Money talks and motivates, how annual incentive plans (AIPs) boost performance

June 17, 2025

Sara Maginn Pacella

Attracting and retaining top-tier talent is a key objective of organizations and, in turn, of human capital management (HCM) professionals. Gallagher’s recent Benefits Strategy and Benchmarking Survey revealed that employee retention is the most important operational priority for many organizations, outperforming revenue. As a part of ongoing employee retention strategies, annual incentive plans (AIPs) are effective ways to boost morale and performance.

HCM Podcast

Produced with Google Notebook LM Using AI Narration

What are annual incentive plans (AIPs)?

AIPs are annual reward plans that employers use to motivate individual staff and teams by rewarding employees who meet and exceed specific, shorter-term performance targets. These plans often focus on monetary or stock option rewards (although some organizations also offer non-monetary rewards). These financial rewards are generally a percentage of an employee’s base salary.

Many people prefer AIPs to more traditional bonuses as they are based on specific, measurable goals and have less subjective bonus structures.

What are the benefits of using annual incentive plans?

There are many reasons why a company may want to implement an AIP. Leading organizations use AIPs as practical tools to:

- Align employees with overall business strategies and goals;
- Reward high-performing employees
- Encourage accountability;
- Enhance employee engagement;
- Improve targeted and overall performance;
- Promote a positive workplace culture;
- Retain and attract top talent; and
- Increase profitability.

How do you design an AIP?

Like anything that is goal-based, AIPs should be simple and reflect SMART goals. SMART is an acronym referring to a goal-setting framework that keeps people focused by creating specific, measurable, achievable, relevant and time-bound goals. This framework provides an excellent check and balance for leadership to ensure that incentives are linked to clearly defined targets. This makes it easier to track progress and determine payouts. These goals should be simple, as a clear understanding of targets increases motivation to perform and makes goals realistic to achieve. There is no reason why goals shouldn’t provide some stretch in overall performance, but they shouldn’t be so ambitious that achievement feels impossible.

How do AIPs differ from small businesses to larger organizations?

Factors like number of staff, budgetary restraints and resources mean that AIPs may differ between smaller businesses and their larger counterparts. Smaller businesses often offer AIPs that are more simple and more flexible, while larger organizations may have more nuanced and complex plans. Smaller businesses may also offer more non-financial AIP rewards such as extra paid vacation days or learning bursaries, and that may be what’s preferred. SmartBrief reports, “An overwhelming 65 per cent of employees prefer non-monetary incentives instead of monetary rewards.”

What are some examples of annual incentive plan metrics and KPIs?

Annual incentive plans can celebrate individual and collective successes with incentives for individuals, teams or an organization as a whole.

AIPs can use many different performance indicators, including profit-based ones such as:

Earnings per share;
Earnings before interest and taxes;
Net income;
Operations expense ratio;
Gross profit margin;
Revenue growth rate;
Customer acquisition revenue;
Total revenue;
Variance to budget; and
Achievement of budgeted revenue.

They can also include non-financial-based performance measures such as:

- Health and safety;
- Production and quality control;
- Employee engagement;
- Employee training and development;
- Leads and new business;
- New partnerships and strategic alliances;
- Environmental, social and governance factors;
- Customer satisfaction;
- Customer retention;
- How likely a customer is to recommend the company to others;
- Conversion rates (a set base percentage of interactions that result in a sale);
- Diversity and inclusion goals;
- Resolved customer support tickets;
- Percentage of projects delivered on time;
- Average time to hire;
- Employee turnover rate; and

Rate of internal promotions.

What is the difference between a short-term incentive plan vs. a long-term incentive plan?

While long-term incentive plans are based on annual targets that may get renewed and adjusted each year to reflect ongoing longer-term strategic objectives, short-term incentive plans are much shorter. Short-term incentive plans (STI plans) may be paid out quarterly or, in some cases, monthly.

How do you calculate annual performance bonuses?

If you follow SMART objectives, you would decide how to calculate these bonuses before they are presented to staff. When these are monetary based, they are often a percentage of an employee’s salary or a one-off monetary reward of a set amount based on meeting a particular threshold of a goal.

HCM professionals should use local taxation guidelines to ensure that staff have the correct federal and provincial taxes applied to any AIP payouts.

How have AIPs evolved?

In the past, only high-level executives and members of sales teams qualified to receive AIPs, but that has been changing. A Mercer Short-Term Incentive Plan Design survey revealed that 93 per cent of survey participant companies offer STI plans to support staff and those who work alongside sales staff and company executives.

As the costs associated with hiring and retaining the best staff become better known among senior leadership, the prevalence of AIPs is increasing. AIPs are one of many ways that organizations can improve corporate culture and show employees that their contributions to the overall goals of an organization matter.

What are your thoughts on