Why You Should Save Your Annual Bonus into a Brokerage Account

By Kelly Metzler, CFP®

As we approach the end of the year, many executives are gearing up to receive their annual performance bonuses. You’ve worked hard this year and may already be thinking about how you’ll spend it – maybe a home project you’ve been hoping to start or that well-deserved vacation. However, before you commit to spending it all, here is another consideration: saving & investing your bonus in a taxable brokerage account.

What Should You Do with Your Bonus Money?

Use your annual bonus to boost your retirement savings and make sure you’re staying on track for retirement. It’s likely that you don’t rely on your bonus to cover your basic living expenses. If you’re able to meet daily needs out of your salary and just use your bonus for the “extras” in your life, consider earmarking at least some of your bonus for medium or long-term savings goals.

Saving Your Bonus Money

As an executive, you want to continue your comfortable lifestyle throughout retirement. Therefore, you need to make sure you’re saving enough so that you can afford that same lifestyle when you retire. For high-earners, saving to your 401(k) alone often isn’t enough. A brokerage account offers another opportunity to invest to help you reach your retirement goals.

Pros and Cons of Using a Brokerage Account

A brokerage account is an investment account where you can invest in a wide variety of investments, including stocks, bonds, mutual funds, and ETFs. Unlike a 401(k) where you contribute pre-tax dollars, you put in after-tax dollars to a brokerage account. Investment income – like interest, dividends, and capital gains – is taxable in the year in which it is earned.

Certain types of investments and investment vehicles are more tax-efficient than others. Qualified dividends and long-term capital gains are taxed at lower rates than ordinary income. So with strategic investment choices and portfolio construction, you can build a tax-efficient portfolio to minimize your taxes.

You have the potential to grow your wealth over time by investing in a well-diversified portfolio of stocks and bonds. You must be willing to take on risk and accept volatility in the markets in exchange for higher long-term investment returns. As a financial advisor, I help executives take a disciplined approach to investing. Incorporating investment decisions within the context of your financial plan will give you the best chance to meet your specific goals.

Investing in a brokerage account can provide you with greater flexibility. There are no contribution limits with a brokerage account and no restrictions on withdrawals. You can take the money out whenever you’d like, which makes a brokerage account a useful savings vehicle for expenses that you’ll have prior to age 59 ½ since there is no early withdrawal penalty.

Opportunity for a Tax-Efficient Withdrawal Strategy in Retirement

One of the biggest advantages for executives to build up a brokerage account is to help control your tax bracket in retirement. Having your investment portfolio divided between tax-deferred accounts, taxable accounts, and possibly even tax-free accounts (i.e., Roth accounts) will give you tax diversification and the potential to keep more of your money in your pocket.

If you retire with only assets in a tax-deferred 401(k) or deferred compensation plan, every dollar you withdraw will be taxed as ordinary income. This means if you need to spend $200,000 a year after-tax for living expenses, it could potentially require a $300,000 gross withdrawal from your investment portfolio. However, if you have taxable and/or tax-free accounts to withdraw upon as well, you can come up with a coordinated withdrawal strategy to stay within a certain tax bracket each year and control the taxes you owe.

Conclusion

Many executives have a bonus as part of their executive compensation package. Before you spend your bonus this year, figure out how much of it you’ll be able to set aside for medium-term and long-term savings goals.

Heading into the new year is a good time to reevaluate how much you’ve saved this year and whether you’re on track for retirement. And if you feel that you haven’t saved enough, you should consider catching up by saving your bonus.

As a financial advisor, I help executives continue the lifestyle they have worked decades to create. If you’re not sure how much you need to be saving each year or whether you’re on track for your retirement goals, schedule a call.