Compensation Types Explained: What Every HR Pro Should Know

Compensation Types Explained: What Every HR Pro Should Know

For many employees, the word “compensation” is tied directly to their paycheck—but you know that is only part of the story.

At the most basic level, compensation is understood as wages that are offered in exchange for work completed. Compensation is categorized into two types: direct and indirect.

It’s your job to understand and effectively communicate both compensation types—direct and indirect—to employees and prospective employees. Doing so will help attract and retain qualified talent.

What are the most-promoted benefits—and the emerging ones to watch? Download MorganHR’s Biannual Benefits Study to find out.


What are the different types of employee compensation?

Direct Compensation: Base Pay, Short-Term Incentives, and Long-Term Incentives

Direct pay consists of wages paid by employers to employees as well as variable pay in the form of short- and long-term incentives, such as cash bonuses, commissions, and company stock awards.

  • Base pay: Wages and salary. Base pay is the foundation of total compensation because it establishes employees’ standard of living and is the primary indicator of the value the organization places on specific roles and contributions. (SHRM)
  • Short-Term Incentives: Short-term incentive plans often include gain-sharing or profit-sharing plans, annual incentive plans, commission, and cash recognition awards. (SHRM)
  • Long-Term Incentives: A long-term incentive, as the name suggests, is a vehicle that has an extended time horizon (generally greater than one year) and that can be a strategic compensation vehicle to promote long-term retention and alignment with company goals. (Mercer)

In summary, direct pay is what employees see in their paycheck each pay period and on their W2 every year.

Indirect Compensation

Indirect compensation is a non-monetary reward exchanged for an employee’s work—what HR professionals often refer to as benefits.

Indirect compensation typically includes health, life, dental, vision, and other types of insurance; 401(k) or other retirement plans; paid time off (note: PTO isn’t a true exchange for services because it supplies a reward for not doing work, but it still falls under indirect compensation); perks (free food, discounts, gym memberships, and many more); etc.

Indirect compensation is a powerful tool for attraction and retention, but it can be difficult to measure because it doesn’t always have a monetary value in the same way direct compensation does.

However, it does have tangible value to employees and employers: Strong indirect compensation can give employers a competitive edge in the hiring process, improve employee retention by boosting morale, and very often reduce turnover rates.

Sharing your employees’ total compensation with them in the form of a total compensation statement is one way to provide the whole picture of your company’s compensation to your employees.

Bonus Download

At MorganHR, we understand the value of offering a strong total compensation package. However, we also know that benefits are always evolving, and what matters to employees and potential hires is changing as quickly as the job market.

Fortunately, you can stay up-to-date with all the latest changes in the world of employee benefits—what’s trending now and what new benefit programs you should be paying attention to—by downloading our biannual benefits study.

Understand Compensation To Stand Out Among Your Competitors

Understanding different compensation types will help you retain your top talent and help you attract new talent to your organization, but it’s just one aspect of compensation your HR team needs to understand. Job alignment, compensation structure, and manager compensation training are all things we help organizations with at MorganHR—and we’ve seen the positive culture changes as a result. Let us do the same for you! Get in touch with our team today to learn more.

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About the Author: Alex Morgan

As a Senior Compensation Consultant for MorganHR, Inc. and an expert in the field since 2013, Alex Morgan excels in providing clients with top-notch performance management and compensation consultation. Alex specializes in delivering tailored solutions to clients in the areas of market and pay analyses, job evaluations, organizational design, HR technology, and more.