Annual Incentive Plan (AIP)
What is an annual incentive plan?
An annual incentive plan (AIP) is a formal, formulaic cash incentive program that rewards employees for performance against predefined goals over a twelve-month period. It is a short-term incentive — a STIP — as distinct from long-term equity incentives, and it is non-discretionary: the metrics, weights, and payout curve are set at the start of the year, and the payout follows from the results.
That last word is the whole point. An AIP is not a bonus that someone decides on in December. It is a formula that was published in January.
The AIP formula
Payout = Base salary × Target incentive % × Performance factor
Structure per Meridian Compensation Partners; the large majority of large-cap companies use formulaic designs with predefined metrics and weightings.
The payout curve
Every AIP has three points, and a plan missing any of them is not really an AIP.
What this means?
The curve is the plan. A company that publishes a target incentive percentage and no curve has told employees what they get if everything goes exactly to plan — which is the one outcome that never happens. Below threshold, nothing pays. Above maximum, nothing more pays. Both boundaries are where employees discover the plan they thought they were on.
A worked example
Anita, a Finance Manager. Base salary $110,000. Target incentive: 15%. Metrics: company revenue (60% weight), EBITDA (20%), individual objectives (20%).
Payout = $110,000 × 15% × 0.87 = $14,355 — against a target of $16,500.
Anita's company beat its revenue number and she still earned 87% of target, because EBITDA fell below threshold and contributed zero. That is the curve doing exactly what it was designed to do, and it is also the conversation nobody has in January.
Why AIPs matter for finance teams
The AIP is usually the second-largest variable comp line after sales commission, and it is unusual in one important way: it is self-funding by design. Because the metrics are typically company financials, a bad year mechanically reduces the payout. That is a feature — but it means the accrual moves with your own forecast, and every re-forecast during the year changes the AIP accrual for every participant simultaneously.
Unlike sales commission, an AIP payout tied to company EBITDA is a period expense, not an incremental cost of obtaining a contract. It is not capitalized under ASC 606. Companies that run both instruments in one spreadsheet frequently blur this.
Common mistakes with annual incentive plans
1. Publishing a target percentage with no payout curve
Employees will assume linear payout from zero. It almost never is.
2. Metrics that cannot be independently computed
If an employee cannot calculate their own performance factor from published results, the plan is discretionary in effect — whatever the document claims.
3. Adding discretion after the fact
An AIP whose payout is adjusted at management's discretion in a bad year has taught the company that the formula is advisory. Every subsequent year's plan is now negotiable.
How Visdum handles annual incentive plans
Visdum runs AIPs as formulaic components — metrics, weights, threshold/target/maximum curves, and the base × target% × factor formula — calculated from actual results rather than assembled at year-end. Participants see their weighted performance factor as it develops, so a plan that pays 87% of target is a number they watched arrive rather than one they were handed. Finance gets a live AIP accrual that moves with the forecast, and because AIP components are distinguishable from sales commission components, the period-expense and capitalizable treatments stay separate through close.
Take a self-guided product tour →, or read the complete guide to annual incentive plans.
Related terms
Annual Incentive Plan vs Bonus · Incentive Compensation Plan · Bonus · MBO · Incentive Compensation
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Frequently asked questions
What is an annual incentive plan?
A formal, formulaic cash incentive program rewarding performance against predefined goals over a twelve-month period. It is a short-term incentive plan (STIP), distinct from long-term equity. The defining feature is that it is non-discretionary: metrics, weights, and the payout curve are set at the start of the year and the payout follows from results.
How is an AIP payout calculated?
Base salary × target incentive % × performance factor. The target incentive percentage is set by role level — commonly 10–20% for mid-level employees and 40% or more for executives. The performance factor is derived from actual results against the payout curve, running from 0 below threshold to 1.0 at target and up to 2.0 at maximum.
What is a typical AIP target percentage?
It varies sharply by level. Mid-level employees commonly carry a 10–20% target incentive as a share of base salary; executives frequently sit at 40% or higher. The percentage alone is not the plan, though — without the payout curve, an employee has only been told what happens if everything goes exactly to plan.
What is threshold, target, and maximum in an AIP?
The three points on the payout curve. Threshold is the minimum performance for any payout, commonly 70–90% of target performance. Target is the expected outcome, paying 100% of the target incentive. Maximum is the ceiling, commonly 110–130% of target performance, with payout often capped at 200% of target.
Is an AIP the same as a bonus?
No. An AIP is formulaic and non-discretionary — the metrics and payout curve are published in advance and the payout follows from results. A bonus is typically discretionary, decided after the fact, and may not be tied to any published measure. The words are used interchangeably in conversation and should not be in a plan document.
Is an AIP payout capitalized under ASC 606?
Generally no. An AIP payout tied to company financials such as revenue or EBITDA is a period expense, not an incremental cost of obtaining a customer contract, so it is not capitalized and amortized the way sales commission is. Companies that run both instruments in one spreadsheet routinely blur this distinction.