Thursday, October 29, 2009

Bonus v Raise

Mighty Bargain Hunter picked up on the MSN article about the difference between not receiving a COLA this year and being paid a US$250 one off payment resulting in pensioners receiving US$10,000 less in total benefits due to the future compounding effect of the COLA in future years. While this is obviously bad news for pensioners, it is good news for taxpayers.

MBH also made the comment that, if faced with a choice between a raise and a bonus employees should always take the raise because the effect of the raise will (a) replicate itself each year and (b) will compound future the effect of future pay increases.

I'm not sure if the decision is that straight forward. While the maths may make it look like the pay increase is the better option (for the reasons given above), the decision is not that simple:

(i) the effect of returns on investing the bonus received today need to be taken into account;

(ii) tax bracket creep may start to affect numbers - as income rises you may get pushed into higher tax brackets in the future (or tax rates may go up or down);

(iii) you need to consider how long you will be working for that employer - if retirement is near there may not be much, if any, compounding;

(iv) it is not a given that future salary increases will be the same in percentage terms. Often, employees whose salaries lag their peers get larger percentage increases than equivalent workers on higher salaries - in effect the gap will often close substantially reducing the calculated benefits of taking the salary increase (alternatively, an underpaid worker may be able to change jobs);

(v) more expensive workers may be more vulnerable to being laid off if cost cutting becomes necessary;

(vi) a bonus is more likely to be invested than an increase in income (at least in my case).

Unless the numbers were very one sided, I would most likely prefer the bonus now than the possibility of enhanced future earnings.

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