Personal Finance

Is the annual pay raise dead?

Don't bank on a pay raise: Study
Don't bank on a pay raise: Study

Already have plans to spend that big end-of-year bonus on something special? You might want to stop dreaming. While you're at it, you might want to stop planning too.

A recent study proclaimed troubling news for workers: For the fifth year in a row, employee bonus pools will come in below target, according to benefits consulting firm Towers Watson. And 2015 bonuses will be funded even less than last year. That means companies have fallen short of their financial goals, so expect whatever end-of-year gift you were hoping for (planning for?) to be a disappointment.

A different compensation research firm, Aon Hewitt, disagrees with Towers' finding, and said bonus pools are basically right on target this year (102 percent of target, actually). Whew!

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Don't plan to buy that new car just yet, however. Both companies agree on one thing: There will be no raises this year, or next, or ... maybe not for a long time.

"Base salary increases are flat. We don't see the prospect of that changing much at all in the next several years," said Ken Abosch, who studies compensation issues for Aon Hewitt.

In other words, the annual raise is dead. It was already on life support last decade, but the Great Recession has finished off the raise. It's been replaced by "variable compensation" — the bonus. (See the chart from Aon Hewitt below.)

"The quiet revolution has been the change in compensation mix," Abosch said. "Through a series of recessions, organizations have pulled back dramatically on fixed costs. And base salaries are often a company's most significant fixed cost ... [They] have a compounding effect, and create a drag on an organization's ability to change."

In a perfect world, variable compensation allows companies to align corporate and worker incentives, and it rewards high performers and hard workers. It also allows companies to pull back on employee costs during hard times without resorting to layoffs.

In reality, switching from raises to bonuses has mucked up a lot of things. For starters, it's hard to make long-term financial plans with such short-term financial commitments from your employer. It's nerve-wracking to take on a 30-year mortgage if your income is $100,000 this year but might be $80,000 next year.

Workers also complain that the relationship between performance and bonus is often indirect — determined by factors outside their control, such as turnover in other departments or the overall economy.

In a larger sense, when a substantial portion of a worker's compensation is unpredictable, one benefit of full-time work fades. The "bonus" employee ends up in the same boat as an independent contractor, not quite knowing what their income will be in the future. The Aon and Towers Watson disagreement about funding of bonus pools speaks to the high degree of uncertainty that variable compensation can bring.

Meanwhile, Sandra McLellan of Towers Watson said bonuses aren't working for many companies, either. There's tacit admission on all sides that some part of the bonus is a de facto part of base salary, so managers grant them to just about everyone. Ultimately, that means less money at the top to reward good workers. An effective bonus range pays 50 percent of target payout on the low end, and 150 percent for the high end. The Towers Watson survey shows the range this year is 67 to 115 percent.

"We are seeing managers trending towards the middle," McLellan said.

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One way to look at those numbers: Companies "punish" poor performers at more than twice the rate they reward top performers. The worst get dinged 33 percent of their target bonus, while the best can only expect 15 percent above target.

McLellan sees it the other way around, however.

"This is saying managers are feeling the need to give something to everybody," she said. "In some cases, managers are feeling that the bonus is not related to performance but part of what people should be entitled to."

That humane-sounding approach throws a big monkey wrench into the big idea behind bonuses, which is part of the reason corporations are now complaining that they are having trouble holding on to their best employees.

While the economy is still growing in only fits and starts, and wages overall are barely rising, leverage has changed for top talent, McLellan said. The Towers Watson survey found that 40 percent of firms said turnover is rising, and 52 percent said they are having difficulty retaining "critical-skill" employees, compared to 41 percent last year.

"We are starting to see mobility in certain categories," Abosch said. "People with a specialized skill set, like engineers, financial auditors, analysts."

You'd think the solution to the problem of "talent mobility" would be relatively easy to solve — more pay.

"It's not that complicated, but it's hard to put into practice," McLellan said. Managers are not necessarily comfortable picking winners and losers on an annual basis. "And if your bonuses are not funding at 100 percent, it puts managers into more difficult discussions."

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The news isn't all bad for workers. Aon Hewitt, which thinks bonus pools will be fully funded, said the percent of revenue companies will spend on compensation is at its highest level in 39 years. Certain kinds of workers — executives and salaried professionals — fare very well in the bonus-heavy environment. McLellan said the overall number of workers who are eligible for bonuses continues to grow, as companies lump more workers into the variable compensation model.

On the other hand, the variable compensation model is bad news for hourly and nonexempt workers, who won't get either bonuses or substantial raises again.

McLellan's advice to workers worried about their bonus is straightforward: Some workers have a lot more leverage in today's marketplace than others. For example, high-skill workers, such as computer programmers, can negotiate for better pay.

"If you are the employee reading this, you want to be that person," she said. "And, if you are the employer reading this, you want to make sure you know who those people are in your organization. Know what skill set keeps your business going."