Nothing brightens employee morale like a big bonus. The amount of your bonus that you can stash in your 401(k) depends on how much you've already contributed, the size of the bonus and your age. Money in a 401(k) only avoids taxes temporarily. You’ll have to pay taxes when you take the money out.
A 401(k) plan allows you to contribute pre-tax compensation. The money in the plan can be invested in a variety of assets. In some plans, your employer controls the investment choices, but other accounts give you this opportunity. Your employer can contribute to your account. These contributions may be on a matching basis. For example, your employer might match every dollar you contribute with a 50-cent contribution of its own. Employers can also make nonelective contributions, which is money you can’t receive as current compensation.
As of 2013, you can contribute up to $17,500 of your compensation to your 401(k) account. If you’re age 50 or older, you can kick in an extra $5,500. If your employer contributes to your account, the sum of all contributions can’t exceed your total compensation or $51,000, whichever is less. If you’re 50 or older, the cap rises to $56,500. If your bonus fits within these limits, you can contribute all of it to your 401(k) plan. You want to avoid excess contributions, because these are not tax-deductible and you’ll have to pay taxes when you withdraw them in later years -- that’s double taxation. You can undo an excess contribution by April 15 of the following year.
Individual Retirement Accounts
If your bonus is more than your 401(k) can accept, you can put some of the excess into an Individual Retirement Account. As of 2013, you can contribute up to $5,500 per year to an IRA. The limit bumps up to $6,500 if you’re 50 or older. Your contributions to a 401(k) don’t limit the amount you can contribute to an IRA, but it might limit the amount you can deduct from your taxes. For 401(k) participants, the Internal Revenue Service begins cutting IRA deductions when modified adjustable gross income hits $59,000 and eliminates it entirely once modified adjustable gross income tops $69,000. The thresholds for married couples filing jointly are $95,000 and $115,000, respectively.
Even if you can shoehorn your entire bonus into your 401(k), you’re still on the hook for payroll taxes on this and all your contributions. When you receive your W-2 form reporting your annual income, your 401(k) contributions are included in the boxes for Social Security wages and Medicare wages. Although you can access your 401(k) money when you leave your job, you’ll have to pay a 10 percent penalty if you are under the age of 55. You can avoid taxes and penalties by rolling your 401(k) into an IRA. You must start taking minimum distributions from your 401(k) once you reach age 70 1/2.
Eric Bank is a senior business, finance and real estate writer, freelancing since 2002. He has written thousands of articles about business, finance, insurance, real estate, investing, annuities, taxes, credit repair, accounting and student loans. Eric writes articles, blogs and SEO-friendly website content for dozens of clients worldwide, including get.com, badcredit.org and valuepenguin.com. Eric holds two Master's Degrees -- in Business Administration and in Finance. His website is ericbank.com.