Lucky you! You just found out you are getting a nice year-end bonus soon. Before you start celebrating your good fortune, here are five things you should know.
Taxes. Don’t expect to get a check for the full amount of your bonus. That’s because all the usual taxes will be deducted before you see the money: social security tax and Medicare taxes as well as federal and state income taxes. Bonuses are “supplemental wages” in IRS Speak, and your employer will probably withhold federal income taxes at a flat“ supplemental rate” of 25%. So if you receive a $5,000 bonus, $1,250 (25% of $5,000) will go straight to the IRS for income tax withholding. But it may not be gone forever: the bonus is included in taxable wages on your W-2 and the withholding is included in income tax withheld. If your actual tax rate on your tax return is less than 25%, you may get part of those withheld taxes back in a tax refund. If your tax rate is higher, it may result in additional taxes due on April 15. TurboTax has a bonus calculator to help you figure out how much may be withheld from your additional income.
Timing. If your employer announces your bonus in December but doesn’t pay it until January, the income and withholding will appear on next year’s tax return. That’s good news if you expect to be in a lower overall tax bracket next year. But if your top tax bracket is below the 25% supplemental withholding rate, then you’ll want the payment to be accelerated to this year if possible, so the over-withholding can boost this year’s refund instead of waiting until next year to get the excess withholding refunded.
Spending. Consider carefully what to do with the bonus you receive. You may be tempted to spend it on new toys or a nice vacation, but before you do, consider your alternatives. If you have an uncomfortable amount of credit card debt, paying down that debt may give you more overall satisfaction and long-term benefit than buying electronics that will be outdated before next year.
Saving. If you are constantly skating on the edge with your finances, one paycheck away from disaster, use part of your bonus to create an emergency fund you can use when unexpected things come up (and they always do). Having those funds available will give you some peace of mind as you begin the new year.
Remember others. Earmarking part of your bonus for charity will give you a warm glow this holiday season, knowing that you helped make someone else’s future a little brighter. After all, isn’t peace on earth and goodwill toward all what the holiday season is really about?