Can I Put All of My Bonus in My 401(k) to Avoid Taxes?

Contributing your bonus to your 401(k) plan won't avoid payroll taxes.

Contributing your bonus to your 401(k) plan won't avoid payroll taxes.

Getting a bonus is welcome, but many times your employer withholds way too much in taxes because a bonus is a large lump-sum payment. Even though you'll get back the extra withholding when you file your tax return, some people want to put their bonus into their 401(k) plan to avoid the excess withholding. But this isn't always possible, and it doesn't get you out of all taxes.

Tax Deferral

The money that you contribute to your 401(k) plan out of your paycheck isn't included in your taxable income for the year. However, even if you're able to put it all in your 401(k) plan, you still owe payroll taxes on the contributions. As of 2013, the employee's share of payroll taxes equals 6.2 percent for Social Security taxes (but only on the first $113,700) and 1.45 percent for Medicare taxes. If the bonus represents income exceeding $200,000, you owe an additional Medicare tax of 0.9 percent.

401(k) Contributions from Bonuses

Many 401(k) plans include bonuses as eligible to be contributed. If so, and if you've already asked your employer to withhold a specific percentage of your pay for your 401(k) contributions, that percentage is automatically used unless you ask your human resources department to change it.

For example, say you routinely have 5 percent of each paycheck put into your 401(k) plan. If bonuses are included in the plan's definition of compensation and you receive a $10,000 bonus, $500 will go into your 401(k) plan. However, this definition isn't universal, so your plan might not include contributions from bonuses.

Contribution Limits

Depending on the contributions you've already made during the year, you might might not be allowed to put your entire bonus in your 401(k) plan because of the IRS contribution limits. As of 2013, you're allowed to put up to $17,500 in your 401(k) plan each year. So if you've already contributed $16,000 and you receive a $5,000 Christmas bonus, you couldn't put more than $1,500 of it into your 401(k) plan.

Deferring Not Avoiding

Putting your bonus money in your 401(k) plan only defers the income taxes; it doesn't avoid them forever. Once you put the money into your 401(k) plan, it will grow tax-free as long as it stays there. But when you take withdrawals, you must include the money in your taxable income that year. Plus, if you take a distribution before you're 59 1/2 years old, you'll be slapped with a 10 percent penalty unless you qualify for a special exception.


About the Author

Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."

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