Annual Bonus Planning: Strategies to Help You Meet Your Long-Term Goals

Executive bonus planning is complex and time consuming. Your advisors can help you optimize all forms of compensation in order to meet your goals.

For executives participating in incentive compensation plans, annual bonuses often represent a large portion of your total compensation. Understanding the options and the associated tax impacts are vital in order to maximize your benefit and achieve your goals.

In this article, we explore ways to make the most of this year’s bonus season based on your career phase:

• Early, establishment
• Mid-point, advancement
• Late, nearing retirement

Common Forms of Incentive Compensation

Note that planning for restricted stock awards and options can be complex. We recommend meeting with your advisor, who can weigh the costs and benefits of each form of compensation through a Goals-Driven Wealth Management lens in order to optimize your plan.

If you receive any or all of the above forms of incentive compensation, your current career stage will largely determine the strategies you use to address priorities and reach established financial goals.

Early, establishment career phase

For professionals early in their career, making disciplined decisions today can have meaningful consequences for the future.

Consider the following strategies for your cash bonus:

• Build cash reserves. Revisit your monthly expenses and ensure you have adequate reserves of cash or cash equivalents in your emergency fund.
• Use and manage debt wisely. Allocate a portion of a cash bonus to pay down high interest rate debt — credit cards and student loans, for example. While leveraging credit is commonplace in our economy, too much personal debt can limit your ability to maximize investments, obtain a loan to start a business or secure a favorable mortgage.
• Fully fund retirement accounts. Supplement existing retirement contributions to reach your annual savings goal. Consider making the maximum annual contribution to a 401(k), Roth or traditional individual retirement account (IRA) and, if appropriate, a health savings account (HSA). Investing in these types of accounts can lower your current and future income tax liability (depending on the type of account), while also harnessing compounding returns to help you prepare for the future.
• Consider paying down your mortgage. If you are a homeowner with a high interest rate mortgage, consult with your advisor to weigh the costs and benefits of using your cash bonus to pay down the mortgage debt on your home. Paying down your high-interest mortgage may be a way to free up monthly cashflow and pay less interest over the life of the loan. Discuss the tax consequences of itemizing income tax deductions, including mortgage interest, with your tax preparer.

Mid-point, advancement phase

As your career develops, your financial planning considerations often shift. As part of an incentive bonus, you may also be granted equity-based compensation such as restricted stock awards and stock options. Your wealth may become concentrated in investments, including in a current or past employer, and it is important to have a plan in place for the near- and long-term.

Consider the following strategies for making the most of your incentive awards:

• Actively manage positions. Monitor your stock options and work with your tax preparer and financial advisor to determine the optimal timing for exercise. An effective exercise schedule will take into account vesting schedules, proper tax planning and maximizing return.
• Develop your strategy for holding and selling. Determine whether to hold or sell stock awards upon vesting in accordance with regulatory limitations. Be mindful of becoming overly concentrated in your company stock, and remain aware of the importance of diversifying your overall portfolio to protect against downside risks.
• Fully fund your health savings accounts. Many people tend to overlook and underutilize their health savings accounts (HSA). These tax-advantaged accounts allow you to contribute pretax, the funds grow tax free and distributions for qualified medical expenses are income-tax free. Decades of contributions and compound growth in HSAs, undiminished by income taxes, can lead to a sizable investment available for use in retirement.

• Plan for education. Consider funding your children’s or other family members’ education with a 529 plan. Funds contributed grow tax-free, and distributions for qualified education expenses are income-tax free. Many states also offer a state income-tax deduction for these contributions.

Nearing retirement, late career phase

After decades as an accomplished professional, you are placing the finishing touches on your career and may be committed to mentoring the next generation. This might be one of your last bonuses, or the very last. It is important to assess cash needs in light of your pending retirement.

• Calculate liquidity needs. Evaluate your overall portfolio, calculate your future needs and address any gaps. Consider working with your advisor to use any cash element of your bonus to fund your Portfolio Reserve — a buffer of relatively stable assets designed to meet cash flow needs and fund lifestyle goals through periods of market distress.
• Evaluate the diversification and investment strategy of your portfolio. While a concentrated position may have helped build wealth, diversification can help preserve it. With stock awards having vested over the years and options exercised, it is not uncommon to be heavily concentrated in the stock of a single company.
• Use credit strategically. Using a line of credit can help bridge cash flow needs for major or unanticipated expenditures. If you are uncomfortable with debt, use your cash bonus to reduce or eliminate outstanding debt so that you are not allocating funds to pay interest in retirement.

Give

No matter the phase of your career, there are myriad opportunities to advance your philanthropic and charitable goals.

• Contribute to a donor advised fund (DAF). A DAF provides a formal structure for your giving and affords you the opportunity to track the results of your generosity, without ongoing operational expenses. It also allows you to set aside funds today to give to charities of your choice in the future.
• Consider an annuity trust. A charitable remainder trust pays an annuity income stream to you or a family member, with the remainder going to charity. In a high interest environment, a charitable remainder trust is an effective tool to provide an annuity stream and maximize an income tax deduction, especially in a year in which a cash bonus is paid.
• Structure your giving. Work with your tax preparer to ensure that your giving maximizes any income tax deduction by “bunching” several years of gifts into one gift.
• Create a private foundation. In addition to other distinct characteristics that can make it an attractive option, a private foundation provides an opportunity to engage your children, grandchildren and other family members on giving and align as a family on values. Explore ways for others to potentially become involved — for example, through the foundation’s grantmaking and activities.

Additionally, many use their bonuses to take family vacations, engage in home remodeling, or purchase discretionary assets. Your financial advisor can help you determine the timing, budget and overall planning of such a purchase while ensuring that you remain positioned to achieve your long-term goals.