Should 401k Be Deducted From a Bonus Check?

A common question among employees receiving a bonus is whether a portion of this additional income can be directed into their 401(k) retirement account. This inquiry often stems from a desire to maximize retirement savings or to manage the tax implications associated with bonus payments. The ability to contribute bonus funds to a 401(k) is generally permissible, but it depends on the employer’s specific 401(k) plan rules and payroll systems. Understanding the process and financial implications of such contributions helps optimize financial planning.

Electing to Contribute Bonus Funds to Your 401(k)

Employees generally initiate the process of contributing bonus funds to their 401(k) by communicating their intent to their employer’s human resources or payroll department. This election is often made through the 401(k) plan’s online portal or via specific forms provided by the administrator.

Most types of bonuses, such as annual performance bonuses, sign-on bonuses, or retention bonuses, are eligible for 401(k) contributions. Employees elect to contribute a percentage of their bonus or a specific dollar amount. It is important for employees to confirm with their employer whether their particular bonus type qualifies for such deferrals.

The timing of this election is important; employees often need to make their contribution decision well in advance of the bonus payout date. Some employers may require changes to contribution rates to be submitted several days or even a week before a special payroll run to ensure proper processing. This advance notice allows the payroll system to accurately apply the elected deduction to the bonus check.

How Bonus 401(k) Deductions are Processed

Once an employee elects to contribute a portion of their bonus to their 401(k), the employer’s payroll department or the 401(k) plan administrator handles the deduction. Bonuses are considered supplemental wages by the Internal Revenue Service (IRS), and employers have specific methods for withholding taxes from them. Regardless of the tax withholding method used, the 401(k) deduction occurs before the net bonus amount is paid to the employee.

The payroll system identifies the bonus payment and applies the employee’s elected contribution rate or amount. For instance, if an employee has a standing 401(k) deferral rate, that rate may automatically apply to bonus payments unless the employee specifically adjusts it. The withheld funds are then directly transmitted by the employer to the designated 401(k) plan provider. This ensures the money is invested according to the employee’s chosen allocation within the retirement account.

If an employee’s regular 401(k) contributions already put them close to the annual IRS contribution limit, a significant bonus contribution could cause them to reach that limit earlier in the year. If this occurs, future regular payroll deductions for 401(k)s may cease for the remainder of the year. Employees should monitor their contributions to ensure they do not miss out on potential employer matching contributions later in the year if their plan stops matching once the employee’s contribution limit is met.

Implications for Annual Contribution Limits and Tax Withholding

Contributing bonus funds to a 401(k) has implications for annual contribution limits and tax withholding. All employee contributions, including those from bonuses and regular pay, count towards the annual IRS employee deferral limit for 401(k) plans. For 2025, the limits are:

The standard employee deferral limit is $23,500.
Individuals aged 50 and older can contribute an additional catch-up amount of $7,500, bringing their total deferral limit to $31,000.
Those aged 60-63 can make an enhanced catch-up contribution of $11,250, increasing their total to $34,750.
The overall 401(k) limit, including both employee and employer contributions, is $70,000. This can increase to $77,500 (or $81,250 for those aged 60-63) with catch-up contributions.

Pre-tax 401(k) contributions, whether from regular wages or a bonus, reduce an employee’s taxable income for the year. This means that the portion of the bonus contributed to a pre-tax 401(k) is not subject to immediate federal income tax withholding. For example, if a bonus is $5,000 and an employee directs $2,000 of it to their pre-tax 401(k), their taxable income from the bonus is reduced to $3,000, leading to lower immediate tax withholding on the bonus check.

Bonuses are subject to federal income tax withholding, often at a flat 22% rate for amounts under $1 million, or through an aggregate method where the bonus is combined with regular pay for withholding calculation. By contributing a portion of the bonus to a pre-tax 401(k), the amount subject to this withholding is reduced. The taxes on these deferred funds and any investment earnings grow tax-deferred until withdrawal in retirement, at which point they become taxable income. This tax deferral can be a benefit, allowing more of the bonus to be invested and grow over time.