Despite a steadily improving economy, historically low unemployment and record corporate profits, bonuses for year ending 2017 are expected to be rather unimpressive.
A nationwide survey of human resource professionals by job placement firm Challenger, Gray & Christmas, showed that just 39% of companies plan on implementing either a companywide or performance-based bonus for 2017, down from 41% last year.1 The respondents also revealed that 35% won’t be paying any bonus at all for 2017.2
Still, there are some industries, including finance, that are bucking that nationwide trend. Wall Street compensation is expected to be quite strong, depending on what department you’re in.
Where the 2017 Bonuses are Strong
With financial markets continuing to post strong returns, it’s no surprise that Wall Street is expected to have a good bonus season in 2017. New York City bonuses are predicted to rise 3.8% year over 2016 bonuses, according to the State Comptroller.3 That would equate to an average bonus of $143,462.4 Yes, that’s just the bonus. Keep in mind this is an average, not a median, so it is likely skewed upwards by some mega-incomes.
Here’s a look at a few specific areas to see how their 2017 bonuses are stacking up to last year.
The underwriting division of banks is expected to see the largest increases in bonuses, a whopping 15% increase over last year according to consulting firm Johnson & Associates.5
Underwriting is simply industry jargon meaning raising capital for an institutional client, typically a publicly traded company. Finance professionals in these groups structure debt and equity offerings for their clients. They pitch the customers on their need for financing, then determine the best way to raise capital, debt or equity, determining the lowest cost of capital and gauging other considerations.
In equity offerings, underwriters arrange a sale of the company’s common stock. They make the necessary contacts, pitch their financing idea, arrange a nationwide roadshow and rally the sales teams to find buyers to fill the order book.
If the company is already public, subsequent equity offerings are called secondaries. Historically, banks enjoyed underwriting fees equal to roughly 7% of the deal size but those rates have come down to around 5%. Depending on the size of the deal, it can get even lower due to scale.
With interest rates still near all-time lows and an insatiable demand for yield from investors, companies are finding it very easy to raise money through debt offerings (bond sales). Debt issuance often provides the lowest cost of capital, since the debt’s interest expenses is tax deductible.
In fact, U.S. corporate debt issuance is on pace for a record year, according to S&P Dow Jones Indices.6
But the appetite for consumer debt is also strong. When credit is loose, individuals are more inclined to purchase homes, automobiles and recreational vehicles on credit. Lending in the auto industry for 2017 has been through the roof and is surely a contributing factor in the outsized bonuses.
Loan originators working for commercial banks have been very active in underwriting loans which then get packaged and sold to institutional investors. Wells Fargo is one of the biggest names in this space.
As long as interest rates stay low, it places a premium on any securities with above average yields and should allow the underwriting groups to see a profitable 2018.
Actively managed alternative investments, such as hedge funds, have posted nice returns, reportedly up 7.2% for 2017 (through October 31st).7 While this trails the broader market averages, it is their industry’s best performance since 2013.
While fees are down from the classic ‘2 and 20’ days (2% of total assets and 20% of profits above a high-water mark) they are still hefty. Bonuses appear to be on the rise.
According to Wall Street Oasis, a site dedicated to all things investment banking, the typical hedge fund bonus for 2017 (analyst level through third-year associate) ranged from $54,000-$102,000.8 All full-time employees reported a median bonus of $92,000.9 This does not include summer interns who reportedly averaged $78,000 in total compensation for the summer.10 Higher-end professionals such as vice presidents and managing directors report well over $200,000 in bonus alone.11
Interestingly, these bonuses could be actually paid out in 2017. Typically, hedge funds distribute bonuses to employees in the first quarter of the following year. But since nearly two-thirds of hedge funds are located in New York and Connecticut (two of the highest taxed states) there is a rush to pay the bonuses out in 2017 while the SALT deduction (state and local taxes) is still around. There is a real possibility of these deductions going away next year when the Trump tax plan is finalized.
Of course this also leads to a dilemma. Since hedge fund professionals received their 2016 bonuses in calendar 2017 (probably February), an accelerated bonus payout for 2017’s bonus would cause a doubling up of bonuses in one year. This might cause the professional to bump into a higher tax bracket. The key might be how the bonus is structured and how the compensation is counted for tax purposes (see tax section below).
Where the 2017 Bonuses are Not
Trading is expected to see some of the lowest bonuses in finance in 2017. According to data compiled by Quartz Media, every major Wall Street bank (Morgan Stanley, Bank of America, Goldman Sachs, Citigroup and JP Morgan) have all experienced a decrease in profits in 2017 from 2016 levels.12 As a whole, professional traders at large banks have been experiencing headwinds for years now. Increasing regulation, automation and low volatility have all contributed to decreased trading profits for banks.
The result is that bonuses are expected to be barely increased or even down year over year. Equity market traders are the only subsector of banking that is projected to experience a year over year bonus decline, albeit a modest -0.25%.13
Fixed Income Trading
Given the absence of volatility in financial markets over the last couple of years. Fixed income traders fared slightly better than their stock market counterparts and are expected to see bonus increase of 2.5% year over year.14 Trading efficiencies are lower in the mostly OTC bond market, which means better returns for fixed income market makers than their equity counterparts.
Despite the global market capitalization approaching $100 trillion for the first time ever, we were surprised to learn that asset management bonuses for 2017 were coming in bland. The increase in assets is being offset by the continued reduction in fees.
With a stock market that has essentially gone straight up for two years, there is insatiable demand for passively managed funds, designed to replicate market indexes. Unfortunately for the managers, the fees on these funds (known as the expense ratio) are extremely low, ranging from 0.09% charged by Vanguard for their S&P 500 ETF, SPY, to just 3 basis points for Schwab’s S&P index mutual fund! Minuscule fees indicate that even with tremendous assets under management, the profitability is waning.
Other asset managers such as Blackrock and State Street are also major players in passive investing strategies and products. The real winners of this trend are the customers.
How are Bonuses Taxed?
According to Intuit’s TurboTax, bonuses are typically considered “supplemental wages” by the Internal Revenue Service.15 They are subject to withholding by your employer by one of two methods, 1- the percentage method or 2- the aggregate method.16
The percentage method uses a flat 25% tax rate for the bonus. The bonus amount is singled out from your normal income bracket and taxed directly. It is a more popular method for many employees due to simplicity as well as usually paying a lower rate on the award (depending on your tax bracket).
The less-common aggregate method lumps the bonus into your paycheck (regular wages) and taxes the amount as ordinary income. Unfortunately, this rate typically results in you paying more taxes on the bonus. Fortunately, the aggregate method is used less than the percentage method.
If you are lucky enough to have a bonus of over $1 million, your employer will withhold 39.6% of the amount above $1 million for taxes.17
Stock, or equity, is another type of bonus given by employers. This aligns the company’s overall performance with compensation and keeps employees more focused on longer-term goals. It can also help retain or attract top talent if a company is performing particularly well.
Stock bonuses are usually ‘restricted’, meaning there’s a waiting period until an employee can sell them. Once this ‘vesting’ period has elapsed, they may be sold. The day they are eligible for sale becomes your cost basis, just as if you bought them through your broker.18
When you decide to sell them you will pay tax on any gains (assuming the value has increased) in one of two ways. If you held the shares for less than one year once they’ve vested, you will pay your ordinary income rate on the gain. If the gain comes one year or later, it is considered a ‘long-term capital gain’ rate which is 15% for most investors.19
Keep in mind, this article is intended for informational purposes only and is not intended to be financial advice. Tax strategies are highly individual, so always check with a qualified accounting professional for tax advice (preferably someone with a CPA or MAcc).