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How do employee benefits work?

April 23, 2021 - 21 min read


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What are employee benefits?

The importance of employee benefits

The difference between mandatory and non-mandatory employee benefit plans

Types of employee benefits

How to develop an employee benefits plan

The scope of employee benefits has expanded over time, but the basic concept remains the same. Great benefits help attract new talent and support the employees you have.

Competitive benefits can help a business recruit in-demand talent. Great benefits also help keep current staff healthy, motivated, and less distracted by life concerns.

In this article, we'll look at some common employee benefits and how companies create benefits packages. We’ll also consider how employer-sponsored assistance is evolving to accommodate changing needs.

What are employee benefits?

Employee benefits are a form of compensation offered in addition to a salary or wages. Common non-wage benefits include medical, disability, and life insurance, retirement savings, paid time off, and sick leave.

In the US, the IRS excludes many benefits from an employee’s taxable pay. Employees are not taxed for health insurance, health savings account contributions, life insurance, tuition assistance, and retirement savings.

A variety of non-cash, fringe benefits – also called “perks” – can also help attract and retain employees. These may include tuition assistance and flexible medical or child-care spending accounts.

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The importance of employee benefits

The monetary cost of offering competitive benefits can be high for an employer. But, the actual value they provide is higher in the long run. 

According to the U.S. Bureau of Labor Statistics, worker compensation cost private-sector employers $35.95 per hour worked on average. Benefits accounted for nearly 30 percent of those costs. Wages and salaries make up the rest.

That may seem like a high markup for maintaining a happy workforce. But talent shortages are a key risk for organizations worldwide according to a Gartner’s 2019 Emerging Risks Survey. Being too frugal with employee benefits makes it harder to compete for in-demand talent. Good benefits also help retain long-term employees with valuable institutional knowledge. 

Medical insurance in particular can be very expensive. But, if competing employers are offering similar location, salary, and job title, a better health plan can put you in a stronger position.

A good benefits package is also good for morale and can inspire worker loyalty. Workers see that their employer is invested in helping them achieve their personal and financial goals. Satisfied employees tend to miss fewer workdays, are less likely to quit, and are more committed to company goals.


The difference between mandatory and non-mandatory employee benefit plans

Mandatory benefits are required by law. Non-mandatory, or discretionary, benefits are designed to increase loyalty and job satisfaction and appeal to prospective employees.

Businesses are required by the federal government to provide the following mandatory benefits:

  • Medicare and Social Security
    All U.S. employees pay into these federally mandated benefits programs while working. Workers “benefit” from the programs after retirement or age 65. Medicare and Social Security are called payroll taxes because both the employee and employer pay through payroll deductions.
  • Workers’ Compensation Insurance
    Workers’ compensation insurance covers the employee’s costs related to injury or illness as a result of their job. These costs include medical care, treatment, rehabilitation, and paid leave or replacement income.
  • Unemployment Insurance
    This mandatory insurance is available if an employee involuntarily loses his or her job. It provides partial income replacement for a specified period of time. Both employee and employer contribute to unemployment compensation insurance. It is administered by the government on both a state and federal level. Do not confuse this with severance — a company might pay severance to an employee who is terminated or laid off from a position. People often apply for unemployment benefits after their severance has been paid.
  • Health Care Coverage
    The Affordable Care Act (ACA) requires any organization with 50 or more full-time employees to provide health care coverage. Businesses must report the value of health insurance on employee W2 forms. They also file paperwork with the IRS detailing the cost and types of insurance plans they offer their employees. Under the ACA, the federal government can assess penalties against businesses that do not offer sufficient health insurance to full-time employees.
  • Federal Family Medical Leave Act (FMLA)
    This law requires private businesses employing more than 50 people to provide workers with up to 12 weeks of unpaid leave. FMLA protects the employee’s job security. Employees can apply for family leave upon the birth of a child, when a spouse or family member with a serious medical condition needs care, when transitioning to active duty military service, or when caring for their own serious health condition.
  • Individual state governments may have other requirements. For example, most states entitle employees to time off for jury duty or to vote.

