We love it when our members ask us that because we think a year end bonus represents opportunity. That money can be used in a variety of ways to increase your financial security and improve your life. Here’s what you need to know.
How Much is the Average Holiday Bonus?
Let’s start with some numbers. We don’t know what size your year end bonus will be, but we can share some averages with you to help you get an idea of what to do with the money you receive.
According to a survey conducted by Accounting Principals, the average holiday bonus handed out by companies with fewer than 500 employees was $878 as of 2015. For larger companies, the average jumped to $1,072.
A later survey found that bonuses jumped 66% between 2016 and 2017, with the 2017 average coming in at $1,797 for companies with more than 500 employees. Overall, 63% of businesses give cash bonuses at the end of the year.
Companies use several methods of calculating bonus amounts. Some use a merit or performance-based system, while others use profit-sharing calculations. Some companies use a hybrid of the two.
Of course, some executives receive bonuses of a million dollars or more, but for most people, the average is in the low four figures.
Tax Implications of Holiday Bonuses
When it comes to using your holiday bonus, the first step is understanding how much of the money you’ll actually be able to use. Taxes and withholdings break down as follows:
Social Security tax. As of 2018, employees pay Social Security tax on compensation up to a maximum of $128,400 for the year. If your year-to-date compensation is less than that amount, your employer will withhold 6.20% from your bonus for Social Security.
Medicare tax. Medicare taxes are paid on all compensation, so your employer will withhold 1.45% for Medicare.
Federal income taxes. The tax reform bill passed in 2017 decreased the federal tax rate for withholding on bonuses from 25% to 22%.
Since Florida doesn’t have a state income tax, you won’t need to worry about state withholding unless your primary residence and tax filing is in a state that does have an income tax. If that’s the case, you should expect your employer to withhold whatever the state requires.
You should also be aware that if your employer regularly withholds a percentage of your paycheck to put into your 401k, they may do the same for your bonus unless you specifically instruct them not to.
What to Do with Your Year End Bonus
Now that you know how much money you can reasonably expect to get, let’s talk about some of your options regarding what to do with your bonus money when you receive it. Here are some of the things we suggest to our Addition Financial members.
Roll your bonus money into your 401k. If you have a 401k and have not maxed out on your annual contributions, you may want to consider rolling your bonus money directly into your 401k. The maximum contribution for 2019 is $19,000.
Use your bonus money to open a retirement account. What if you have maxed out your 401k or you don’t have a retirement account? If that’s the case, you may want to use your bonus money to open a traditional or Roth IRA and jump-start your retirement savings.
Use your bonus money to start a 529 savings account for your child’s college education. While 529 contributions are not tax deductible, your account will grow tax-free and you won’t need to pay taxes when you deduct the money.
Start a family emergency fund. We recommend having six months’ worth of expenses saved in case of an emergency. If you’ve got less than that, you may want to consider using your bonus money to seed (or top off) your emergency savings fund.
Make a downpayment on a house. If you’ve been saving up to buy a house, then you know that coming up with a sizeable downpayment is important. You may want to put your bonus money into your savings account to put toward your new home.
Of course, none of this means that you can’t have a little fun with your bonus money, too. We sometimes suggest using 20% of the money for something fun, such as a weekend getaway or dinner at a fancy restaurant, and putting the remaining 80% toward your financial goals.
Getting a year end bonus is exciting and can help you increase your retirement savings, save for your child’s education or buy a home.
Are you looking for ways to invest your holiday bonus? Click here to learn how Addition Financial can help!