Meet Victor – he currently makes $100k annually with a 10% annual bonus. He has learned that he is getting a promotion next year, and will be receiving additional compensation. He can choose between two options – a one-time 5% raise or having his annual bonus upped to 15% for next year and all subsequent years. Which should he choose?ir-leasing.ru
At first glance, many would choose the bonus, based on the idea that the bonus is a recurring benefit. In the first year, some would say, the additional 5% bonus would be equivalent to the additional 5% salary, but in subsequent years, the recurring benefit from the increased bonus (15% versus 10%) would make the bonus the more attractive option.
Let’s do the math and examine this claim. Currently, his $100k salary and 10% bonus bring him $110k per year. If he takes the 5% salary increase for next year, he will make $105k, and his 10% bonus will tack on an additional $10,500, bringing his annual haul to $115,500. In contrast, if he takes the extra 5% on his bonus, he will continue to make $100k for his salary, but his bonus will rise to $15,000, bringing his annual compensation to $115,000 – $500 less than what the salary increase will bring.
What about subsequent years? Will the recurring benefit of the increased bonus make it the more profitable option in year 2? For the sake of realism, we will assume a 3% annual merit increase on Victor’s salary, but we will assume this to hold true across both of the scenarios we are tracking. So, if his initial move was to go with the 5% salary increase, which brought him to $105k in salary, then a 3% merit increase in the next year will bring him to $108,150. Once his 10% bonus has been paid, he will have made $118,965 for the year.
What would have happened in year 2 if he had gone with the bonus? His 3% merit increase would have brought him to $103k in salary. Then, his big 15% bonus would kick in, giving him another $15,450. Yet, the two together come to only $118,450, or $515 less than he would have gotten in year 2 had he taken the initial salary bump instead of the bonus. The gap has now gotten wider, from $500 the first year to $515 in the second.
You can probably see how this will play out. The gap will just keep getting wider, because he is always 5% higher in salary than he otherwise would have been for a given year, and then his bonus is calculated on top of that. In year 3, assuming another 3% merit increase, the initial salary bump results in a salary of $111,395 and a bonus of $11,140, yielding $122, 535. In contrast, the initial bonus would bring a salary of $106,090, and a bonus of $15,914, yielding a total of $122,004. The gap is now about $530 in favor of the salary increase.
The math here is pretty simple, but maybe not terribly intuitive. Many folks seem to think that the recurring bonus is the thing to get excited about, but they don’t realize that when salary increases are calculated this way (and for many people, they are), that one-time salary bump has even greater recurring benefits. Food for thought the next time you have to negotiate compensation …