Stop Paying Taxes on Work Bonuses—Legally
Christmas is around the corner and for many, this means it’s time for the annual work bonus. If you work for a publicly traded company, I hope your bonus is not tied to your stock price, or you might owe your company! What is the best way to handle a bonus? Save it? Blow it? Invest it?
The best use of a bonus or any windfall of money is to fill your emergency savings first. But, if you don’t need the savings, consider putting your bonus into your 401(k). Why would you do such a thing? Bonuses are treated differently than normal income, thus, they are taxed at a higher mandatory rate. Have you ever noticed that you are always disappointed when you get your bonus because taxes ate half of it? This is exactly why you should consider putting the bonus in a tax-sheltered account.
If your employer allows you to, have them funnel your bonus into your 401(k) and assuming you have a traditional versus a Roth account, you will get the entire bonus—no taxes. This is great for a couple of reasons. For one, the additional money that is usually spent on taxes, goes to work right away for you earning interest. The difference of investing $2,500 (after-tax bonus amount) versus $5,000 (pre-tax bonus amount) for 20 years is approximately $12,000! Secondly, the added benefit of lowering your income for the year never hurts when it comes time to do taxes. The last thing you want a bonus to do is to edge you up into a higher tax bracket, which would result in an extreme tax bill. You’d be better of rejecting a bonus in this situation, that’s strange.
So the next time you get a bonus, consider the tax advantages of putting it into a tax-sheltered account. If you get a good one this year at Christmas, you will likely profit even more by purchasing equities at the recession discount. (Sadly, as I write this, the song “Free Falling” is on satalite radio.) One last point, if you really want to purchase something special with your bonus and don’t want it all to go into your 401(k), that’s ok because you deserve it. Consider borrowing a few bucks from your savings and still put the bonus into your 401(k). Seriously, you’ll get more out of your bonus and assuming you are constantly setting money aside for your savings, you will be ok. $
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Comments
As I understand it, it’s basically up to whoever handles the checks for your company. Just like they put money into your 403(b), the same process would be done for your bonus. In fact, I would think a separate check would be even easier for them. Technically all a bonus is profit. Think of it as a raise, employers can put more money into your 403(b) if you get a raise upon your request, why not the bonus?
My company won’t do it, unfortunately, because they do a match and it would make their accounting difficult. It is an interesting idea though!
Not that I think I’ll be getting a bonus this year - it has just been that kind of year, sadly.
This is something that my company allows and I think I’m going to seriously consider it this year. I’ve been wanting to invest more while everything is on sale. On the other hand I’m really close to paying off my last consumer debt and putting the bonus towards that instead would cut the amount owed in half. What to do, what to do?
Some will say that if your APR on your debt is less than you think you can get in the market then invest. Personally, I think there is a huge physiological boost to have debts paid off and that’s what I would do.
Unfortunatly, this is not entirely correct. Contributions to a 401(k) are not exempt from FICA and Medicare taxes. These tax amounts are considered taxable income for Federal, State and Local income tax withholding purposes. So the calculation of FICA and Medicare taxes, gives rise to the need for income tax withholdings. Even claiming exempt, it is just not possible to defer 100% of your pay. At least some of it must always go towards taxes.
This is legal but as I understand you aren’t supposed to do it a lot, but I changed my dependents on my taxes to 9 before they gave out bonuses and changed it back after I got my bonus (August). That way they didn’t take out as much in taxes had I left the dependent number it originally was. Unfortunetly we can’t put our bonuses directly into our 403b (non-profit’s version of 401k) because it’s a written check. But to have it go directly into a 403, will most employers put the money in there instead of writing a check?