Congratulations! Your employer just announced that you will be receiving a bonus at the end of the year. Your first thought is to begin mentally packing a suitcase for that dream trip to an exotic beachfront resort.
Although you may not want to hear it, don't book that flight quite yet.
According to a recent annual compensation study from human resources and management consultant Aon Hewitt, U.S. organizations reported the highest level of compensation spending in 39 years. However, that jump was owed mainly to "the majority of funds allocated to variable pay, such as incentives, bonuses and cash awards."
In other words, at some employers, as small as they have been on average in recent years, bonuses might be replacing traditional raises, according to Mercer.
Variable pay is a big movement at U.S. companies and it's spreading to all levels of the workforce, not only to the typical high earners in fields such as investments or finance. Aon Hewitt said that 90 percent of companies are shifting to some form of incentive model for a very important reason - a focus on traditional, annual raises simply makes long-term employees more expensive over time.
So to heck with that bonus check, right? Wrong. You've been given a good opportunity to think about your job, your annual earnings and the financial decisions you're making and might need to make in the future. Here are ways to proceed.
Make sure you understand whether this is a one-time award or whether your employer is really shifting to a variable pay system. This is not only a money question, but also an important career question. If you are going to be evaluated under new benchmarks and measurements for work you've done every day, you should fully understand these new guidelines and how you can maximize them in your best interest. Keep in mind that companies approach variable pay in different ways. Some may keep a system that preserves basic raises but steers more compensation toward bonuses and other incentives based on performance. Others might build overall division or company profits into the compensation calculation.
When clarifying any questions you have about your bonus, be diplomatic. If you have questions about a one-time bonus or a bonus that is part of a new compensation system, go to a designated human resource representative or manager directly. If there is explanatory material, study it, plan any questions in advance and be polite when asking questions face-to-face. Take notes to remember what was said.
Get qualified advice. A one-time bonus or a long-term change in the way you're compensated is an important financial event. Consider speaking with a qualified financial planner or tax expert about any bonus news you receive and see if they have questions or guidance relevant to your individual financial situation. Keep in mind that the Internal Revenue Service generally considers bonuses as supplemental wages that can be taxed at a higher rate than regular weekly wages. Check IRS Publication 15 for more detail or speak with a qualified expert for more guidance.
Be practical, but don't forget the fun. Consider treating your bonus like your paycheck - evaluate how to pay expenses and put aside savings first and then figure out what you can spend for fun. Maybe diverting more of your bonus to essentials this year will give you more money for fun next year. However, do find a way to enjoy at least a part of your bonus -- after all, you earned the money.
On the subject of earned income, never forget how important your basic wage level is to your lifetime benefits and preparation for retirement. If you earn a nice bonus each year but your actual salary level doesn't rise significantly over time, that's important for a number of reasons. For one, your salary level - not extra money you get from bonuses or other incentives - provides the basis for calculating the employer and government benefits you'll receive in retirement. Also, lenders look closest at your actual wages when deciding whether to grant you a mortgage or other credit. In other words, you might want to consider saving or investing that bonus instead of spending it.
Finally, if you can't accept change, be ready to make one. Companies like performance-based pay systems for another important reason - they can help weed out individuals who might be poor performers. As more employers adopt variable pay and performance grading systems organization-wide, you should consider important issues beyond the money. For example, if you are doing work you love, will meeting new performance targets change how you feel about your job? Are you ready to take on the challenges of a workplace where you're graded and evaluated in a different way than you're used to? In some environments, new employee compensation methods can be liberating and financially rewarding; in others, it can make it tougher to stay. Certainly keep an eye on all pay, tax and financial planning issues as you accept or compete for bonuses, but above all, make sure you're happy with your career. If not, consider looking for a better opportunity.
Bottom line: A bonus is always great news, right? In most cases, definitely. However, any workplace awards or incentives you receive can have a long-term impact on your finances. Getting qualified investment or tax advice on bonuses can be helpful.
Nathaniel Sillin directs Visa's financial education programs. To follow Practical Money Skills on Twitter: www.twitter.com/PracticalMoney