Expecting a bonus? These moves cut the tax bill and put every dollar to work
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Expecting a bonus? These moves cut the tax bill and put every dollar to work
Yahia Barakah December 29, 2025 at 8:11 AM
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Expecting a bonus? These moves cut the tax bill and put every dollar to work (MoMo Productions via Getty Images)
Your holiday bonus is a reward for the work you've put in all year, and it deserves a plan that honors both your present and your future. You've earned this money, and the best approach lets you enjoy some of it now while making progress on your financial goals.
Yes, taxes will take their share before the money hits your account, but what remains is still yours to use wisely. The key is finding balance between today's happiness and tomorrow's security.
Here's how to maximize every dollar before and after your bonus arrives.
How much of your bonus do you actually get?
The first thing you'll notice when your bonus hits is that a chunk of it never arrives. Your employer withholds federal income tax, Social Security, and Medicare before the money reaches your account. They send this portion to the Internal Revenue Service (IRS) on your behalf, just like they do with every paycheck.
The difference is that bonuses count as supplemental income, which means they face different tax withholdings than your regular salary.
The flat-rate method
Most employers use this method because it's simple. They withhold a straight 22% for federal income tax, regardless of your salary or tax bracket. If your bonus exceeds $1 million, everything above that threshold gets a higher 37% withholding rate.
This approach treats everyone the same. A manager earning $60,000 and an executive earning $200,000 both see 22% withheld from their bonuses.
The aggregate method
Some employers combine your bonus with your regular pay, then calculate withholding based on what that combined amount looks like annually. This approach can push you into a higher bracket temporarily, meaning more withholding upfront.
Your employer adds your bonus to your regular paycheck, multiplies that total by the number of pay periods in a year, then withholds based on that annualized amount.
This method can be more accurate for very high or very low earners, but it often results in larger withholdings than the flat-rate method for middle-income workers.
What the math looks like
Regardless of the method your employer uses, you'll pay two more deductions on your bonus:
Social Security (6.2%). This applies only to earnings up to $176,100 for 2025.
Medicare (1.45%). This applies to all bonus income with no cap.
State income tax will also take a bite, but that amount depends on where you live.
Let's look at examples of both methods using a $10,000 bonus so you can see exactly how much lands in your account.
The flat-rate method
Gross bonus
$10,000
Federal tax withholding (22%)
-$2,200
Social Security (6.2%)
-$620
Medicare (1.45%)
-$145
Take-home (before state tax)
$7,035
The aggregate method
Regular paycheck
$3,000
Bonus
+$10,000
Combined total
$13,000
Annualized ($13,000 × 26 pay periods)
$338,000
Elevated federal tax withholding for one pay period (32%)
-$3,200
Social Security (6.2%)
-$620
Medicare (1.45%)
-$145
Bonus take-home (before state tax)
$6,035
Withholding doesn't equal what you actually owe
The withholding method your employer chooses affects your immediate take-home, but it doesn't determine what you ultimately owe in taxes. This is because the amount deducted from your bonus is set aside for your tax filing and isn’t your final tax bill.
When you file your taxes, your bonus will be added to all your other income from salary, bank account interest and other sources, and will be taxed based on your total income for the year.
Mortgage interest deductions, child tax credits, student loan interest deductions and other credits or deductions can lower what you actually owe. On the other side, interest from bank accounts, investment returns, profits from a business and other taxable earnings can push your tax bill higher.
If you're in the 12% tax bracket. Your bonus gets taxed at 12%, even though 22% was withheld, which means you may get a tax refund. Deductions and credits could increase this refund, while additional taxable earnings could reduce it.
If you're in the 24% tax bracket. Your bonus gets taxed at 24%. If 22% was withheld, you might owe a small amount, break even or get a refund, depending on your complete tax picture.
If you're in the 32% tax bracket. Your bonus gets taxed at 32%. If only 22% was withheld, you may owe taxes when you file, though substantial deductions or credits could lower that amount, while other taxable earnings could increase what you owe.
Learn more: Best tax software: 5 low-cost and premium options to maximize your return
How to keep more of your bonus in your pocket
You can dodge some of the tax bite by routing your bonus into tax-advantaged retirement accounts. The options available to you depend on your employer, so it's best to check with your HR department.
