By Joel Chouinard, ChFC®

December 2nd, 2024

Congratulations! You’ve navigated another year in the demanding world of big law. With that, your year-end bonus is now in sight, and you're probably already envisioning a well-deserved reward for all those late nights.

As a high-earning big law attorney, your year-end bonus represents a significant opportunity to build wealth, reduce debt, and secure your financial future. But you also work really hard to earn this money, so it’s completely normal to want to splurge on something. My goal with this blog post is to provide you with strategies to treat yourself and address your other financial goals. You heard that right—go ahead and plan that vacation or start shopping for that nice watch. Just make sure you’ve done these five strategies first.

 

1. Tax Strategies for Big Law Bonuses

 

With this big bonus, you will also receive a big tax bill. With proactive planning, you can minimize your tax burden.

Keep a portion of your bonus for taxes

First, make sure you save a portion of your bonus for taxes. If you’re an associate, your bonus will only be subject to a 22% withholding rate (unless it’s above $1M), but your actual tax liability might be higher depending on your tax bracket and filing status. For example, if you are married and file taxes jointly with a combined taxable income of $400,000, you will fall into the 32% tax bracket. This means an additional 10% of your bonus should have been withheld, but it wasn’t. I recommend adopting the following strategies, depending on when you receive your bonus:

• If you get your bonus before year-end, simply keep a portion of it in your savings account until you file your taxes in the first quarter of the following year.
• If you receive your bonus in the first quarter, you can either use it to pay your previous year’s tax liability (this is risky, given bonuses aren’t guaranteed), or increase your paycheck withholdings by updating your W4 form.

If you’re a partner, the taxes on your bonus will be due with your next quarterly estimated tax payment. Work with your tax professional to ensure you send enough money to the IRS and avoid underpayment penalties.

Minimize taxes through tax-loss harvesting

If you have investments in a taxable account, utilizing tax-loss harvesting could help you minimize your tax burden. In a nutshell, tax-loss harvesting is a strategy where you sell investments that have lost value to realize a capital loss. This capital loss can then be used to offset capital gains you may have realized from other investments or up to $3,000 of ordinary income.

Consider donating a portion of your bonus through a Donor-Advised Fund

A Donor-Advised Fund (DAF) is a charitable investment account that allows you to contribute money, get an immediate tax deduction, and then direct grants to your preferred charities over time. The money inside the DAF gets invested, grows tax-deferred, and can be donated tax-free to charities of your choice whenever you want. This allows you to significantly reduce your tax burden in the year you receive your bonus while fulfilling your charitable goals for many years.

 

2. Prioritize Debt: Student Loans and Beyond

 

If you have credit card debt, this should be your number one priority. Not only are you accruing high interest on that debt, but it’s also usually a big psychological stress. If you can’t pay off your entire credit card debt with your bonus, explore balance transfers to credit cards with 0% interest introductory offers. This allows you additional time to settle your debt without it escalating further.

If you have student loans, the decision to pay off a large chunk with your bonus is more nuanced than with credit card debt. It usually comes down to your personal preference and your attitude toward debt.  Most financial advisors will recommend investing your extra dollars instead of paying off your student loans because of the opportunity to earn a higher return in a diversified portfolio of stocks. Although that’s a valid point (especially if you have a low interest rate on your student loans), this strategy discounts the fact that student loans and other debts are a psychological burden.

If your goal is to be financially independent (i.e., flexibility in choosing where and when you want to work), having a mountain of student loans won’t help you. You should ask yourself, how does this debt feel? Does it keep me up at night? Is it preventing me from pursuing a different career? If that’s the case, you should prioritize your student loans with your bonus. If not, then investing your extra dollars is the way to go.

 

3. Build a Solid Emergency Fund

 

Unexpected events, like sudden job loss or unforeseen medical expenses, can derail even the most carefully crafted financial plan. Your emergency fund acts as a safety net to your financial plan, ensuring you don’t resort to high-interest debt or dip into your long-term investments during challenging times. Your goal should be accumulating 3-6 months' worth of essential living expenses in a readily accessible account. This should cover necessities like housing, food, childcare, and utilities. A high-yield savings account offers a secure and liquid option for storing your emergency fund, allowing it to grow while remaining readily available when needed. Consider using a portion of your bonus to replenish your emergency fund.

