Should you make a 401(k) bonus contribution?

If you’re expecting a bonus from your employer, you may already be planning what to do with the extra moolah. Whether it's a holiday bonus, performance incentive, or monetary gift, there are various options for making the most of this extra money, including adding the bonus to your 401(k).

A 401(k) bonus contribution is the process of adding part or all of a bonus payment to your 401(k) retirement account. If maximizing your bonus is your top priority, consider all possible options. 

We'll cover how 401(k) bonus contributions work and are taxed. If you're already familiar with how 401(k) bonus contributions work, skip ahead to see when you should or shouldn't be contributing your bonus to your 401(k).

What are 401(k) bonus contributions? 

401(k) bonus contributions are additional funds you contribute to your 401(k) from a bonus payment. These are subject to the same tax advantages and limitations as regular 401(k) contributions — meaning they are tax-deferred if you have a traditional 401(k). 

When deciding whether to invest your bonus into your 401(k), there are a few considerations, including your goals and tax situation.

401(k) tax breaks and your bonus 

The first thing to know is that taxes for your bonus are different from your regular pay. So, when you get your bonus check, it might be lower than expected. 

Most employers withhold 22% of your bonus for income taxes. One way to keep more of your hard-earned money and reduce your bonus tax burden is to invest all or part of it in a tax-deferred account like a 401(k). The money you invest will effectively lower your taxable income for the year. 

Bonus 401(k) contributions can boost your retirement savings allowing you to build a larger nest egg for post-work years.

How bonus 401(k) employer contributions work 

If lowering your taxable income sounds attractive, make sure your employer allows it. Many employers won’t have restrictions on what you can do with the bonus, but some may disallow you from investing it in your 401(k).

Typically, if your employer allows you to contribute bonuses to your 401(k), the contribution rate for your paycheck and bonus will be the same. For example, if your contribution rate is set to 10% for your paycheck, then 10% of your bonus will go toward your 401(k). 

Some plans may have different contribution levels for regular pay versus bonuses or commissions, so check your plan documents or ask HR. 

While bonus contributions can offer retirement savings advantages and tax benefits, individuals should consider annual 401(k) contribution limits before making a decision. 

401(k) employer matching and bonus contributions 

When an employer offers a match, they are willing to “match” a portion of the contributions you make to your 401(k). Employers will usually match a percentage of your contributions, up to a certain percentage of your salary.

For example, say your employer offers a 50% match on contributions up to 6% of your salary. Your salary is $75,000, meaning that you can contribute $4,500 to your 401(k) and your employer will contribute $2,250. 

Let’s compare what your retirement account would look like after five years with and without employer-matching contributions. 

How employers treat matching bonus contributions

To learn how your employer handles matching bonus 401(k) contributions, check the details of your retirement plan for the definition of compensation, including any exclusions for bonus or commission. 

For example, if you plan to make a large contribution to your 401(k) and your employer offers matching contributions, you’ll want to ensure you have a “true-up” option. 

A true-up requires your employer to provide you with the full match you’re entitled to in the event you max out your contributions early in the year or make uneven contributions. A true-up makes up for the fact that your employer can only match a certain amount per pay period. 

Now, say your salary is still $75,000, and you receive a one-time bonus of $10,000 early in the year. If your employer offers a true-up option, you can contribute the entire amount – if you’ll still be at or below the annual contribution level – and receive the full employer match. 

Note that there’s no income limit for contributing to traditional 401(k)s, but there is a maximum income for employer matching. In 2024, you only get employer matching on the first $345,000 of your total compensation. 

Can you put all of your bonus into a 401(k)? 

Yes, but it depends on the size of your bonus and how much you have already contributed to your 401(k) for the year. You can put all of your bonus into a 401(k) if you’re below the annual contribution limit. Remember you’ll have to manually request this by changing your contribution rate before you receive your bonus. 

The annual 401(k) contribution limit for 2024 is $23,000, or $30,500 if you’re 50 or older. Note that employer-match contributions do not count toward this limit.

Calculate your 401(k) contributions to see how much of your bonus you can contribute. Also, don’t forget to update your contribution rate for future paychecks to avoid going over the limit. If you exceed the annual contribution limit, you may be subject to penalties. 

When you should make bonus contributions

Consider your financial goals and the tax implications of making a bonus 401(k) contribution. 

You’ll want to make 401(k) bonus contributions if: 

• You’re below the annual contribution limits 
• You won’t miss out on employer matches 
• You’re in a higher tax bracket
• You’ve paid off high-interest debt 
• You have sufficient cash reserves  
• You’re behind on retirement savings

You should also consider the timing of your bonus payout, as it can impact your tax bracket and overall financial situation. If receiving a bonus will push you into a higher tax bracket, contributing a portion of it to a pre-tax account can help reduce your taxable income and keep you in a lower tax bracket. This can potentially save you money on taxes and have a positive impact on your overall income.

If you can afford to make a bonus contribution and don’t need the money to fund other savings goals, using your bonus to contribute to a retirement plan can be a smart financial move.

When to skip bonus 401(k) contributions

You may want to skip putting your bonus into your 401(k) if you’re in one of  these situations: 

• You’ll exceed the contribution limit for the year 
• You’ll miss out on employer-matching contributions
• You have high-interest debt 
• You need to establish or refill your emergency fund 
• You need to save for a short-term goal

First, skip bonus 401(k) contributions if you will need the money for upcoming expenses or need to save it for a near-term goal like a home down payment. 

If you have high-interest debt like a credit card or loan, you may want to use some of the bonus to pay the balances off. And if you don’t have an emergency fund, you can use the bonus to create one to help cover unexpected expenses.

Other tax-savvy ways to invest your bonus 

If you hit your 401(k) contribution limit for the year — or plan to — you can still reduce your taxable income by investing in other tax-advantaged accounts. 

Traditional IRA 

You can open a traditional IRA even if you have a 401(k). Contributions to traditional IRAs are tax-deductible, and you can contribute up to $7,000 ($8,000 if you’re 50 or older) for 2024. 

However, when you contribute to a 401(k) and IRA, there are limits to how much of a tax deduction you get based on your income. 

For example, if you contribute to a 401(k), your tax deductions for traditional IRA contributions will be reduced if your tax filing status is single and your income is over $77,000 or if you’re married filing jointly with income over $123,000. 

Health Savings Account (HSA) 

You should also consider a health savings account (HSA) for tax breaks if you’re enrolled in a high-deductible health plan. 

Your contributions to an HSA are tax-deductible, and the money grows tax-free. There’s also no income tax on withdrawals if you use the money for medical expenses. 

The HSA contribution limits for 2024 are $4,150 if you have a self-only plan or $8,300 for a family plan. You can contribute an additional $1,000 if you’re 55 or older. 

The Playbook take: Make 401(k) bonus contributions when you can 

It can be smart to use your bonus as extra fuel for your 401(k) growth and lower their taxable income for the year. If you’ve already maxed out your 401(k) for the year, there are other tax-savvy options for making the most of your bonus. 

Looking for other ways to maximize your tax advantages while also saving more for retirement? Playbook can build a tax strategy that fits your individual situation. 

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