What to do with Annual Bonus

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DGE
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What to do with Annual Bonus

Post by DGE » Sun Feb 23, 2014 6:35 pm

Hello fellow Bogleheads, I've been more of a lurker than a poster for a few years now, but I have a topic I would like your input on.

My March 15th paycheck will include my 2013 Annual Bonus, while it's not a "game changing" amount, it's a nice chunk of change (will be around $6-7k). In prior years, I've just allowed my bonus check to come to me as is, and then mutter profanities under my breath as I calculate the +40% rate it is taxed at. Fortunately, it comes in addition to our regular paycheck, so a portion of it is at least "sheltered" by 401k contributions (i.e., $1,000 bonus, 10% 401k contribution rate, $100 would go towards 401k, remaining $900 is taxed at +40%).

I do max out my 401k each year, all of which goes towards a Schwab Total Stock Market Fund (my fixed income holdings are in Total Bond Market ETF's in my Roth IRA and misc. savings bonds/CD's). Now I'm tossing around the idea changing my 401k contribution rate to 100% before my bonus gets distributed so that I can actually realize the full bonus. Then I would just reduce my 401k contribution rate to make up the remaining contributions throughout the year.

Has anybody else done this before? The only downside I can see is that I'd be losing the benefit of DCA (dollar cost averaging) by making such a large lump some contribution towards the Schwab Total Market Fund, but on the flip side, I'll have "sheltered" my bonus from being taxed +40%. Any input, advice or personal experiences you can share would be much appreciated!

DGE

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damjam
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Re: What to do with Annual Bonus

Post by damjam » Sun Feb 23, 2014 6:43 pm

It may feel like your sheltering your bonus, but then your just subjecting more of your "regular" pay to the 40% tax. It all comes out the same.
I will caution that some 401k matching contributions by employers are based on a per paycheck basis. So if you front load your 401k contributions such that you max out before the end of the year, you could miss out on some employer match. That is assuming you get an employer match and that it is structured that way.

ajcp
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Re: What to do with Annual Bonus

Post by ajcp » Sun Feb 23, 2014 6:47 pm

damjam wrote:It may feel like your sheltering your bonus, but then your just subjecting more of your "regular" pay to the 40% tax. It all comes out the same.


+1

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Meaty
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Re: What to do with Annual Bonus

Post by Meaty » Sun Feb 23, 2014 6:50 pm

Why not start a Roth?
"Discipline equals Freedom" - Jocko Willink

Retread
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Re: What to do with Annual Bonus

Post by Retread » Sun Feb 23, 2014 6:58 pm

Are you sure you're taxed at 40%? That's withholding, not your eventual tax.
Bruce
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ogd
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Re: What to do with Annual Bonus

Post by ogd » Sun Feb 23, 2014 7:09 pm

In general, it makes sense to front-load the 401k contributions as early as possible, because you are earning money on unpaid, un-withheld taxes. Even more so if you have an employer contribution, which would otherwise sit around unused.

In the end, you pay the same taxes but you pay them later this way. I always ramp up contributions to 100% at the beginning of the year, usually exhausting them before the bonus even gets paid.

This goes against the idea of dollar cost averaging, but 1) lump sum is mathematically the better idea anyway, and 2) you can still have your contributions sit in a more conservative allocation, still making you money, ramping up aggressiveness as you go -- in case you value the psychological comfort of not diving in all at once. The transactions to switch aren't costing you anything in the 401k, very likely.

oncall
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Re: What to do with Annual Bonus

Post by oncall » Sun Feb 23, 2014 7:14 pm

Do you receive any matching contributions from your employer when you contribute to your 401k? It's still early in 2014, so making a large contribution to your 401k now could reduce your ability to take full advantage of that company match with your future 2014 contributions. I guess it will depend on how the matching program is structured.

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ogd
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Re: What to do with Annual Bonus

Post by ogd » Sun Feb 23, 2014 7:20 pm

oncall wrote:Do you receive any matching contributions from your employer when you contribute to your 401k? It's still early in 2014, so making a large contribution to your 401k now could reduce your ability to take full advantage of that company match with your future 2014 contributions. I guess it will depend on how the matching program is structured.

Ah yes -- I should have made clear that front-loading contributions is only a good idea if the matching does not have monthly limits, only yearly. I don't know specifically of any programs with monthly limits, but I've heard rumors thereof.

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damjam
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Re: What to do with Annual Bonus

Post by damjam » Sun Feb 23, 2014 7:27 pm

ogd wrote:Ah yes -- I should have made clear that front-loading contributions is only a good idea if the matching does not have monthly limits, only yearly. I don't know specifically of any programs with monthly limits, but I've heard rumors thereof.

My spouse is in a plan that matches 50% of 8%. So if the bonus was contributed at 100% to the 401k, the max would be reached before the end of the year and the maximum match would not be achieved.

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ogd
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Re: What to do with Annual Bonus

Post by ogd » Sun Feb 23, 2014 7:31 pm

damjam wrote:
ogd wrote:Ah yes -- I should have made clear that front-loading contributions is only a good idea if the matching does not have monthly limits, only yearly. I don't know specifically of any programs with monthly limits, but I've heard rumors thereof.

My spouse is in a plan that matches 50% of 8%. So if the bonus was contributed at 100% to the 401k, the max would be reached before the end of the year and the maximum match would not be achieved.

Does it specifically say that it's limited to the income year to date? Because otherwise, if it's 8% of yearly salary per year, you are still getting the maximum match you can. What are the exact terms? I'm curious what to look for when friends and relatives ask me a similar question.

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damjam
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Re: What to do with Annual Bonus

Post by damjam » Sun Feb 23, 2014 7:39 pm

ogd wrote:Does it specifically say that it's limited to the income year to date? Because otherwise, if it's 8% of yearly salary per year, you are still getting the maximum match you can. What are the exact terms? I'm curious what to look for when friends and relatives ask me a similar question.


From a company benefits brochure:

"Mega Company will contribute to your account through a Company Matching Contribution equal to 50% of your contributions, up to 8% of pay and capped at $5,000 annually. If you are contributing to the plan, the Company Matching Contribution is made on a per-paycheck basis and is subject to three-year "cliff" vesting..."

Unfortunately, I don't have the verbage from the actual plan documents.

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Kosmo
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Re: What to do with Annual Bonus

Post by Kosmo » Sun Feb 23, 2014 7:55 pm

1) if you already max out the 401k every year it won't make much of a difference. You might lose some of the match if there isn't a true up at the end if the year.

2) the bonus isn't taxed at 40%, its just withheld at 40%. When you file your tax return you'll effectively get back that additional tax paid.

MN Finance
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Re: What to do with Annual Bonus

Post by MN Finance » Sun Feb 23, 2014 8:01 pm

I'm missing the "problem" that we're trying to solve. We're assuming you're not in the top fed tax bracket, making your statement about being taxed at 40 true. Since if you made that much, a 6k bonus would just be a rounding error in your bank account. So while the bonus is withheld at 40 (probably 25 Fed, 7 fica, 7 state) it's taxed the same as everything else you make. Or is this a cash flow problem? You want more of your bonus cash?

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