As we finally start to turn the page from Summer to Fall, corporate executives likely have an idea of their bonus payout next year.

From a financial planning perspective, bonuses are tricky. Bonuses are highly variable, employers do not withhold enough taxes and the formulas that calculate them are esoteric. It is extremely difficult to know the amount until you receive that off schedule direct deposit. Even then, there is likely a tax liability embedded in that amount since employers do not withhold enough taxes.

Due to the complexity, executives typically take one of two approaches. First is the "Just Surprise Me" approach. Whatever amount the bonus pays out is fine because the bonus dollars are not assigned to any specific expenditure.

The second is the "Bonus Bank" approach. This group plans for an 80 - 100% payout and typically spends the money in the year leading up to the payout with the plan that the eventual bonus will replenish the accounts in Q1.

The first group will build wealth faster than the second, but both approaches have issues. Again, planning for bonuses is tricky so here are 4 approaches to consider when you think about your bonus payout.

1) If No Bonus Means Driving an Uber, Rethink the Budget

It is important to understand what it means to your lifestyle, family and financial goals if the bonus pays out at 0%. It is fine (and recommended) to earmark bonus dollars for some types of expenditures.

Of course, not all expenditures are the same. For example, if the result of a 0% bonus is a cutback in highly discretionary items such as a boat, an extra vacation getaway or extra savings, the risk of no bonus is fairly low.

On the other hand, if you earmark bonus dollars for fundamental expenditures such as college education, paying down high interest debt or saving for retirement, the risk of no bonus is much higher and will have a negative impact on your life.

2) Make a Plan, Avoid Impulsive Purchases

Bonus time is (usually) exciting for employees, but do you know who else gets excited? Boat salespeople, car salespeople, contractors, insurance and investments salespeople... Pretty much anyone selling stuff to high earners knows exactly when bonus day is.

Salespeople know that lots of people do not have concrete plans on how to spend these lump sum bonus payouts and they are all trying to convince you to make an impulsive decision.

The point is NOT to avoid buying these big ticket items. What is the point of money if we do not use it? The point is to have a plan well before the bonus pays out. Salespeople are convincing. If you do not have a plan, salespeople only need to convince you in that moment to buy. If you have a clear thought out plan, you are less susceptible to making an impulsive purchase. Plus, you will likely get a better price once the salesperson knows you are not in a hurry to buy.

3) Remember the April Tax Bill

It is common for a significant portion of the bonus payout to go towards the tax bill in April. Or worse spending the bonus and then tapping savings to cover the tax bill.

Remember that employers typically only withhold 22% of your bonus for taxes. Corporate Executives are in a much higher tax bracket. For example, if you receive a $100,000 bonus, you are likely already in the hole $10,000 - $15,000 because your true marginal tax rate is probably 32 - 37%. Once you tack on the underwithholding for equity compensation and investment income, the April tax liability really grows.

The two main things to remember on bonuses and taxes:

1. It is important to realize that the dollar amount that hits the bank account is not all yours because there is likely a tax liability embedded in it.

2. Plan for the tax payment in April so that you do not need to tap savings to cover it.

If you are interest in learning more about Income Tax and Withholding for Corporate Executives you can look at the post: Understanding Taxes for Corporate Executives: Income Taxes, Tax Rates and Withholding.

4) Hey Boss, Just Pay Me Later

Many large employers allow certain employees to defer payment of their bonuses through a Non-Qualified Deferred Compensation Plan. While it does not make sense for everyone, if you are close to retirement (or more technically, close to being in a lower tax bracket) it is a tax efficient way to save for the future.

If you are a Walmart employee, Sr. Directors can defer 80% of the MIP and Officers can defer 100% of MIP. If interested in learning more about the Walmart DCMP, I have a post that goes into detail: 3 Key Decisions for Your Walmart Deferred Compensation Matching Plan (DCMP.)

Thanks for reading,

Mark Chisenhall, CFA

Taurus Financial Planning

www.taurusfinancialplanning

Taurus Financial Planning is a Fee-Only Wealth Management firm based in Bentonville, AR. The firm offers comprehensive financial planning, tax planning and investment management to corporate executives across the country.

Taurus Financial Planning is a Registered Investment Advisor with the State of Arkansas. This information is provided as a guide to assist you in your financial planning. The specific examples are provided for illustration purposes only and are not representative of specific investments or guarantees of future returns. Please consult with a professional for specific questions regarding your particular situation. If there is any error or inconsistency between this document and the official company plan documents, your company plan documents will govern.

This publication is for informational purposes only and is not intended as tax, accounting or legal advice or as an offer or solicitation of an offer to buy or sell or as an endorsement of any company security fund or other securities or non securities offering. This publication should not be relied upon as the sole factor in an investment making decision. Past performance is no indication of future results. Investment in securities involves significant risk and has the potential for partial or complete loss of funds invested. It should not be assumed that any recommendations made by the Author, in the future, will be profitable or equal the performance noted in this publication.