Abstract Background Additional payment approach has been one of the most important incentives in long-term care (LTC) systems for the past 20 years in Japan. Objective To estimate the effect of additional payments on functional decline in long-term care health facility (LTCHF) residents of Japan. Design A 24-month retrospective cohort study. Setting and subjects Residents aged ≥65 years who were newly admitted to LTCHFs in the 2014 fiscal year. Methods National LTC claims data were linked to the survey of institutions and establishments for LTC. Competing risk regression was performed with functional decline as the primary outcome, and additional payments as exposure, controlling for individual and facility characteristics. The level of LTC needs certified in the LTC insurance system was applied as a proxy of functional ability. Death, hospitalisation, discharge to home and transfer to other LTC facilities were treated as competing events. Individual- and facility-level additional payments were presented as binary variables: being reimbursed or not during the follow-up period. Results At baseline, 146,311 residents from 3,724 LTCHFs were included. The vast majority of additional payments were associated with a lower risk of functional decline at follow-up. At the individual level, additional payment for pre/post admission instructions had the strongest association with a lower risk of functional decline. Despite this, only 8% of residents were reimbursed for this additional payment. At the facility level, residents in LTCHFs with additional payments for support for home-life resumption and nutritional management were associated with a decreased risk of functional decline. Conclusions The results of our study may be of particular interest to policymakers in monitoring and evaluating additional payment approaches and provide insight into improving quality of care.