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What’s the Tax Rate on my Bonus if I Invest it in the Stock Market?

So, you’ve just received a big bonus at work and you’re wondering what you should be doing with it, any quite frankly, you’re worried about losing a lot of it due to such a high bonus tax rate. 

First off, CONGRATS! 

A bonus is a big deal. 

It means you’re getting your stuff done and you’re killing it at your job.  I am a very firm believer that a bonus should be meant to treat yourself and that you should do something fun with it. 

Maybe that means spending some of it on some clothes, or a trip, or maybe your version of fun is investing in your retirement. 

No matter what your version of fun is, you really should use some of this bonus to treat yourself, but make sure that the vast majority is being used to help you get ahead in life, whether that means saving, paying down debt, or investing for your future.

So how is your bonus taxed, currently?  Employers have two options right now:

  1. They can pay it out as bonus pay, which is taxed at 22% up to $1,000,000 annually, or
  2. They can add it to your normal paycheck and then tax that at your current tax bracket

At the end of the day, the options likely could be different, but you should expect to get that money back at the end of the year if you’re over-taxed or owe if you’re under-taxed, so they’re somewhat indifferent. 

But, how can you take advantage of this bonus to get yourself setup for a more successful future and to minimize your tax implications?  Easy.

Invest in Your Retirement

Investing for your retirement is easily the #1 option in my eyes and you likely had already thought about this.  Instead of paying 22% tax on that $5000 bonus, and therefore losing $1100 to taxes, why not try to invest it all for your retirement? 

This way you’re not paying any taxes at all and you’re setting yourself up for a better future, and likely an earlier retirement.  You could do this through a 401K or a Traditional IRA, and both answers are right. 

Both of these accounts will take pre-tax dollars and go into an investment account where they will be taxed upon distribution after your retirement.  One thing to look into would be that if your company offers a company match then try to find out if they match on bonuses (I assume they do). 

If they do, then you definitely should make sure you’re putting some in the 401K to max out that match for the bonus payment.

HSA

A HSA really is an undervalued way to put pre-tax money to work for you and also to decrease your total taxable income, not only with bonuses, but just in general as well. 

Specifically, with a bonus, if you can avoid 22% tax on your HSA dollars, then you should.  Personally, I’ve had a HSA for years, and I was never close to maxing it out because I always had the mindset that I was a healthy individual that never really went to the doctor, so why should I “waste” money by putting it in a HSA when instead I could be investing that money? 

Well, there’s quite a few reasons:

  1. Unexpected things happen.  It’s much better to have money in your HSA for a “what it” situation rather than not have money in and something really bad happens, where now all of your money is tied up in a retirement account and you’re finding yourself paying a penalty to take it out, so you can cover medical bills
  2. The HSA money can be rolled over, so even if you don’t spend it that year, you can simply save it for the next year, or the next, or the next.  Eventually you’re going to need to spend that money on something.  Maybe it will be on you for a broken ankle when you’re 24 playing recreational basketball, or maybe it will be when you’re 75 and have expensive medicine that you take every day.  Maybe it will be on your spouse or maybe during the birth of your child.  Regardless of when it is, the fact is that I GUARANTEE you will use this money at some point, so why not save 22% of your bonus from taxation and put it to use for the future.
  3. If you still have money in your HSA when you hit age 65 you can withdraw from it for non-medical reasons tax-free.  I cannot stress how amazing this is.  Essentially, you have saved a ton of money amongst your career for “health uh ohs” and then you’ve gotten to retirement age and decided to just take the money and run, so you’ve basically created a Traditional IRA that has also been there from age 22 – 65+ in case you wanted to use it for health reasons during this time.  The downfall of this is that you have to wait 5.5 extra years to withdraw the cash vs. a Traditional IRA of age 59.5, but the benefit is that you’ve had the security of knowing that money can be used for health issues for many, many years for both yourself and your family.  I think that’s more than a fair trade off, not to mention that being forced to keep my money invested in the market and not being able to be withdrawn isn’t’ exactly a bad thing.
  4. Workplace Benefits over Cash

This likely is not an option if you work for a large corporation, but if you work for a small business they might be willing to “trade” you some of your bonus for some other benefits, such as extra vacation, work-from-home days, flex hours, or other items. 

Not saying that all companies are like this, but some definitely are.  If you’re someone that is more motivated by vacation, then maybe you could trade your bonus for extra time off.  For instance, if your bonus was $5000 on a $50,000 salary, you’re looking at a 10% bonus. 

That would mean your weekly salary is $962, so maybe you could offer a way to meet in the middle and ask for a $2500 bonus and two extra weeks of vacation? 

If the company agreed, they’d be saving money vs. the $5000 bonus ($2500 bonus + $1924 for two weeks of salary = $4424). 

Yes, the company might find this more detrimental for you being away extra time and you’re clearly very valuable since you’re receiving a bonus, but maybe this is a starting ground for negotiations and a true “Win-win”.

All in all, you really have many great options to help you avoid those tax implications and get ahead by maximizing your bonus. 

I challenge you to really think about what is the most important in your eyes and try to be creative to max out the benefit of your bonus.  Most importantly, remember that this is a bonus! 

You weren’t expecting this, so you can’t really do anything that’s going to set you back, but why not try to get ahead?