What to Do with Your Year-End Bonus

Key Takeaways

• Whether your bonus is delivered on a consistent schedule or is a pleasant year-end surprise, review your goals carefully before deploying those funds.
• Additional financial resources can help you accomplish more goals, reach your goals faster, and/or increase your current goals.
• Disciplined Microsoft employees can utilize a cash flow strategy that maximizes their 401(k) and ESPP benefits.

One of the first things I ask new clients is whether their year-end bonus was expected or a pleasant surprise. If your bonus is not part of your normal annual compensation, then, congratulations! Reward yourself with a trip, splurge on a gadget you’ve wanted, or pamper yourself with a day at the spa.

However, many professionals receive performance bonuses annually, if not more frequently. Whether received in cash or stock, the bonus is a critical piece of their overall compensation package. Like many of our clients employed by Microsoft, they receive generous non-cash bonuses and compensation. While some workers rely on regular paychecks to meet their living expenses and use their bonuses for savings or special purchases, we recommend the opposite for Microsoft employees.

Take Advantage of the Corporate Benefits

We have helped several Microsoft employees maximize their 401(k) and Employee Stock Purchase Plan (ESPP) contributions and use their quarterly vested ESPP and Restricted Stock Units (RSUs) to supplement their living expenses. This strategy allows them to defer a large portion of their salary into their pre-tax 401(k) and after-tax 401(k) while getting the full benefit of the ESPP. To review the after-tax 401(k) strategy, see my earlier post: Are You Taking Advantage of this Little-Known Microsoft Retirement Benefit?

While this approach initially sounds great, it takes discipline to execute as the employee’s regular paychecks are often not enough to cover their monthly expenses. To make up the shortfall from deferring this large portion of their monthly income, I recommend immediately selling and pocketing their vested ESPP shares and RSU’s every quarter. The cash infusion received every three months replenishes their checking account and the process begins again in the next quarter. This “refill” strategy can also work at other companies where employees receive quarterly performance bonuses or large (and predictable) annual bonuses.

Real World Example

Sam, a Microsoft marketing executive, earns a base salary of $160,000 and an $80,000 bonus paid quarterly in RSU’s. Under the plan described above, Sam can defer from his base salary:

$19,000 pre-tax or Roth 401(k)

+ $27,500 after-tax (which converts to Roth every quarter)

+ $25,000 in ESPP (which vest quarterly and are promptly sold)

= $71,500 total or nearly half of his paycheck

While Sam’s smaller paychecks do not cover his family’s monthly expenses, as the ESPP and RSU’s vest and are sold each quarter, the checking account is refilled. This allows Sam to maximize his savings dollars and take full advantage of the Microsoft compensation plan.

Think of Cash as a Resource

In any business, extra resources can:

• Make it faster.
• Make it better.
• Make more.

You have the same options for your financial situation. In this case, your resource is cash. With ample cash, you can:

1. Accomplish your financial goals faster. Pay down debt or execute goals sooner, like making that big-ticket purchase, such as buying a new car, making a down-payment on a home, or taking that big trip you’ve dreamed about. The extra cash might also enable you to start working less or to retire earlier.
2. Improve your standard of living. The additional discretionary cash flow can provide a better lifestyle or enable you to make a bigger impact in your community.
3. Increase your goals. With the extra cash, you can create new goals or amend your current goals, such as planning an extra vacation, purchasing a larger home, or making a greater philanthropic impact with your money.

Rely on Expert Advice

A financial advisor who understands your unique situation can help when a bonus or other cash windfall is received. With your advisor’s assistance, you can be confident about your financial decisions and focus on what’s important to you. In my next post, we’ll look at the smartest ways to utilize an inheritance that comes your way.

This report is intended to be used for educational purposes only and does not constitute a solicitation to purchase any security or advisory services. Past performance is no guarantee of future results. An investment in any security involves significant risks and any investment may lose value. Refer to all risk disclosures related to each security product carefully before investing. Soundmark Wealth Management, LLC, its advisors and its affiliates do not provide tax or accounting services. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for, tax or accounting advice. Please consult with your tax advisor prior to engaging in any transaction.