Author Topic: Max out 401k using a variable annual bonus contribution  (Read 4677 times)

hewy9

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Max out 401k using a variable annual bonus contribution
« on: January 02, 2015, 07:30:08 PM »
This year I plan to max out my 401k contribution; however, since starting at my company I have received a year-end bonus that I have also contributed to enjoy the tax savings (my bonus has ranged from $3000-$8500).  My company has paid out a bonus for the past 10 years and mine has increased each year since I started, but this is obviously dependent on how profitable my company is each year.

To avoid the 35% tax rate that would be taken out, I would like to continue to contribute this to my 401k at the end of each year.  Therefore, I am trying to balance my interest in maxing out my 401k with leaving enough room so that I can apply the majority of my bonus each year.  The other tricky thing for me is that I have been at my company for less than 4 years, so each year the amount of my bonus is still a bit of a surprise.  My initial thought is to assume an amount slightly less than my bonus from the previous year (to hopefully be conservative) and calculate my monthly contributions to match the difference. 

I also realize that some years we may not get a bonus and I don't want to avoid maxing out my 401k those years.  However, my company is pretty transparent with our financials, so if we did have an unprofitable year (this information is reported to the employees each quarter), part way through the year I could plan to increase my monthly contributions to offset what I was hoping to get from a bonus.

I assume others have dealt with this issue (or hopefully have thoughts about the best way to handle this) and I would appreciate your advice. 

MDM

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Re: Max out 401k using a variable annual bonus contribution
« Reply #1 on: January 02, 2015, 07:52:01 PM »
It appears you think the tax on the bonus differs from the tax on regular salary.  That is not correct.

It is true that withholding on a bonus can differ from withholding on regular salary.

In other words, just max the 401k from regular salary and treat the bonus...as a bonus. :)

hewy9

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Re: Max out 401k using a variable annual bonus contribution
« Reply #2 on: January 02, 2015, 08:10:10 PM »
Perhaps I should have mentioned that my company is employee owned, therefore, I our bonuses are taxed differently than our regular income to allow the company to receive more favorable tax conditions.  So regardless of the tax bracket I am in, my bonus will always be taxed around 35%.  However, I agree with the sentiment and I should probably just get over paying higher taxes for a bonus :)

m8547

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Re: Max out 401k using a variable annual bonus contribution
« Reply #3 on: January 02, 2015, 08:13:56 PM »
My company's bonuses are given out as 401K contributions, so they don't count against my personal limit but the combined limit which is much higher. Maybe see if they can do that instead to save the 35%?

desrever

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Re: Max out 401k using a variable annual bonus contribution
« Reply #4 on: January 03, 2015, 07:05:29 AM »
Perhaps I should have mentioned that my company is employee owned, therefore, I our bonuses are taxed differently than our regular income to allow the company to receive more favorable tax conditions.  So regardless of the tax bracket I am in, my bonus will always be taxed around 35%.  However, I agree with the sentiment and I should probably just get over paying higher taxes for a bonus :)

From what you've said so far it sounds like (a) your conservative plan is maybe the best you can do and (b) it's really a shame that this money is paid out in December rather than January. But -- it really seems like the right advice here will really hinge on how the company and this yearly bonus are structured, so that we know the tax treatment. Can you share more details?

FeynmanFan

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Re: Max out 401k using a variable annual bonus contribution
« Reply #5 on: January 03, 2015, 08:48:04 AM »
Is your plan an ESOP?

hewy9

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Re: Max out 401k using a variable annual bonus contribution
« Reply #6 on: January 03, 2015, 07:05:18 PM »
As part of my company's annual profit distribution, eligible employees receive a cash bonus (which my question relates to and is based upon the company's profitability that year) as well as an ESOP contribution (unrelated to my question).  Unfortunately, the cash bonus is paid at the very end of December and as I understand it, my options for the cash bonus are to: 1) receive a check (with ~35% taxes taken out), 2) apply towards my 401k, 3) apply to my Roth (same issue with ~35% taxes). 