1. Traditional 401(k) deposits
You can ask your employer to send your bonus straight into your 401(k) instead of your bank account. Some benefits platforms let you automatically set aside a percentage of your bonus for your 401(k).
A $10,000 bonus deposited into your traditional 401(k) reduces your taxable income by $10,000 for the year. If you're in the 22% tax bracket, that's $2,200 in federal tax savings. The money grows tax-deferred until retirement, when you'll pay ordinary income tax on withdrawals.
The catch is that you'd lock that money away until age 59 1/2. Pull it out earlier and you'll face a 10% penalty on top of regular income tax. Some narrow exceptions exist, but they're limited.
Learn more: 401(k) withdrawal rules: What to know before cashing out — and how to avoid penalties
2. Traditional IRA contributions
You typically can't route your bonus directly into an IRA through your employer. Instead, you'll receive your bonus after withholdings, then you can transfer the amount you want to your IRA yourself.
The tax benefit comes when you file your return. Contributing to a traditional IRA reduces your taxable income for the year. If you're in the 22% bracket and contribute $5,000 of your bonus, you'll save $1,100 in federal taxes. The money grows tax-deferred and gets taxed as ordinary income when you withdraw it in retirement.
There’s still a catch here. If you have access to a workplace retirement plan, your ability to deduct traditional IRA contributions phases out once your income exceeds certain thresholds. High earners may not qualify for any deduction at all. You also face the same 59 1/2 age restriction as 401(k)s, with a 10% penalty plus income tax for early withdrawals.
3. HSA contributions
If you have a high-deductible health plan, you can funnel your bonus into a health savings account (HSA) after receiving it. Contributing $3,000 of your bonus in the 22% bracket saves you $660 in federal taxes.
HSAs offer three tax benefits:
Contributions reduce your taxable income
The money grows tax-free
Withdrawals for qualified medical expenses at any age are penalty- and tax-free
If you use the funds for non-medical expenses before 65, you'll face a 20% penalty plus income tax. After 65, non-medical withdrawals just get taxed as ordinary income.
3 smart ways to use your take-home bonus
Maxing out retirement accounts and HSAs protects your future, but your present self earned this money and deserves to enjoy some of it.
1. Pay yourself first
Start with the foundations that keep your finances stable when life throws curveballs your way.
Build up your emergency fund. Save a portion of your bonus in a high-yield savings account or money market account to build a cushion for emergencies. These accounts pay you interest well above that of traditional banks, enabling them to outpace inflation while keeping your money accessible.
Knock out high-interest debt. Credit cards charging 20% or more drain your money faster than almost any investment can grow it. Using your bonus to eliminate these balances gives you a guaranteed return equal to the interest rate you're paying. If you're juggling multiple cards, consider the debt snowball or debt avalanche methods to pay them off strategically.
Chip away at your mortgage, auto loan or student loans. Making extra principal payments on a loan reduces the total interest you'll pay over the loan's life. A $5,000 bonus applied to a 30-year mortgage at 6.5% could save you over $15,000 in interest, depending on your mortgage’s age.
Learn more: Should you pay off your mortgage early? 5 top factors to consider first
2. Live a little
Financial plans that prohibit all pleasure rarely survive in the long term. If every dollar goes toward debt or savings with nothing left for joy, you might abandon the plan entirely.
A bonus is your chance to move forward financially while also rewarding yourself for the effort that earned it. That's why you should set aside a part of your bonus for guilt-free spending. Building in intentional enjoyment now prevents wasteful spending later.
Give yourself something tangible to celebrate your hard work. Maybe it's an experience you've been putting off, an upgrade to something you use daily or treating the people who matter most to you. The key is making it deliberate rather than letting your bonus disappear into everyday expenses.
Learn more: How to create a simple budget with the 50/30/20 rule
3. Build wealth that lasts
Put money into long-term investments that move beyond emergency savings and grow your wealth over time. This includes Roth IRAs, brokerage accounts or 529 college savings plans if you have kids.
Investing in mutual funds or index funds that hold hundreds or thousands of companies gives you a stake in the stock market's long-term growth without trying to pick individual winners. Just remember that your investment value can fluctuate, meaning your balance may drop during rough patches and increase during more stable periods.
Learn more: How I started investing with just $100 — and why you shouldn't wait either
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Source: “AOL Money”
