Which would you choose: An annual bonus or a salary increment?

We know a lot of people are going to be sceptical or critical of the fact that anyone will ever be put in a situation where they have these two options. We agree.

What we're trying to achieve in this article is getting everyone to think about which will deliver the more beneficial outcome in certain scenarios, and to understand how our choice between the two could have implications on our mindset, finances and career.

THE HYPOTHETICAL SITUATION

You're having your annual review with your supervisor, discussing your performance during the year. Things are going positively - you've accomplished most of what was expected of you, and your supervisor thinks you can be pushed to achieve more. Basically, your supervisor sees value in your work and wants you to stay.

You're presented this option: "Would you prefer a year-end bonus or a salary increment next year?"

WHAT YOU SHOULD BE THINKING ABOUT

At the heart of this question, is whether you prefer to take a lump sum or upfront bonus or whether you prefer to get a higher amount each month.

# 1 HOW LONG YOU ARE GOING TO REMAIN IN YOUR JOB

The first thing we should consider is whether we intend to stay in our job for a long time or if we are planning to leave soon.

In most situations, if we plan to leave our jobs soon, we would be better off taking the bonus. This is mainly because if we choose to take the salary increment, it would typically be a small percentage of our existing salary and only last for a few months.

The bonus on the other hand is already in our pockets, and we can simply leave our job whenever we want after that.

# 2 IN WHICH SITUATION YOU WILL BE FINANCIALLY BETTER OFF?

In general, each month of bonus we get is worth 8.3 per cent in terms of monthly salary increments. So, if we have no intention of leaving the job, we should try to beat this hurdle rate when opting for a pay raise.

For example, if we are offered a 20 per cent monthly salary increment or 2-month bonus, we would be better off with the salary increment. The 2-month bonus would only translate into a 16.7 per cent monthly salary increase. If we have to choose between a 30 per cent monthly salary increment or a 6-month bonus, the bonus, giving up to 50 per cent increment on a monthly basis, would usually be the better option.

This argument disregards any investment returns, which we will get into in a subsequent point below.

# 3 INDIVIDUAL SCENARIOS

If we are planning to buy a home, have upcoming big-ticket payments for our home renovation, have a large outstanding credit card bill, or want to go on a European vacation, the bonus option becomes much more attractive than getting a higher salary each month.

If our aspiration is to climb up the ladder within the company, gunning for promotions, which usually come with the salary increment, should be the main priority.

# 4 ARE YOU ABLE TO MAKE SAVVY INVESTMENT DECISIONS?

Recapping the example above, where we should choose the 20 per cent monthly salary increment over the 2-month bonus (which only adds up to a 16.7 per cent in monthly salary increment), the choice may not be so straightforward if we are able to achieve a good rate of return on an investment.

If we are able to achieve an investment return of 10 per cent in the year, taking the bonus may become more attractive. Our 2-month bonus (or a 16.7 per cent increase in monthly salary) now delivers 26.6 per cent, beating the 20 per cent monthly salary increment in the example.

Of course, we could also invest our salary increments and achieve a decent return in the year. However, a lump sum allows us to make a larger upfront investment.

# 5 LOSING OUT IN EMPLOYER CPF CONTRIBUTION

Given this choice, we should also note how our employer (and employee) CPF contribution rates will be impacted. There are two main things we need know about our CPF contributions in Singapore.

Firstly, we have a monthly salary cap of $6,000 on our CPF contribution rates. This means anything above the first $6,000 will not require CPF Contributions.

If you think this sounds complicated, fret not, it isn't. Consider the following scenarios:

Employees who earn $6,000 and below will have to contribute 20 per cent of their monthly salaries into their CPF accounts. Their employers will have to contribute an additional 17 per cent into their CPF Account.

Anything above the $6,000-mark will not require either employee or employer CPF contributions. This means if we earn $4,500, and get a 20 per cent salary increment to $5,400, nothing changes in terms of CPF contributions.

If we are earning $5,500 and receive a 20 per cent salary increment to $6,600, we will not be enjoying a 20 per cent increase on our employer CPF contributions, and we won't need to pay the full employee CPF contribution either. In the table, the employer CPF contributions is increased to $1,020 from $935, translating to a 9.1 per cent increment only.

If we are earning $6,500 before our 20 per cent increment, we can see that our employer CPF contributions do not increase at all.

One other thing we should note is that instead of only receiving 80 per cent of our salaries in take-home pay, we will get more. Of course, this is because we also don't have to make an employee CPF contribution on anything above the first $6,000 of our salary.

Secondly, this will not be the case if we choose to receive a 2-month annual bonus. This is because our CPF Annual Limit is $37,740. Even if we earn $6,000 a month, and make the required employee and employer CPF contributions, we will only contribute $26,640 to our CPF accounts, leaving a remaining $11,100, that we must continue making CPF contributions on from our bonus payments in the year.

This is what happens in the same scenario as above, for a person earning $4,500, $5,500 and $6,500.

In this scenario, we can see that regard we will get a full CPF contributions for the salary levels stated in the examples. In many instances, this beats the increase in CPF contributions that we get when opting for a 20 per cent increase in salary.

These are just examples, and we need to crunch the numbers on our own to decide the best outcome for ourselves.

# 6 PAYING TAXES

The last consideration is that we have to pay taxes on our salaries. If we get a salary increment, we have the time to consider the tax implications in the following year, and will have sufficient time to procrastinate or put in place plans to reduce our taxes.

If we receive an annual bonus, especially if it is given after our yearly review and in the month of December, there may not be sufficient time to reduce our taxes during the year.

KNOWING THE IMPLICATIONS OF OUR PREFERENCE

Preferring a lump sum bonus could mean that we want to leave our jobs as soon as we can find a replacement OR it could also mean we will be better off receiving our employer CPF contributions share.

On the other hand, opting to go with a salary increment could just be that we want to be financially better off OR it could mean that we see ourselves growing at the company and rising up to take on senior-level responsibilities.

At the end of the day, we need to know why we have a certain preference, the implications of our preferences, as well as how our preferences may actually impact our career choices.

This article was first published in Dollars and Sense.