From Bonus to Nest Egg: Funding Your 401(k) with Year-End Bonus
By: Jeff J. Kim
As the year winds down, many employees eagerly anticipate their year-end bonus—a hard-earned reward for a year’s work. While it’s tempting to splurge on gifts, vacations, or other indulgences, I’m here to advocate for a more strategic approach: using that bonus to fund your 401(k) plan. This move can give your retirement savings a significant boost and position you for long-term financial security.
When Are Year-End Bonuses Paid?
Timing varies depending on your employer, but year-end bonuses are often distributed in December or January. The exact timing can impact how the bonus fits into your financial and tax planning:
December Payouts: Bonuses paid before December 31st count as income for the current tax year. This timing is crucial if you’re looking to maximize your 401(k) contributions for the year.
January Payouts: Some companies wait until the new year, meaning the bonus applies to the next tax year. While this delays the tax impact, it provides additional flexibility for contributions in the new year.
Understanding your company’s bonus schedule is the first step in deciding how to allocate the funds. Check with HR or payroll to confirm the details.
Why Use Your Bonus for a 401(k)?
Investing your bonus in your 401(k) isn’t just about saving, it’s about making your money work for you. Here’s why it’s a smart move:
Tax Benefits: Traditional 401(k) contributions are made pre-tax, reducing your taxable income for the year. This is especially valuable if your bonus pushes you into a higher tax bracket. Even if you’re using a Roth 401(k), the tax-free growth on investments makes it a powerful retirement tool.
Compounding Returns: Contributions made early or in lump sums have more time to grow through compounding. A large bonus contribution can accelerate your retirement savings.
Employer Matching: Many employers match 401(k) contributions up to a certain percentage of your salary. Directing part of your bonus to your 401(k) ensures you don’t leave free money on the table.
How to Allocate Your Bonus to a 401(k)
Know the Contribution Limits: For 2024, the 401(k) contribution limit is $23,000, with an additional $7,500 catch-up contribution for those 50 and older. Calculate how much you’ve already contributed during the year to avoid exceeding these limits.
Adjust Contributions for the Bonus: Many employers allow you to specify a percentage of your bonus to allocate to your 401(k). This might be separate from your regular paycheck contributions, so speak with your HR department about your options.
Understand Employer Policies: Not all employers treat bonuses the same way for 401(k) contributions. Some may not allow the bonus to qualify for matching, while others might have a cap on how much you can contribute from a bonus.
Roth or Traditional?: Consider your current and future tax situation when deciding between a traditional 401(k) (pre-tax) and a Roth 401(k) (post-tax). If you expect to be in a higher tax bracket in retirement, a Roth 401(k) could be the better choice.
What to Do if You’ve Maxed Out Your 401(k)
If you’ve already hit the 401(k) contribution limit, don’t let your bonus go to waste. Here are some alternative strategies:
Fund an IRA: Depending on your income, you may be eligible to contribute to a traditional or Roth IRA.
Invest in an HSA: If you have a high-deductible health plan, consider contributing to a Health Savings Account (HSA), which offers triple tax benefits.
Taxable Investment Accounts: Invest in a diversified portfolio outside of tax-advantaged accounts to keep building wealth.
A Balanced Approach
While funding your 401(k) is a fantastic use of a year-end bonus, it’s also essential to balance this with other financial goals. If you have high-interest debt, consider allocating part of your bonus to pay it down. Similarly, bolstering your emergency fund or saving for upcoming expenses can be wise choices.
A year-end bonus is a golden opportunity to supercharge your financial goals, especially your retirement savings. Allocating it to your 401(k) plan not only reduces your tax liability, but also helps ensure you’re on track for a secure retirement.
As we close out the year, think strategically. Your future self will thank you. Let’s make those hard-earned dollars work as hard for you as you did to earn them.
Gerber Kawasaki Wealth & Investment Management is an investment advisor located in California. Gerber Kawasaki Wealth & Investment Management is registered with the Securities and Exchange Commission (SEC). Registration of an investment advisor does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the Commission. Gerber Kawasaki only transacts business in states in which it is properly registered or is excluded or exempted from registration. A copy of Gerber Kawasaki Wealth & Investment Management 's current written disclosure brochure filed with the SEC which discusses, among other things, Gerber Kawasaki Wealth & Investment Management's business practices, services and fees, is available through the SEC's website at: http://www.adviserinfo.sec.gov .
Jeff J. Kim is a Financial Advisor of Santa Monica, California-based Gerber Kawasaki Inc., an SEC-registered investment firm with approximately ~$3.16B billion in assets under management as of 9/30/24. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which course of action may be appropriate for you, consult your financial advisor. No strategy assures success or protects against loss. Readers shouldn't buy any investment without doing their research to determine if the investments are suitable for their situation. “All investments involve risk and one should consult a financial advisor before making any investments. Past performance is not indicative of future results."