MDM

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Re: Max out 401k using a variable annual bonus contribution
« Reply #7 on: January 03, 2015, 10:32:09 PM »
At the risk of confirming that I know little to nothing (perhaps closer to the latter) about arcane details of employee-owned company taxation - are you sure this bonus is taxed differently than your normal income?  E.g., does it appear somewhere other than on a W-2 form with the rest of your pay?  What line on form 1040 does it go to?

Just guessing, but it seems desrever and FeynmanFan have similar questions...?

Depending on your state tax, you could very well have ~35% withholding on a bonus: 25% for federal withholding, plus whatever for state withholding, plus medicare, plus SS (if applicable) plus excess medicare (if applicable).  That would also apply to any employee of a non-employee-owned company, so it still isn't clear whether this is a withholding or a tax issue.  Those are certainly related, but not identical....

MDM

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Re: Max out 401k using a variable annual bonus contribution
« Reply #8 on: January 03, 2015, 10:49:09 PM »
Interesting fact: A bonus would need to exceed $86,300 in order for both Social Security tax and Additional Medicare tax to be withheld from it. (That is a necessary condition, not a sufficient one.)
$83,000 would be the difference between the SS maximum of $117K and Add'l Medicare minimum of $200K - how did you get $86,300?

I agree that only one of the "if applicable" conditions in my previous post is likely to be applicable for any individual. ;)


MDM

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Re: Max out 401k using a variable annual bonus contribution
« Reply #9 on: January 03, 2015, 10:59:38 PM »
Yep, agreed on the "interestingness."  Couldn't figure it out at first, then hit on the SS max/AM min difference - just wondered if there was an additional wrinkle.  All set.

hewy9

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Re: Max out 401k using a variable annual bonus contribution
« Reply #10 on: January 17, 2015, 05:18:51 PM »
I finally went back and looked at my first bonus (which I had taxes taken out) and MDM you are correct.  I did some searching and learned that this is because bonuses are considered as "supplemental wages" with a 25% federal tax rate.  Thanks for helping me to dig into this!

MDM

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Re: Max out 401k using a variable annual bonus contribution
« Reply #11 on: January 17, 2015, 06:07:12 PM »
I finally went back and looked at my first bonus (which I had taxes taken out) and MDM you are correct.  I did some searching and learned that this is because bonuses are considered as "supplemental wages" with a 25% federal tax rate.  Thanks for helping me to dig into this!
Yes, supplemental wages are treated differently from regular wages and the 25% federal rate is the most common.  Most can stop reading here. 

If anyone wants to know more about withholding from supplemental wages, see section 7 in http://www.irs.gov/publications/p15/ar02.html#en_US_2014_publink1000202352.  One might be interested if the bolded line below is applicable (either from the employer or employee perspective).
Quote
Supplemental wages identified separately from regular wages.   If you pay supplemental wages separately (or combine them in a single payment and specify the amount of each), the federal income tax withholding method depends partly on whether you withhold income tax from your employee's regular wages.

1.  If you withheld income tax from an employee's regular wages in the current or immediately preceding calendar year, you can use one of the following methods for the supplemental wages.
     a.  Withhold a flat 25% (no other percentage allowed).
     b.  If the supplemental wages are paid concurrently with regular wages, add the supplemental wages to the concurrently paid regular wages. If there are no concurrently paid regular wages, add the supplemental wages to alternatively, either the regular wages paid or to be paid for the current payroll period or the regular wages paid for the preceding payroll period. Figure the income tax withholding as if the total of the regular wages and supplemental wages is a single payment. Subtract the tax withheld from the regular wages. Withhold the remaining tax from the supplemental wages. If there were other payments of supplemental wages paid during the payroll period made before the current payment of supplemental wages, aggregate all the payments of supplemental wages paid during the payroll period with the regular wages paid during the payroll period, calculate the tax on the total, subtract the tax already withheld from the regular wages and the previous supplemental wage payments, and withhold the remaining tax.

2.  If you did not withhold income tax from the employee's regular wages in the current or immediately preceding calendar year, use method 1-b. This would occur, for example, when the value of the employee's withholding allowances claimed on Form W-4 is more than the wages.

Regardless of the method you use to withhold income tax on supplemental wages, they are subject to social security, Medicare....