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My bonus is taxed at a higher rate than my regular paychecks, so should I contribute 100% of my bonus to 401k?

Is there any tax advantage that I can gain if I invest my bonus into my 401k account, instead of using it as normal salary? For tax purposes, my status is married filing jointly with the tax bracket of 28% (according to 2010 tax brackets.)

The reason I am asking this is because if I want to use it as normal salary, the bonus will be taxed with the highest tax bracket of my income and adding the FICA & local taxes to that would take away a very big chunk of it (~35-40%).

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Linking to the other question per @JoeTaxpayer suggestion. –  littleadv Dec 17 '12 at 18:12
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marked as duplicate by littleadv, JoeTaxpayer, C. Ross Dec 19 '12 at 19:28

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3 Answers

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Basically, a bonus is no different from your normal income. You will get the same benefits from putting the money in a 401(k) as you would if you decided to put more of your normal income into a 401(k).

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Would love to hear more detail here. Are bonuses not taxed at a higher rate? Mine are. –  Christopher James Calo Dec 16 '12 at 20:21
    
Bonuses are taxed at your marginal tax rate, just like a raise would be. Basically, your first X dollars of income are taxed at one rate, your next Y dollars are taxed at the next rate, etc. So, your effective rate is somewhere between the two rates. When you get a raise or a bonus, all of it is taxed at the higher rate, because you've already "used up" all of the income for the lower rate. –  Jeremy Dec 17 '12 at 1:28
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It sounds like my confusion stemmed from the fact that the amount withheld from a bonus paycheck is not the same as the amount that will eventually be taxed. So while more is taken out of my bonus paychecks than regular paychecks, it sounds like regular pay and bonus pay will be taxed at the same rate when I file. –  Christopher James Calo Dec 17 '12 at 14:21
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Earned income is earned income. You can put your bonus in a tax-advantaged account, or not, just like you can put your salary in a tax-advantaged account, or not. If you don't, it's taxed as ordinary income.

Now, it may look like they're taking a ton out of your paycheck, but part of what may be happening is that, for that paycheck, it looks like you're making a whole lot more, so they're withholding a whole lot more based on a probably conservative formula that will make sure you (and they) don't get in trouble with the IRS for underwithholding. So, if they're taking out too much with this paycheck, you'll get it back when you file your taxes. Or, you can change your withholding yourself to account for this.

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"…it looks like you're making a whole lot more, so they're withholding a whole lot more based on a probably conservative formula that will make sure you (and they) don't get in trouble with the IRS for underwithholding." Can you provide evidence that this is why bonus paychecks are taxed higher? –  Christopher James Calo Dec 16 '12 at 20:23
    
I've seen it happen to my paychecks (the times I've gotten bonuses). –  mbhunter Dec 16 '12 at 20:31
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401(k) contributions are pre-tax dollars, but at the cost of locking the money up. So you wouldn't have to pay taxes on it, but the funds wouldn't be available either.

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With the added point that you are giving up a certain tax rate now, and taking on the risk of an uncertain tax rate on the monies at the time of withdraw from the 401(k). –  Jason Jan 29 '11 at 1:46
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