How to design a bonus scheme

Before you start

Legal basis. Contracts and scheme rules set the terms, within equality law [4][5], wages law [6], tax rules [7][8][9], pay gap reporting [10][11] and case law [2][3].

Who to involve. Reward, HR, finance, legal, payroll and the remuneration committee.

What you need. Current rules and contracts, headcount by grade, working pattern and sex, the budget, and past payouts.

Step 1: Set the purpose

Agree what the scheme is for; later choices follow.

In the lumi benchmark, retention is the common primary aim of incentives, at 31.7% (n = 268). Cost control, at 23.1%, is an alternative. Combination (17.9%), performance (16.4%) and not defined (10.8%) are rare (full findings).

Step 2: Decide who is eligible

In the lumi benchmark, 36.2% of organisations make 75% or more of employees eligible for a bonus (common) and 26.9% make none eligible (alternative) (n = 268).

Two legal points apply:

• Part-time staff. Less favourable treatment for working part time must be objectively justified, and the pro rata principle applies unless inappropriate [5].
• Maternity leave. A woman's bonus must cover time before her maternity leave, her compulsory maternity leave and time after she returns [4].

Step 3: Choose how the pool is funded

In the lumi benchmark (n = 145, N/A excluded), 39.3% fund the main pool bottom-up from targets (common), 33.1% top-down as a profit share (alternative) and 27.6% as a hybrid (alternative).

Step 4: Choose measures and weightings

In the lumi benchmark (n = 151; more than one answer allowed), 83.4% use company financial performance, 67.5% individual objectives and 47.0% a performance rating. 27.5% include ESG, safety or people measures, as a modifier or underpin or as weighted measures (n = 266).

Define each measure's data source, threshold, target, maximum and payout. Weightings add to 100%.

Step 5: Set the gatekeeper and model payouts

A gatekeeper is a profit, safety or compliance condition that must be met before anything pays. In the lumi benchmark, 61.2% of organisations have one (common) and 38.8% do not (alternative) (n = 196).

Here, on-target bonus is 10% of an illustrative £48,000 salary, capped at 150% of target, and group profit must reach 90% of budget.

TARGET, CAP, GATE = 0.10 * 48_000, 1.5, 0.90   # salary illustrative
W = {"profit": 0.5, "revenue": 0.2, "individual": 0.3}

def curve(a):  # 0 below 90%, 50% at 90%, 100% at 100%, 150% at 110%+
    if a < 0.90: return 0.0
    if a <= 1.00: return 0.5 + (a - 0.90) * 5
    return min(CAP, 1.0 + (a - 1.00) * 5)

def bonus(profit, revenue, individual, gatekeeper=True):
    s = {"profit": curve(profit), "revenue": curve(revenue),
         "individual": min(CAP, individual)}
    score = sum(W[k] * s[k] for k in W)
    if gatekeeper and profit < GATE: score = 0.0
    return round(score, 4), round(TARGET * score, 2)

In every case, unit revenue is 97% of target and the individual score is 120%.

The gatekeeper removes £2,544 in case B. B and C show the cliff edge at 90%. In the lumi benchmark, the median reported average payout in the last 12 months was 75% of maximum bonus potential (n = 179, N/A excluded).

Step 6: Define discretion after the formula

In the lumi benchmark (n = 267, N/A excluded), 38.2% let a committee adjust the formula outcome with documentation (common) and 31.8% let managers adjust it (alternative). For 19.1% the formula is final, and 10.9% adjust informally without documentation (both rare).

In Braganza v BP Shipping, the Supreme Court held that a contractual discretion must be exercised rationally and in good faith: considering relevant matters, ignoring irrelevant ones, and not reaching an outcome no reasonable decision-maker could reach [2]. For bonuses without set criteria, Lord Hodge saw little scope for intensive scrutiny [2]. Record who may adjust, on what grounds and why.

Step 7: Decide on deferral

In the lumi benchmark, 76.5% of organisations do not defer bonuses (common, n = 268). Deferral for executives (10.4%), senior leadership (9.7%) or a wider population (3.4%) is rare. Where bonuses are deferred (n = 63), 38.1% defer into shares (common), 31.7% into 1-year cash and 30.2% into multi-year cash (both alternative).

Cash is taxed at the earlier of payment and entitlement [7], so state when entitlement arises.

Step 8: Draft malus and clawback

Malus reduces unpaid awards. Clawback recovers paid ones. In the lumi benchmark, 42.9% of organisations use malus (alternative) and 57.1% do not (common) (n = 196). 78.5% use clawback (common) and 21.5% do not (alternative) (n = 158, N/A excluded).

Drafting points:

• Triggers and period. List events, such as misstatement or misconduct, and how long they apply.
• Discretion. Applying malus or clawback is a discretion, so the Braganza duty applies [2].
• Recovery. A deduction from wages needs a prior written contract term or prior written consent, and cannot cover earlier events [6].
• Gross or net. Say which you will recover.
• Penalty rule. Clawback triggered by breach may be tested for being out of all proportion to your legitimate interest [3].
• Leavers. Say whether the provisions survive employment.

Step 9: Set payment timing and leaver rules

In the lumi benchmark, 55.5% of organisations pay annual bonuses within 3 months of year end (common), 35.1% over 3 to 4 months (alternative) and 9.4% over 4 months (rare) (n = 265).

Tax and NIC. Operate PAYE at the earlier of payment and entitlement, and work out NIC on total pay in the period the bonus is paid [8]. For 2026/27, employers pay 15% above £417 a month; employees pay 8% from £1,048 to £4,189 a month and 2% above [9]. Case A's £5,424, paid with an illustrative £4,000 monthly salary, costs £813.60 employer NIC and £119.82 extra employee NIC, as only £189 falls below £4,189. After the P45, use code 0T non-cumulatively [8].

Warning: directors. That example uses a monthly earnings period. Company directors have an annual, or pro rata annual, earnings period, whatever their pay frequency: NICs are worked out each time on total earnings paid so far in the tax year against annual thresholds, less NICs already paid [13]. Executive bonuses will therefore give a different result from the figure above, so model any scheme covering directors on the annual basis.

Step 10: Check the gender pay gap and communicate

Employers with 250 or more employees report mean and median bonus gaps and the proportions of men and women paid a bonus [10][11]. Bonus pay includes performance, incentive and commission pay [10] in the 12 months to the snapshot date. Bonus figures are not pro-rated [11], so pro-rated part-time bonuses lower the averages for groups with more part-time staff. Shares count when they create an income tax charge [11]. Model the gap before finalising Steps 2, 4 and 7.

Tell eligible employees in writing how the scheme works, whether it is contractual, and what they could earn. Each year, explain results and adjustments. Changing a contractual scheme needs agreement, and fire-and-rehire protections start in January 2027 [12].

Checklist

• Purpose agreed
• Eligibility checked for part-time staff and maternity leave
• Funding route, measures and weightings set
• Gatekeeper set and payouts modelled
• Adjustment rights and record-keeping written in
• Deferral and entitlement dates set
• Malus and clawback drafted and reviewed
• Leaver rules, payment date and NIC costs set
• Bonus gap modelled
• Employee summary issued

Related

• Bonus scheme design: UK benchmark 2026 — the benchmark findings behind the figures in this guide.
• How to set up an all-employee share plan: SAYE or SIP
• How to run an annual pay review: process and governance
• How lumi works: methodology — how these figures are collected and calculated.