Here are some of the many discretionary benefits that employers are not required to provide:

  • Certain forms of supplemental insurance
  • Life insurance
  • Retirement savings plans
  • Dental and vision care
  • Wellness programs, such as a gym membership reimbursement
  • Paid vacations, holidays or sick leave
  • Health insurance (only if an employer doesn’t meet the ACA’s conditions for coverage, such as employing fewer than 50 people)

    Understanding which benefits are required is the easy part — every business will have them. Discretionary benefits are where employers can get creative. This is where they do most of their thinking when designing a package. 

Here are more details about the most common discretionary benefits that employers offer their employees.


Types of employee benefits

Child Care/Dependent Care Benefits

An employer might offer on-site childcare facilities. Some allocate specified dollar amounts for child and elder care. Other companies offer programs so that employees can set aside funds for these expenses from pre-tax pay.

Commuting/Travel Assistance

Some employers with offices in high-traffic or smog congested areas provide a company van service, a carpooling allowance, or public transportation allocations to encourage employees to use environmentally friendly transportation. These may come out of an employee’s pre-tax pay.

Dental Insurance

This may be offered separately to cover dental exams, cleaning, and X-rays, as well as surgical and orthodontic care. Employers determine which services are covered and to what extent (specified by deductibles, co-pay, annual limits, and lifetime maximums).

Disability Insurance

This benefit replaces all or part of the income lost when a worker is unable to perform his or her job because of an illness or injury. The two main types of disability insurance are:

  • Short-term disability insurance begins right away or within a few weeks of an accident, illness, or other disability. For example, someone hurt in a car accident would be offered a few paid weeks to recover.
  • Long-term disability insurance provides benefits to an employee who is unable to perform his or her job as a result of a long-term illness, injury, or disability. 

Domestic Partner Benefits 

Benefits for unmarried partners vary by employer and location. Those that do not offer such benefits could find themselves at a disadvantage to competitors that do.

Employee Assistance

Employee Assistance Programs (EAPs) can help employees in times of crisis and for specific needs. This might include financial planning and tax assistance, drug and alcohol counseling, mental health counseling and clinical care, and other types of crisis support.

Employee Recognition Programs

These programs allow employers to recognize their employees for their performance. Recognition programs send a message about what types of performance the company values and how employee behavior is evaluated.

Gym Memberships or Discounts

Employers may offer to pay all or part of health club or gym memberships to promote physical health and well-being.

Health Care Spending or Reimbursement Accounts

  • Health savings account (HSA) – a bank account employees pay into, usually directly from their paychecks. These funds can be used for eligible health care expenses or saved for retirement. This money can often be invested.
  • Flexible spending account (FSA) – a spending account that can be used for dependent care services, dental or vision expenses, and medical expenses not covered by a health plan.These funds usually expire at the end of each year.
  • Health reimbursement arrangements (HRAs) – an account that an employer owns and contributes to. HRAs are available only to employees who receive health care coverage from an employer.

Life Insurance

Life insurance helps employees provide financial security to a beneficiary – often a spouse, child, or other family member – in the event that the employee dies. Employers typically sponsor life insurance that is capped at a fixed amount of coverage. Employees have the option to purchase additional coverage on the same policy. Company-sponsored life insurance plans are typical for almost all full-time workers in medium and large firms in the U.S.

Maternity and Paternity Leave

The leave time most common for women is six weeks paid and six weeks unpaid. For men, more employers are beginning to offer paternity leave of anywhere from two to six weeks. Often these leave benefits extend to adoptions as well. Around 40% of organizations in the US offer paid parental leave, but that covers only 16% of all US workers in the private sector.

Infertility Benefits

Infertility benefits can be incredibly valuable for women. Women who pursue education, advanced degrees, and career planning in their 20s are aware that they might need more support to pursue parenthood in their 30s and 40s. The value isn’t limited to women, however. Men may also need medical intervention for themselves or a partner.


