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How should I save my bonus?

Posted by Jill Boynton  March 22, 2010 10:38 AM

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"I'm getting a bonus soon. Should I put it in my 401(k) and avoid the tax? My coworker told me it doesn't make a difference, since I have to pay tax on it when I withdraw it later."

Banking your bonus money is a great way to boost your savings. But the type of account you choose can also make a difference. I think your coworker is wrong – putting the money into your 401(k) makes a lot of sense.

Your ability to put some or all of the bonus into your company retirement plan depends on how much you're on track to contribute for the year without the bonus. The contribution limit in 2010 is $16,500 for individuals under age 50 and $22,000 for those 50 and older. Look at your most recent paycheck to see how much you've contributed to date and add to it the remaining contributions for the year. As long as you're under the limit you can add some or all of your bonus money. If your company matches your contribution then you don't want to hit the limit before December 31st because you will probably lose out on some of the match, so be careful not to put in more than is needed to get you just to the limit (besides, that excess contribution will have to be withdrawn anyway.)

Another benefit of the 401(k) is, as mentioned above, the company match. You may earn more of a match by increasing your contribution.

We can't know for sure what tax bracket you'll be in when you retire, but if you think it will be at or less than your current bracket then it makes sense to utilize the 401(k) instead of depositing the money into a taxable account. All of the growth that your money earns over the years will be able to stay in the account and compound, boosting the chances of long-term returns that exceed that in a taxable account.

As an alternative, if your income is less than $105,000 and you are single, (or $167,000 if married) and you are in a very low tax bracket you might consider using a Roth IRA. You won't get the tax deduction now but the money will grow tax-free for retirement.

This blog is not written or edited by Boston.com or the Boston Globe.
The author is solely responsible for the content.

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ABOUT MANAGING YOUR MONEY
Local finance professionals share insights and advice on issues such as budgeting, managing debt, and retirement planning.

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D. Abraham Ringer is a CERTIFIED FINANCIAL PLANNER practitioner and a Financial Adviser with Morgan Stanley Global Wealth Management in Boston. He is registered in MA, NH, NY and several other states to which his articles are directed. For more information please visit www.morganstanleyfa.com/ringer
Financial Planning Association™ of Massachusetts has 900 members who specialize in the financial planning process. Many of its members engage in philanthropic pro bono work in their communities, recommend legislation, elevate public awareness, promote financial literacy, and advocate for sound economic and tax policies.
Odysseas Papadimitriou is the founder of CardHub.com, a credit card and gift card marketplace, and WalletHub.com, a personal finance site. He has more than 13 years of experience in the personal finance industry, and previously served as senior director at Capital One.

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