The Financial Pros and Cons of Year-End Bonuses

Whenever I think about year-end bonuses, it’s hard not to recall Clark Griswold’s disappointment in National Lampoon’s Christmas Vacation. Instead of the cash bonus he was counting on to fund his family’s dream pool, he received a Jelly of the Month club membership — a humorous but all-too-relatable moment for anyone who’s experienced financial letdowns. Clark’s distress wasn’t just about missing the bonus; he had already overdrawn his checking account in anticipation of those funds.

Since people’s year-end bonuses range from a small percentage of their take-home pay to significant multiples of their base salary, how they plan for those dollars can make or break their personal finances. Whether it’s using the bonus to pay off debt, build an emergency fund or invest in long-term financial goals, thoughtful management of these funds is crucial for maintaining financial stability. Here are a few things to keep in mind.

Don’t Spend It Before You Receive It

In practice, I like to model out clients’ finances with a very conservative year-end bonus, and then stress test the plan around whether they even receive that smaller amount. This becomes more difficult with clients who rely on a large portion of their income from bonuses. Although for those individuals, these are usually performance-based bonuses, which is trackable, and able to be budgeted, throughout the year.

Uncle Sam Always Gets Paid

And these days making Uncle Sam wait is more expensive than it has been in years because of the rise in interest rates. In the first quarter of 2025, the IRS will charge a 7% interest rate on tax underpayments—taxes owed but not fully paid. Therefore, it is more important than ever to do accurate tax planning, projecting what you may earn in income and owe in taxes and withholding the correct amount in taxes or making estimated tax payments if necessary. The IRS provides a safe harbor to avoid any underpayment penalties, if;

• Your filed tax return shows you owe less than $1,000 or
• You paid at least 90% of the tax shown on the return for the taxable year or 100% of the tax shown on the return for the prior year, whichever amount is less. If your adjusted gross income (AGI) for 2023 was more than $150,000 ($75,000 if your filing status for 2024 is married filing separately), substitute 110% for 100%.

Now would be a good time to contact your CFP® professional to discuss your 2024 income taxes because the final quarterly estimated tax payment for earnings from September 1 through December 31 is January 15, 2025.

Make Sure You Have the Basics Covered

If you haven’t overspent the year-end bonus and can confidently project what you’ll net after taxes, now is the time to make sure you have the basics covered. Any “bad” debt should be paid off immediately. -- That includes high-interest debt such as credit card balances or auto loans. Next, ensure you have a proper emergency fund: 3 months of nondiscretionary spending for dual earners or those with very secure jobs, and 6 months for all others. Last but not least, use the bonus to grow your wealth and meet your financial goals.

If your focus is on retirement planning, max out your employer retirement plan, then potentially contribute to a Roth IRA through annual contributions or conversions, and lastly utilize a regular brokerage account for any additional savings.

If the goal is education planning for kids or grandkids, then look at 529 education-savings plans, and for other goals, such as their first car or a down payment for a home, utilize a custodial account.

Know Your Value

Finally, while I would not recommend sending Cousin Eddie to your boss’s house if you are unhappy with your year-end bonus, I do think there is a lesson we can learn from Clark. Know your value and don’t be afraid to ask for more. If you receive less than you expected, it does not hurt to ask your boss for a meeting to discuss and make a case for why you deserve more than what you got. The worst case is that your boss says no. No one cares more about your career and your financial goals than you do.