Medical and Health Insurance

This insurance covers the costs of medical care. This includes physician and surgeon fees, hospital rooms and prescription drugs. Employers typically pay at least part of the cost. Employees often pay a percentage of the monthly cost to cover themselves and their dependents. Some medical plans include dental and vision coverage. Others offer them separately at an additional cost to the employee.

Paid Time Off (PTO)

PTO includes holidays, sick leave, and vacation days. In general, employees accumulate PTO as they work, enabling them to continue to be paid when they take time away from work. Some employers offer a specific number of holidays, sick days, and vacation days. Others combine them into a single category that employees can use as they wish. It’s becoming more common for companies to offer unlimited PTO.

Relocation Assistance

Companies sometimes want to encourage employees to relocate to a new city or region. They might also use relocation assistance to entice new candidates to accept a job offer. Relocation assistance may cover many areas of the moving process. These include packing and unpacking services, transportation and moving costs, temporary lodging, disposition of a residence, acquisition of a new residence, mortgage assistance, and cultural and language training.

Retirement Benefits or Accounts

These funds are set aside to provide employees with an income or pension when they retire. These benefits fall into two general categories:

  • Defined benefit plans – often called pension plans – pay a pre-determined benefit based on salary and years of service. In these plans, the employer bears the risk of the investment. These are common with government jobs and some large employers.
  • Defined contribution plans, typically 401(k) plans, let an employer or employee specify the number of contributions. The actual benefit amount is usually tied to investment returns, which are not guaranteed. A 401(k) program can provide a tax-advantaged way for employees to save for retirement. Having the employee designate a set contribution out of each paycheck makes it easier (and more likely to happen). Companies often match a percentage of employees’ contributions.


What began as a benefit to improve work/life balance has become essential during the COVID-19 pandemic. As employers consolidate expensive real estate leases and close offices to cope with the pandemic’s economic impact, many are extending work-from-home policies. Others have adopted permanent hybrid telework arrangements. Which arrangements will be viewed as benefits remains to be seen.

Tuition Reimbursement

Employers sometimes pay for all or part of the costs of attending classes related to an employee’s field of work, with the employer’s approval. This could include classes already taken or classes to be taken, like those in a graduate school program. Sometimes, employers will help employees reduce their student loan debt.

Vision Insurance

Similar to dental insurance, vision insurance may be part of a medical insurance package or offered separately. Such insurance often covers some of the cost of eye exams, glasses, contact lenses and other services offered by ophthalmologists, optometrists and opticians. 

Wellness Programs

Wellness programs focus on improving employee health or fitness. Employers may offer screenings, fitness programs, nutrition counseling, coaching, and preventative care.


How to develop an employee benefits plan

You want to design unique and appealing benefits packages for your workforce. There’s no shortage of possibilities. But it’s important to put them together in a clear and helpful way.  Finally, make sure employees understand what’s available to them. 

Whether it’s your first time or you’re redesigning an existing set, here are some key steps to follow:

  1. Have clear goals. The organization’s benefits objectives and budget will provide overall guidance in establishing the selection and design of the benefits program. You can follow this guide to figure out how to best weigh the cost of benefits
  2. Know what your employees want. A needs assessment can inform an employer’s perception of employee benefits needs, competitors’ benefits practices, and tax laws and regulations. For most companies, there’s no single answer to what employees want. The workforce spans generations and stages of life, as well as geographic distribution. The best benefits plan is one that builds in as much flexibility and ability to personalize value as possible.
  3. Formulate a benefits program. Design the program such that your offerings fit your budget. Using the data collected in step two, an employer can prioritize benefits offerings.
  4. Communicate with employees. Employee understanding of the benefits is critical to buy-in and use. Work with your internal communications department to promote offerings. And, consider conversations rather than just messages.
  5. Periodically evaluate the effectiveness of benefits. Assess how well the program and specific benefits are meeting the organization’s objectives and employees’ needs.

All in all, it’s best to think of benefits as incentives to help your employees in their lives outside of the office. Most employees consider a company’s benefits when deciding to accept a job offer. Keep yours in line with competitors so as not to let great talent pass you by.New call-to-action

Published April 23, 2021

Maggie Wooll

Managing Editor

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