Paying your employees is one thing. Paying them strategically is another.
A well-built compensation plan does more than put money in people's pockets. It shapes your ability to attract top candidates, keep your best people, and build a workplace where performance actually means something. Without one, you're essentially making pay decisions in the dark.
This guide walks you through everything you need to know about how to create a compensation plan that's fair, competitive, and built to last.
What Is a Compensation Plan?
An employee compensation plan is the framework your organization uses to determine how employees are paid and why. It goes beyond salaries and hourly wages to encompass your full approach to rewarding employees for their contributions.
A complete plan typically includes:
- Your company's pay philosophy and guiding principles
- Base pay ranges for each role
- Variable pay structures (bonuses, commissions, incentives)
- Benefits and indirect compensation
- The process for raises, promotions, and performance reviews
- Compliance considerations for applicable labor laws
Knowing how to create a compensation plan as your organization's total rewards strategy: documented, structured, and consistent.
Why Compensation Planning Matters More Than Ever
The stakes for getting this right have never been higher. Workers today have more visibility into pay than any previous generation, and they're not shy about walking away when compensation doesn't measure up.
Staying on top of workforce trends makes it clear: employees increasingly expect transparency, equity, and total rewards packages that reflect their real value (not just a paycheck).
Compensation planning also protects your business by:
- Ensuring compliance with federal, state, and local wage laws
- Reducing the risk of pay discrimination claims
- Creating a consistent, defensible framework for all pay decisions
- Supporting long-term budget forecasting and financial stability
The bottom line? Knowing how to create a compensation plan saves you money, legal headaches, and turnover costs down the road.
The 3 Types of Compensation You Should Include
Before you start building your plan, it's worth understanding what "compensation" actually covers. Most strong packages include a mix of three categories.
Direct Compensation
This is what employees receive in exchange for their work: base salary or hourly wages, plus variable pay like bonuses, commissions, and tips. It's the most visible part of your offer.
Indirect Compensation
These are the monetary benefits that go beyond the paycheck:
- Health, dental, and vision insurance
- Retirement plans and employer contributions
- Paid time off and sick leave
- Tuition assistance and professional development stipends
Non-Financial Compensation
Don't underestimate the value of what money can't directly measure. Flexible schedules, remote work options, growth opportunities, and meaningful employee recognition all contribute to how employees experience their total compensation. In competitive hiring markets, these perks can be the difference between an offer accepted and an offer declined.
How to Create a Compensation Plan in 6 Steps
Ready to build your employee compensation plan? Here's how to approach the compensation planning process from start to finish.
Step 1: Define Your Compensation Philosophy
Start with the "why." Your compensation philosophy is the foundation everything else is built on: a clear statement of how your organization thinks about pay, what it values, and how those values connect to your business goals.
Ask yourself: Are you aiming to lead the market, match it, or lag slightly while offering richer benefits? Your answer shapes every decision that follows.
Step 2: Conduct a Job Analysis
Before you can price a role, you need to understand it. For each position, document:
- Core duties and responsibilities
- Required skills, certifications, and experience
- Impact on the business
- Internal reporting structure and seniority level
This step creates the foundation for internal pay equity. It helps you make sure similar roles are compensated consistently across your organization.
Step 3: Research the Market
Compensation plan design without market data is just guesswork. Look at what comparable companies in your industry, region, and size range are paying for similar roles.
Use resources like the Bureau of Labor Statistics, industry salary surveys, and job boards to benchmark your ranges. For a head start, Nesco's 2026 employment compensation guide provides current pay data across key industries and roles.
Pro tip: Don't just look at base pay. Factor in the total value of competitor packages, including benefits and perks, when benchmarking.
Step 4: Build Your Pay Structure
Now it's time to put the pieces together. A pay structure organizes roles into grades or bands, each with a defined minimum, midpoint, and maximum.
When building yours, consider:
- Internal equity: Are similar roles paid consistently?
- External competitiveness: Do your ranges hold up against the market?
- Budget reality: What can your business sustainably support?
According to the U.S. Bureau of Labor Statistics, employer compensation costs for private-sector workers average over $41 per hour. Wages and salaries make up roughly 70% of that total.
