-time only? Are part-time employees included? And then, when are participants eligible to participate in the plan? Upon hire? After a specified period?
Plan Measures and Establishing Clear Links
As noted, plans commonly include three to five measures. These measures are best when tied directly to key priorities and when they are controllable, measurable, and aligned. It is important to balance company and team or individual measures. Company measures are mainly financial results-driven. It’s important to set targets that are realistic but that also stretch and raise the bar. Goals should be understandable and viewed as achievable, with a payout large enough to justify the effort required to achieve them.
Finally, there must be a clear link between measures and outcomes. Consider this example where this was not the case: A global firm informed senior executives that if individual employee performance helped build the bottom line, they would be rewarded. Yet, line managers tried to balance team orientation that was needed to foster cooperation and innovation. Managers did not emphasize individual performance when allocating incentives but focused on group performance which resulted in minimal differentiation between outstanding and low-performing employees. The bottom 25% of employees received 25% of pay from the performance pool. Unintended consequences resulted in revenues falling short of targets and new business being under-resourced. Ultimately, few low performers left the company and the company’s share price plummeted.
Measurement Levels and Correlation of Goal to Performance
Plans should include multiple measurement levels for each parameter, usually threshold, target, and stretch/maximum. Threshold should be the minimum performance level to achieve a payout. Target should reflect a realistic expected or planned level of achievement. And Stretch or Maximum should indicate the level for superior performance.
Goal and performance payout correlation can be straightforward. For example, achieving 80% of goal at threshold earns 80% of target (or it could be slightly less in that 80% of goal at threshold could only pay at 50% of target). The effort required to hit each measurement level should be considered when determining payout percentage. (NOTE: Other key details regarding how to establish these measurement levels are beyond the scope of this article).
Weights and Payout Levels and Amounts
Weighting goals is just as important as selecting the right goals. No individual parameter should be weighted at less than 10%. If it is not worth at least that, it probably should not be in the plan. Also, including multiple goals within a parameter creates confusion, so weight the most important parameters or business priorities accordingly. Balance team and individual weightings where appropriate. And remember that because weighting communicates direction, desired results should clearly correlate to parameter payouts. Will it be a flat dollar target? Should payout tables for sales plans be based on percent of pay or percent of goal? Should you cap payouts?
Reward Payout Frequency and Plan Funding and Modeling
Reward frequency should fit business cycles and goals. Most management and employee plans pay annually, while customer contact or sales plans pay monthly or quarterly. Consider if the payout amount will sufficiently motivate the employee in deciding the payout frequency. To ensure affordability of the plan, make friends with the Finance team so you can model plans to ensure sufficient funding for various levels of achievement. It is essential to understand both total plan cost and the minimum financial performance needed to start funding the plan.
Plan Documentation and Annual Review
Plan documentation is just as important as plan design because these items govern your plan. Plan documentation should cover eligibility, plan objectives, how the incentive is determined, payout calculations and frequency, and terms and conditions. Consider contingencies, too, including how the plan will work in event of transfers or terminations. Implement an annual process to review and update plans. This review should include customer feedback and metrics, employee survey data, and any other meaningful measures that can be added or revised.
Communicating Plans
Once all of the demanding work for plan design and documentation are done, the next critical step is communicating the plan. This should be both verbally and in writing, of course, via whatever means is most appropriate – for example, in-person, via a webinar, having the manager deliver it, or sharing it in a larger group setting. Enlist someone who is not familiar with the plan to review the plan documentation and communication pieces to ensure they are understandable, error-free, and use concise language. It is vital to ensure employees truly know how they can benefit from the variable pay plan. Remember that communication is not a one-and-done exercise each year. Regularly communicate progress toward results as frequently as possible.
The Bottom Line:
Variable pay plans can take many forms and require careful planning, design, implementation, and management to help motivate top performance. But whether you are starting fresh or updating existing plans, don’t delay! In order to communicate plan parameters or changes in December of each calendar year for the following year, it is critical to begin the process no later than July.
If you are struggling with creating or updating variable pay plans for your organization or fear you might not get everything done in time, let’s talk. We’re here to help! Contact us at 317.589.8529 or reach out via our contact page.
Cassandra Faurote
About Total Reward Solutions:
Total Reward Solutions is your trusted partner for compensation services. Led by Cassandra Faurote, professionally certified Compensation and Human Resources expert and author of the book Compensation Sense 101, Total Reward Solutions offers a broad range of compensation and total rewards consulting services to help your organization attract top talent, motivate employees, and retain top performers.