Bonus Planning 2023: 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.

At the close of 2022, the S&P 500 finished down nearly 20% for the year. Many expect the 2023 bonus season to be subdued compared with last year, with some expecting steep declines in payouts. While record inflation, Federal Reserve rate hikes and pessimistic economic forecasts have prompted some companies to consider reducing bonuses in general, others have floated raising base pay to bolster worker retention in lieu of bonuses. For those executives, senior managers and bonus-eligible employees, understanding the planning options and tax impact is now more important than ever.

A cash infusion can transform your financial standing, prompting the need for strategic planning to make the most of your bonus. As each individual’s income-tax situation is unique, work with your tax preparer to adjust your remaining estimated payments or withholding for the year to avoid any risk of a penalty for underpayment of estimated tax. The withholding rate for supplemental wages below $1 million is generally 22%, which is often too little to fully cover the income tax liability of higher-earning workers. After any income tax issues are addressed, a financial advisor can help you determine how to allocate the remainder for your specific goals. 

Below, 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

Whether you decide to pay down debt, invest or indulge, it is important to understand the full spectrum of strategies and options to position you to meet your goals.

Common Forms of Incentive Compensation

Here are details of some tax implications and potential planning strategies for several common forms of executive compensation. Planning for restricted stock awards and options can be complex, particularly for those with limited time. We recommend meeting with your financial 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 for your specific circumstances and goals.

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

The transition from formal education to a professional workforce comes with long-term planning considerations. It is important to stay disciplined as financial decisions today inevitably impact financial planning tomorrow.

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 may limit your ability to maximize investments, obtain a loan to start a business or secure a favorable mortgage. Explore various debt-structure options with your financial advisor.
• 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 financial 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
• Spend for growth. If you want to reward yourself, do so in a meaningful way. Consider using your bonus for self-improvement to enhance your professional and personal life. For example, purchase fitness equipment, hire a career coach or enroll to obtain executive education, certifications or licensures.

Mid-point, advancement phase

As you enter the middle stage of your career, 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; in some cases there may be a portion concentrated in a current or even past employer. 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 any applicable 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 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. For 2023 the maximum HSA contribution limit for an individual is $3,850 and for a family is $7,750. 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

As you approach your retirement, review your financial position and your long-term goals.

Some matters for you to consider with your financial advisor are the following: After decades as an accomplished professional and sought-out expert, you are placing the finishing touches on an outstanding career and may be committed to mentoring the next generation. You have witnessed a lot of change — in your personal life and, likely, in your industry. This might be one of your last bonuses, or perhaps the very last. It is important for you to assess cash needs in light of your pending retirement.

• Calculate liquidity needs. Evaluate your overall portfolio, calculate your future needs and immediately address any gaps. Consider working with your financial 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 your financial position. 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, such as current or previous employer. 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 steps you can take in order to use your bonus to advance your philanthropic and charitable goals and, consequently, your values. Each option has different income tax considerations to carefully weigh with your tax preparer and financial advisor. These include:

• Contribute to a Donor Advised Fund. 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 CRT 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 for some, 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.

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.

Planning for executive compensation is complex, time consuming and requires a nuanced understanding of individuals’ specific circumstances and goals. At all stages of your career, it is advisable to plan for your long-term goals with your financial advisor who can bring clarity to the picture with the support of a multidisciplinary team of experts. Your financial advisor will work with you to ensure not only that your plan is optimized for each form of compensation, but that it is built with flexibility to adapt to the changing circumstances sure to arise throughout the course of your career.