A strong pay structure also maps out how employees can move within a range and gives people a clear path forward rather than a ceiling they'll hit in year two. Pairing this work with thoughtful competitive pay practices ensures your ranges attract the candidates you're actually trying to hire.
Step 5: Account for Employment Laws
This step isn't glamorous, but skipping it can be costly. Federal, state, and local laws govern everything from minimum wage requirements to overtime eligibility to pay transparency obligations.
Staying compliant is easier when you have strong HR payroll solutions in place. We’re talking about systems that flag potential issues before they become violations and help you maintain accurate, audit-ready records.
Step 6: Communicate the Plan
A great employee compensation plan is only valuable if employees understand it. Once your structure is set, create a clear communication strategy for sharing it with your team.
That means explaining salary ranges, how raises are determined, what performance metrics are tied to bonuses, and where employees can go with questions. Partnering with HR experts on rollout (including understanding how staffing firms work with HR departments) can streamline this process considerably.
Common Mistakes to Avoid in Compensation Planning
A compensation plan is a big undertaking, and a few missteps can undermine the whole effort. Watch out for these:
- Setting it and forgetting it. Markets shift. Your plan should too.
- Skipping the job analysis. Without it, pay decisions are arbitrary and inequitable.
- Ignoring non-financial compensation. A generous salary with no flexibility or recognition rarely retains people long-term.
- Failing to document your process. Undocumented decisions create legal exposure and inconsistency.
- Overlooking pay equity. Disparities across gender, race, or other demographics carry both legal and reputational risk.
When to Update Your Compensation Plan
Your compensation plan isn't a one-and-done document. Plan to review it at least annually (or more frequently) if your business is growing quickly or your industry is especially competitive.
Any time you're expanding your team, entering new markets, or overhauling your workforce structure, revisit your plan alongside your broader staffing plan to make sure the two are aligned.
Build a Plan That Drives Results (and Keeps People Around)
Creating a compensation plan that works isn't just about paying people fairly. It's about building an employee compensation strategy that makes your organization a place people want to stay, grow, and do their best work.
When compensation is thoughtful, transparent, and competitive, it sends a message: we value what you bring to the table. Reinforcing that message through ideas that celebrate your team only strengthens the culture you're building.
At Nesco Resource, we've been helping businesses build smarter workforce strategies since 1956. As a nationally-ranked staffing and workforce solutions company, we connect employers with top talent across industries.
Whether you need contingent labor, direct hire support, or a fully managed workforce solution, we bring the experience and the candidate network to make it happen. If you're ready to build a team as strong as your compensation strategy, we're here to help.
Frequently Asked Questions
What is a compensation plan?
A compensation plan is a structured framework that outlines how a company pays its employees, including base wages, bonuses, benefits, and non-financial rewards. It also documents the philosophy and process behind those pay decisions.
What are the key components of an employee compensation plan?
A complete employee compensation plan typically includes base pay ranges, variable pay (bonuses and commissions), indirect benefits (health insurance, retirement), non-financial rewards (flexibility, recognition), compliance documentation, and a process for performance-based increases.
What is an example of a compensation plan?
A mid-sized manufacturing company might offer hourly wages benchmarked to regional market rates, quarterly performance bonuses, health and dental coverage, paid time off, and an annual review process tied to clearly defined performance metrics. That full package (documented and communicated) is their compensation plan.
What is the first step in designing a compensation plan?
The first step in compensation planning is establishing your philosophy. This defines your organization's values around pay, your goals for competitiveness, and the principles that will guide every pay decision you make.
How often should a compensation plan be updated?
At minimum, review your plan annually. Fast-growing organizations or those in competitive industries should consider reviewing it every six months to stay aligned with market shifts.
Should your compensation plan include incentive pay or just base salary?
Both. Base pay sets expectations and provides stability, while incentive pay motivates performance. A plan that relies solely on base salary often struggles to drive above-average results or retain high performers over time.
What are the biggest compensation planning mistakes employers make?
The most common mistakes include skipping market research, failing to document the process, neglecting pay equity, overlooking non-financial compensation, and not revisiting the plan regularly. Each of these can lead to turnover, compliance issues, or both.