What to do with a retention bonus

What to do with a retention bonus

We’ve been having a lot of turnover at my day job recently, and it’s gotten to the point where management decided to step in and make a change. The change that they opted for was in the form of monetary compensation (yay!) but more specifically in the form of a retention bonus (yay?). Seeing how many of my coworkers (including myself) had questions about retention bonuses, I figured it’d be a good time to discuss and explain how a retention bonus works. The bottom line is that a retention bonus is nice, but with several strings attached.

What is a retention bonus and why would management use it?

Simply put, a retention bonus is a bonus that is paid as a lump sum up front that your earn throughout a defined period of time (often a year). If you leave or are no longer employed by the company you’re at before the time period is up, the bonus will be prorated, and you’ll be required to pay the remainder back to the company. Paying it back may or may not require you to actually write a check to your company, as your pay period is often a week behind (meaning you’ll get one final paycheck) and you may have some PTO leftover.Screen Shot 2015-09-13 at 6.20.30 PM

Retention bonuses are used because they are a cheaper manner of getting employees to stay as opposed to a flat out cash bonus or a pay raise. Employers are able to financially entice employees to stay at a much cheaper cost to them. Employers use it because they may or may not have to pay out the full amount, as inevitably some people will leave before the time frame is up. Why I think retention bonuses are so successful (from an employer’s standpoint) is because people are loss averse. By paying it all up front and requiring you to physically pay it back if you leave early, employees feel as if they are losing money in such a deal, and people don’t like to lose. People are likely to stay to avoid realizing such a loss. Also, not all of us are super great budgeters, and may feel that we can’t leave because we’ve spent the money already!

How do the numbers play out?

Just like with a bonus, you’ll automatically be taxed at a higher rate. The IRS requires this for all supplemental income (aka bonus, including retention) as somewhat of a precaution on their end to ensure you have enough withhold to settle up at year and partially as a safety net for you to ensure you aren’t stuck with a huge bill. In their eyes, it looks like you’ve bumped up in pay and therefore more taxes should be taken out. Plain and simple it sucks. Thankfully, when it comes time to file your taxes, you’ll get the additional you paid back as a tax credit, as you’ve essentially paid extra. Also, retirement (if you’re enrolled in your company’s 401(k) plan) will be taken out at the normal rate you’ve selected. Let’s run some hypothetical numbers here, roughly modeled as what happened to me on my retention bonus.

Retention Bonus: $10,000

Taxes: $4,000

Retirement (10% contribution): $1,000

Take home: $5,000

So, on day one of the retention bonus, you’ve essentially had half of it taken out for retirement and taxes, leaving you with $5,000. That bad news is that if you left a week later, you’d essentially owe back $10,000. Yup, that’s right, you’d owe back the full prorated (51 weeks) of the bonus. Sad part is you don’t have that cash as the government and your retirement fund have part of it, and they aren’t able to give it back just like that. You’ll be forced to pay out of pocket the full-prorated amount. That being said, you’d get back most of the taxes you paid as you didn’t earn the $10K. So come next April (or when you file your taxes next year), you’d get the bulk of that $4K back. It’d still be awfully pain though to pay all that our of pocket.irs

If I were you, I’d keep a running tally and know how much you earn of it per day. A $10K retention bonus would be earned approximately $27 per day or $833 each month. The longer you stay, the less you’ll have to potentially pay out of pocket. Although it shouldn’t make you stay at a job you hate and to turn down a better job, being cognizant of how much you’ve earned and how much you’ll have to pay should be in the back of your mind.

What should I do with it?

What you should do with your retention bonus will really depend on how long you expect to stay at your current job. If you’re like my wife who is a teacher, there’s a pretty good chance (>90%) that she’ll finish out the year with her school. With that in mind, it’s probably safe for her to go ahead and either save or spend that money. For a lot of young professionals though, staying the year out might not be such a sure thing. The economy is doing well and lots of us are changing jobs. What I, being YMF, did with my money was put it all (the 50% I got to after tax/retirement) cash into a savings account (a high yield one!). I’m definitely risk averse and don’t want to mess up other savings accounts to cover if I choose to leave early. I know how much I’ll earn and as time goes on, I’ll slowly start pulling it out and either saving or spending it. I think a safe bet for most of us would be to definitely save a large chunk of it (say 75%) and then spend the rest. That way if something comes up and you do leave, you’ll have a safety net in place to cover what you owe. Your final paycheck and PTO balance could probably help cover what you owe as well, but it never hurts to be safe!

Curious to learn more about what to do with your extra $$$? Check out my article on “What to do with an extra $2K laying around“.

One Response

  1. Our first move with any bonus is to max out our retirement accounts, and then most of the remaining, if any, goes into cash savings for me to invest. Occasionally there’s a big purchase, but that’s not a regular thing and we don’t rely on the bonus, ever, as it’s not a guarantee. I think the same philosophy for retention bonuses works unless you know you’re not going to be there for the full period that it was intended to cover.

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