Many executives and high performing employees earn a large chunk of their income through bonus payouts or other forms of “extra” compensation like restricted stock units or performance awards. Sometimes this “extra” compensation amounts to more than their annual salary. This type of income can be difficult to manage throughout the year, especially since the actual amounts are usually unknown. Here are three tips to help you manage this type of cash flow:
- Don’t count on it
Unless you have a contract in writing that says you are guaranteed to be paid a certain amount or percentage within a specific timeframe – don’t put yourself in a position where you depend on this payment. Bonuses and other forms of non-salary compensation are seldom guaranteed and are the first thing to go during hard times. Sometimes the payout is based on stock price, which can vary daily and take significant hits when unforeseen events occur. Anything can happen: budget cuts, a sudden illness affecting the CEO, or a crazy market downturn like we saw in 2008. If you are dealing with restricted stock units and you are an “insider,” meaning that you are privy to non-public information about the company, you may be subject to blackout periods and have to maintain the stock instead of selling for cash. Other times, compensation can be based on revenue, which, depending on your industry, could be affected by any number of factors. Examples include client satisfaction, product recalls, or market returns. Manage your monthly expenses based on your actual salary and treat any bonus payouts as “gravy.”
- Understand the effects on your total income
Receiving a hefty bonus can be a great thing, but pay attention to how it impacts your total annual income. Did the extra payment bump you up into to the Alternative Minimum Tax (AMT) for the year or put you in a position where your exemptions are phased out? If so, you may have an ugly surprise waiting for you when you file your taxes, including a potential underpayment penalty. Many times, these types of payouts are subject to a standard withholding scheduling. Your payroll department may withhold 25 percent from the bonus, but if you are in the top tax bracket (39.6%), you have a lot of tax to cover.
It is a good idea to do a tax projection with your financial planner or accountant after receiving a large payment to determine if you need to take any action, like submitting an estimated payment to the IRS, adjusting your withholdings for the rest of the year, or saving a chunk of that bonus and holding it in reserve until your taxes are filed. March and April are popular months for bonus and restricted stock payouts. When this money hits your paycheck, you may max out of your Social Security and 401(k) contributions for the year. That means that all of your paychecks for the rest of the year will be larger. This can be dangerous for some as people sometimes adjust to having larger paychecks by increasing your lifestyle, only to go back to “normal” the following year. Once you are accustomed to spending this extra income each month, it can be hard to go back. I recommend continuing to spend your normal monthly expenses and redirecting the “extra” paycheck dollars towards funding some of your long and short term goals, paying off debt, or savings.
- Use it to get ahead.
Bonus payments and stock offerings are truly meant to be a bonus, so use it to accomplish your goals and objectives and get to where you want to be. Many people have little or no cash reserves available in case of any emergency. Make sure that you have at least three to six months’ worth of expenses in a liquid account available to you at all times. Receiving large payouts is a great way to set aside a chunk of cash to build up these “emergency funds.” Bonuses may allow you to pay down student loans, cars, or even your mortgage that will free up cash flow for you each month and put you in a better financial position moving forward. You can also use these large income events to fund goals like education costs for your children, a down payment on a vacation home, or an early retirement. I am a big believer that you should spend a portion of your bonus on something fun for yourself like a purse that you’ve had your eye on, a massage, a weekend mini-vacation, or an expensive “toy” like a barbeque grill or new power tool that you were holding off on purchasing.