If you get a big bonus at work, you might start thinking about how you can minimize your tax burden on that extra money. One option can be to put some of the money into a tax-deferred account, such as a 401(k).
TL;DR (Too Long; Didn't Read)
If you put money from a bonus into a 401(k), that money won't be taxed until you withdraw it, usually when you reach retirement age. There is, however, a limit on how much you can put into a 401(k) in any one year, so this may not help entirely with very large bonuses.
Combining a Bonus and a 401k Contribution
If you know you're receiving a big bonus at work, it can be worth thinking through the tax ramifications.
Supplemental pay such as bonuses is generally subject to a higher withholding rate than ordinary pay. Generally, employers can either use a special bonus tax rate of 25 percent for withholding purposes or combine a bonus with an ordinary paycheck and then withhold tax using tax tables as if you were someone who received that large sum in every paycheck. Either way, that means a higher rate of tax withholding, even if you'll ultimately get that money back as a tax refund.
If a bonus is large enough, it can ultimately be taxed at a higher rate when you file your return, since it can push your income into a higher marginal tax bracket.
One option for at least deferring tax on your bonus is to ask your employer to make a larger than usual 401(k) deduction from the bonus check. In that case, the money is siphoned off to your 401(k) account where it won't be taxed until you withdraw it to retire. Of course, that means you can't use the money in the meantime without a penalty, and it's also subject to the annual contribution limits for a 401(k) or a similar account.
Other Ways to Save Tax on a Bonus
You can also use your bonus in other ways that will get you a tax deduction. For example, you could contribute the bonus to another tax-deferred retirement account, such as an IRA. Or you could donate some or all of the bonus to charity. You could spend the bonus on medical expenses, which you can deduct above 7.5 percent of your income. For example, you might schedule an eye exam or some dental work you've been putting off in the same year that you receive your bonus.
One thing to keep in mind is that thanks to the higher rate of withholding on your bonus, you may not have immediate access to the entire amount of the bonus that you'll get after taxes until you actually file and receive a refund.
Bonus Tax and 2018 Tax Law Changes
In 2018, the amount of money you can contribute to a 401(k) is rising from $18,000 to $18,500. The amount you can contribute to an IRA is staying unchanged at $5,500.
If you're thinking whether it's worth it to try to find itemized deductions, such as donations or medical expenses, to offset your bonus may depend on whether you will find it worth it to itemize at all or simply take the standard deduction. The standard deduction is rising for 2018 to $12,000 for single filers and $24,000 for married couples filing jointly.
Bonuses and Taxes in 2017
In 2017, you can contribute $18,000 to a 401(k) and $5,500 to an IRA.
The standard deduction is $6,350 for single filers and $12,700 for married couples filing jointly.
Steven Melendez is an independent journalist with a background in technology and business. He has written for a variety of business publications including Fast Company, the Wall Street Journal, Innovation Leader and Ad Age. He was awarded the Knight Foundation scholarship to Northwestern University's Medill School of Journalism.