This is the time of the year when clients who earned bonuses from their company for 2024 are receiving them. They might be paid in cash, in the form of company stock grants, stock options, restricted stock units (RSUs) or some combination of these or other forms.
Regardless of how the bonus is paid, the assets need to be included in your client’s investment and financial planning for 2025, especially if the amount of the bonus is significant. Bonus compensation is generally taxable, so this needs to be factored into your planning advice.
Here are some things to consider in working with your clients who have or will be receiving bonus payouts in 2025.
Taxes
If the bonus is paid in cash, your client needs to take this into account for their 2025 tax liability. This is especially critical for 2025 given the uncertainty surrounding the Trump tax plan.
Cash bonuses may have a different withholding level than your client’s normal compensation. Some employers choose to use the percentage method for withholding on bonuses and other supplemental compensation. This means that a flat 22% withholding rate will be used for federal tax withholding. If this is the case for your client, you might consider having them adjust their withholding on their regular paychecks to compensate if needed. Or you could have them make a payment to the IRS for 2025 with some of the cash received.
Bonuses in the form of stock-based compensation are often not taxed when received, but rather when shares are sold or, in the case of RSUs, when the client becomes vested. Be sure to review and understand the current and future tax implications of any stock-based bonus compensation received by your client.
If your client’s 2024 tax bill is high, they might consider diverting some of the cash bonus toward covering this liability. This can be an alternative to liquidating investments elsewhere.
401(k) Contributions
If your client is not on track to max out their 401(k) contributions for 2025, it can make sense to direct a portion of their cash bonus to this tax-deferred account.
You client's employer may allow them to adjust their contribution level for their bonus payout only. Another option is to increase their contribution from all paychecks for the remainder of the year and use some of the bonus cash to offset this reduction in their take-home pay if needed.
IRA Contributions
Annual contribution limits for both 2024 and 2025 are $7,000, with an additional $1,000 in catch-up contributions allowed for those 50 or older. While your client may earn too much to contribute to a Roth IRA or to make a pretax contribution to a traditional IRA, it might still make sense for them to make an after-tax contribution. The money still grows tax-deferred.
If married, they might also consider using some of the bonus money to fund an IRA contribution for their spouse.
They might also consider a backdoor Roth conversion. They would make the after-tax IRA contribution and then convert this money to a Roth IRA. The conversion is taxed on a pro rata basis using the ratio of pre- and post-tax assets in all of the client's IRAs.
Note that IRA contributions for the 2024 tax year can be made until April 15, 2025.
Emergency Fund
As a financial advisor, you know the value of having an emergency fund to cover unexpected expenses. You might encourage your client to use a portion of the bonus to add to an existing emergency fund or to start a new one if needed.
Portfolio Rebalancing
Consider using some or all of a cash bonus to help rebalance your client’s portfolio. The markets have been somewhat volatile lately, and their portfolio might be over- or under-allocated in certain asset classes. Cash from the bonus payment can be allocated to investments in asset classes that have become under-allocated due to market movements.
Adding new cash can help save on taxes that might be incurred by selling securities in overweight asset classes. Additionally, this is a solid way for your client to add to their portfolio in the hope of realizing growth over time.
Even if rebalancing is not a major issue, it makes sense to invest some or all of the cash bonus to add to the client’s existing portfolio.
Alternative Investments
It can make sense to invest some of their bonus money in alternatives, especially if their overall portfolio is in solid shape. This might include an investment in cryptocurrency — perhaps through an exchange-traded fund — or other types of alternatives such as private credit.
Charitable Contributions
If your client is charitably inclined, they can donate some of their cash bonus to charity. If they already make donations, adding some extra money from their bonus might allow them to itemize in 2025, providing a nice tax benefit.
Pay Down Debt
If your client has credit card debt, a car loan, student loan payments or other debt, they should consider using some or all of their cash bonus to pay it down. Excess debt can be a drag on their credit rating. Paying down debt can offer a solid return on investment in the form of reduced or eliminated interest and principal payments. The savings in ongoing payments could be used by your client to invest on a regular basis.
College Expenses
If your client has a child or grandchild in college, the bonus money can be used to help with this cost. While not an investment per se, this money can reduce or eliminate the need to tap investments or other holdings to cover these expenses. It can also help reduce the need for additional student loan debt if applicable.
If your client has children or grandchildren who are not yet in college, some of the bonus money could be used to contribute to a 529 plan or other college savings account for the child’s future benefit.
Stock-Based Bonuses
Bonuses based on stock compensation can be paid out in several ways, including direct access to shares, stock options, restricted stock units (RSUs) and stock appreciation rights.
These and other forms of stock-based compensation offer employees access to company shares.
In the case of options, RSUs and similar forms of stock-based compensation, there is often a vesting period before they can be exercised. There may also be a waiting period before any shares can be sold.
Stock-based compensation can be lucrative if the company’s stock is a solid performer. But be careful: Owning too much of their employer’s stock can result in concentration risk for your client.
Not only is their ongoing compensation tied to their employer, an extended decline in the stock price can have a substantial impact on the value of their portfolio if company shares comprise a significant portion of their overall investments.
Perhaps the best approach is to establish parameters for how much of their portfolio is tied to their company’s stock and take this into account when they receive additional stock-based compensation.
If they receive stock-based bonus compensation on an annual basis, this can be a good time to sell some older shares to keep the percentage in line. You will want to look at the tax implications of selling shares and incorporate this into your client’s overall tax planning if significant.
The proceeds of any sale of company stock can then be invested elsewhere in the client’s portfolio.
Take a Vacation
Depending upon the size of the bonus payment and the client’s overall financial situation, encourage them to use some of the money to have some fun. Taking a vacation is a great use for some of this money, especially if it’s been awhile for them. A vacation or other types of fun activities can be considered an investment in your client’s mental well-being. It can promote a happier life for your client, which can serve to make them more productive in their career.
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