Companies compensate employees in two main ways: directly and indirectly. This blog outlines the differences between the two and how companies can help employees understand the total value of their compensation package.
But compensation is more complex than that. In the HR world, compensation includes all the ways an employer compensates its employees, both directly and indirectly.
What does that mean? Let’s review direct vs. indirect compensation—and how HR professionals should be communicating it as one compensation package.
Direct vs. Indirect Compensation: Defined
Direct compensation is the monetary payment given to employees for time worked or achievements, such as:
- Base salary
In general, direct compensation includes a fixed reward (like base salary) and can also involve short-term and long-term incentives (like overtime and bonuses).
Any other non-cash benefit (with indirect monetary value) is considered indirect compensation. These perks include:
- Insurance (health, dental, vision, etc.)
- Paid leave (vacations, holidays, sick days, etc.)
- Retirement contributions
- Career development programs
- Tuition reimbursement
- Student loan repayment assistance
- Office snacks
In this definition, we’re also talking about non-financial compensation, which has no monetary value at all. This can include:
- Work-life programs
- Company volunteerism
- Corporate commitments to a better society
While some benefits are required by law based on the terms of employment (like health insurance and vacation days), other perks (like career development programs and free snacks) show goodwill to employees, build loyalty and improve retention and productivity.
Now that we know the definitions for direct and indirect compensation, let’s dig deeper into their differences.
Direct vs. Indirect Compensation: What’s the Difference?
The most obvious difference is that direct compensation involves a straightforward monetary reward.
While indirect compensation can provide some monetary value like paid vacation and holidays, it’s subtle (hence, indirect) because it’s not included in the employee’s regular pay.
Non-financial compensation is also an indirect form of compensation that provides emotional over monetary value.
An employee’s direct compensation is based on their performance. If they meet their goals, they may get a raise or bonus.
Indirect compensation isn’t based on performance. An employee’s health insurance plan isn’t determined by how well they work, nor is their performance a factor in how many sick days an employee receives.
An employee’s experience affects their direct and indirect compensation in different ways.
If an employee is fresh out of college, they will likely earn an entry-level salary. Meanwhile, a worker with 20 years of experience will have more knowledge and skills, so they will be paid a higher wage.
When it comes to indirect compensation, companies often give employees more vacation days the more years they work, which is one way to entice workers to stay.
Why Understanding Types of Compensation Matters
Direct vs. indirect compensation is clear. But why does it matter?
Well, employees must receive their earned wages and be paid for the work they’ve done. However, they are not required to use their employee benefits, such as enrolling in their company’s insurance plan, taking vacation days, eating free snacks, etc.
Because of this variability in participation, employees over time become unaware of the full value of their employment—defeating the purpose of the value indirect benefits are intended to provide.
This is a problem. As employees remain unaware of the value of their employment, more and more employees are quitting their jobs to seek higher paying ones with better hard and soft benefits.
What can be done?
Ultimately, an employee’s ability to understand their full value of employment—which involves understanding direct and indirect compensation—depends on the way your company manages it all.
How to Communicate the Full Value of Employment
When you manage compensation, it should go beyond direct compensation. To effectively communicate direct and indirect compensation, you need the right tools to support it—not just a piece of paper they get when they’re hired.
Compensation Management Software
Compensation management software shows employees exactly how they are compensated, both directly and indirectly, so they can comprehend their whole compensation package in real time.
This tool should include:
- Real-time visibility into fair pay practices as awards are made.
- Audit trails for each compensation decision.
- Online employee compensation statements so workers can easily track how and why they are compensated.
- Customized compensation statements for each employee to reinforce the value of their employment.
This kind of transparency and real time awareness of the value of employment inspires your workers to perform their best every day and encourages them to stay.
Total Rewards Communication Software
Total rewards communication software is another way to inform and engage with employees through personalized messaging that is easy to comprehend.
This tool should communicate:
- The total value of compensation.
- A breakdown of employer-provided benefits.
- 401(k) and employee contributions.
- True visibility into benefits and incentives.
Not all employees receive the same rewards. Therefore, you need a tool that provides employees with personalized statements explaining their compensation. That will help you satisfy and retain top talent.
When you compare direct vs. indirect compensation for employees, you’ll find that they both add value to the total compensation package. The important part is communicating this total compensation package so employees understand the full value of employment.
Together, direct and indirect compensation keep workers motivated and satisfied, which is essential to performance and retention.