It’s that time of the year when employees start to receive their annual evaluations and employers start to pay out annual Christmas bonuses. Many people contemplate the payout options for their Christmas bonus and they often seek the advice of a financial advisor.
When clients ask me what they should do with their Christmas bonus my advice always depends on their individual budget, their average tax rate and their personal savings capacity. However, regardless of your personal financial situation the options are always the same. Canadians usually have 4 different options to choose from when you are deciding what to do with your bonus.
Option 1: Put your bonus into your RRSP. This is a very common bonus option for employees because it helps increase your personal savings (aka your net worth) and it may also give you an RRSP contribution receipt to declare as an income deduction on your annual income taxes.
Whether or not you receive an RRSP contribution receipt depends on how your employer chooses to pay out your bonus. If the bonus is paid to you as part of your salary and it is contributed into your RRSP with after-tax money (meaning you already paid tax on the lump sum bonus amount) you will receive an RRSP contribution receipt. However if your employer is contributing the money on your behalf with pre tax dollars you will not receive an RRSP contribution receipt to declare on your income taxes.
It is very important to inquire about the RRSP options for your bonus before making a decision on whether or not you wish to contribute your bonus into your RRSP.
Option 2: Take your bonus in cash. This is another very common option for employees who are receiving a Christmas bonus. Having a lump sum of cash deposited into your bank account just in time for the holidays can be very helpful for all of your seasonal expenses.
If you chose to take your bonus in cash keep in mind that you may have to pay a substantial percentage of the gross amount in taxes; this could leave you with a significantly less amount of your bonus money after taxes. However keep in mind that you may be able to recuperate a portion next year when you file your annual income taxes.
In Canada we have a progressive tax rate system. This means that Canadians do not pay the same percentage of tax on the first $10,000 of income earned at the beginning of the year as we pay on the last $10,000 of income earned at the end of the year.
You may be able to recuperate the difference between the tax rate paid on your bonus at the end of the year (i.e. your marginal tax rate which is the highest percentage paid on the last dollar of income you earned during the year) and your average tax rate. As an example if your bonus is $10,000 and you paid tax on it at a rate of 42% but your average tax rate is only 38% you should receive an income tax refund of $400 ($10,000 x 0.04).
Option 3: Chose a combination of the 2 options. If you want the best of both worlds you can chose to take a percentage of your bonus in cash and you can allocate a certain percentage of your bonus into your RRSP.
Option 4: Defer your bonus and take it in January. Depending on your personal income, your marginal tax rate and your average tax rate it may be beneficial for you to defer your bonus and take it in cash in the New Year. This of course is only beneficial if your marginal tax rate is substantially higher than your average tax rate.
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