Though not everyone enjoys the wonder that is the year-end bonus, for many workers it's the most glorious time of the year. In a 2014 study, 80% of employers claimed to offer workers some sort of additional year-end payment. And while not every bonus check is of the over-the-top Wall Street variety, even an extra thousand dollars or two could have a serious impact on your finances.
But although you'd think your annual bonus would be something to celebrate, if you're not careful, it can hurt you as well -- namely, if you're counting on it and it doesn't come through. That's why you'll need to be cautiously optimistic when it comes to your bonus, and avoid making the mistake of factoring that money into your budget from the get-go.
Don't plan on that bonus
The danger of expecting a bonus is that unlike your regular salary, that payment typically isn't guaranteed. This means that if you're counting on your bonus to cover a major bill, or are including that income as part of your budget, you could be setting yourself up for disaster.
Imagine you typically receive $1,000 after taxes as an annual bonus but your company has a bad year and can't make that payment this time around. If you buy a $1,000 TV with the expectation that you'll pay it off quickly once your bonus arrives, you could end up throwing out a ton of money in credit card interest. The same holds true if you add $83 to your monthly budget, only that cash never comes in.
Unless your bonus is absolutely guaranteed, in writing, operate under the assumption that it may not land in your lap. Once you have that cash in hand, you're free to spend it as you see fit (though you're of course better off using that money responsibly). But until then, work off your salary alone when making financial decisions.
Don't let your bonus take the place of a raise
Here's another problem with getting a bonus: Some companies offer employees the promise of a lump-sum payment at the end of the year rather than an actual raise. And from a worker's perspective, that's risky for a couple of reasons. First, unless that money is guaranteed, in writing, there's a chance it won't come through, whereas raises often take effect immediately and aren't dependent on your individual performance, or that of your company.
Furthermore, if you're promised a year-end bonus in lieu of a raise, you'll run into the same problem as folks who get a sizable tax refund -- missing out on the opportunity to utilize that cash sooner. Most working Americans are already living paycheck to paycheck without much, if anything, in the way of emergency savings. If you have a month where you're short on cash and are forced to charge expenses on a credit card, you'll lose out in the form of costly interest -- because even if your bonus is more than enough to cover your balance, you'll have already racked up unnecessary charges. You're far better off getting access to that cash as you earn it.
Of course, not every company offers a bonus instead of a raise. If yours does, however, then you may want to ask to forgo that lump-sum payment and instead snag a guaranteed boost in salary.
Beware of bonus taxes
One final problem with bonuses is the way they're taxed. Though your regular paycheck is taxed based on the bracket you fall into and the number of exemptions you claim on your W-4, bonuses are considered supplemental wages and, as such, are taxed differently.
Employers have a couple of options for taxing bonuses, the most popular of which is the percentage method, where a 25% flat tax rate is applied to your lump-sum payment. (Incidentally, bonuses that exceed the $1 million mark are taxed at an even higher rate -- 39.6%.) Your bonus might therefore put much less money in your pocket than expected after taxes are factored in, so don't make plans for that money until you see how much it actually translates into.
Of course, the good news is that things will even out when you file your return, so if you are overtaxed on your bonus, you may wind up with a refund. But again, that's a lot less ideal than having access to your money up front.
Though your annual bonus may be something to look forward to, don't bank too heavily on getting that cash. If you're careful not to make assumptions when it comes to your bonus, you'll be in the best position to make the most of that money if it actually ends up coming your way.