 

4. Invest Your Year-End Bonus

 

Once you've addressed your tax obligations, debt, and emergency fund, it's time to focus on building long-term wealth.

• Maximize your 401(k): For 2024, you can contribute up to $23,000 to your 401(k). Although most big law firms don’t offer a match, it’s still a great way to build wealth and save on taxes. If your employer allows, allocate a portion of your bonus directly to your 401(k) before it's paid out.
• Fund your Backdoor Roth IRA: Roth IRAs are a phenomenal tool for building wealth because, if utilized properly, all the growth in your account is tax-free. If you make too much money to contribute directly to a Roth IRA, consider using the Backdoor Roth IRA strategy. For 2024, you can contribute up to $7,000/year into your Roth IRA, and you have until your tax filing deadline or April 15^th (whichever comes first) to fund it.
• Invest in a taxable account: Once you’ve maximized your retirement accounts, the next best savings bucket will be a taxable account. Below are things to consider when investing in a taxable account:
  • Use Index ETFs: I recommend using Index ETFs to build your portfolio for three reasons: (1) they offer instant diversification, compared to a portfolio of hand-picked stocks; (2) they typically have much lower internal costs than mutual funds; and (3) they are super tax efficient because they don’t distribute capital gains and are less frequently traded than mutual funds.
  • Use municipal bonds for the safe portion of your portfolio: The income generated from corporate or Treasury bonds is considered taxable income at the federal level, even if you reinvest it in your portfolio. Municipal bond income, on the other hand, is received free of federal and potentially state taxes.
  • Regularly check your account for tax-loss harvesting opportunities: As I mentioned above, you can use tax-loss harvesting to offset your realized capital gains and $3,000 of your income.

 

5. Create a Travel Fund

 

In the introduction paragraph of this blog, I mentioned that I love helping my clients find ways to spend their hard-earned money. When you know all of the components of your financial plan are addressed, why not splurge on your next vacation? Imagine exploring the Amalfi Coast or finally taking that safari you've always dreamed of without worrying about your credit card bill. A dedicated travel fund can turn those aspirations into reality without the guilt!

Below are three easy steps to create your travel fund:

1. Estimate your travel costs for the year: Are you planning a lavish trip overseas or a camping trip a few hours away from your home? Take some time to map out your travel plans for the year and add up all the estimated costs (airfares, rental car, hotels, shopping, pet sitter, restaurants, etc.).
2. Open a separate savings account labeled Travel Fund: This is key to properly utilizing your travel fund. If your travel money is mixed in with your checking or savings account, it will be easy to spend it on other things. Once you have your travel budget for the year, take a portion of your bonus and transfer it to your new travel fund.
3. Reimburse yourself from your travel fund as you incur travel expenses: As you incur travel expenses throughout the year, reimburse yourself by transferring money from your travel fund to your checking account. This allows you to continue taking advantage of credit card points while smoothing out your cash flow.

 

Final Note

 

Your year-end bonus is more than just a reward for the countless hours you spent in the office—it's a tool that can empower you to achieve your financial goals. By taking a strategic approach to taxes, debt management, and investing, you can build a solid foundation for your future while still feeling good about splurging. Remember, financial planning isn't about deprivation. It's about making informed choices that align with your values and aspirations.

SharpEdge Financial LLC is a registered investment adviser registered with the State of Texas. Registration does not imply a certain level of skill or training. The views and opinions expressed are as of the date of publication and are subject to change. The content of this publication is for informational or educational purposes only. This content is not intended as individualized investment advice, or as tax, accounting, or legal advice. Although we gather information from sources that we deem to be reliable, we cannot guarantee the accuracy, timeliness, or completeness of any information prepared by any unaffiliated third-party. When specific investments or types of investments are mentioned, such mention is not intended to be a recommendation or endorsement to buy or sell the specific investment. The author of this publication may hold positions in investments or types of investments mentioned. This information should not be relied upon as the sole factor in an investment-making decision. Readers are encouraged to consult with professional financial, accounting, tax, or legal advisers to address their specific needs and circumstances.