After a seemingly endless year of work, it’s finally that time of the year: getting rewarded with a well-deserved bonus! Though exciting, it’s also a challenge. Many of us spend so much energy working toward that bonus that we forget to spend any time thinking about what we’ll do with it when it arrives.
When it comes to bonuses, it’s important to think ahead. I have several clients who credit their strong financial position with the plans we created around their year-end bonuses. They proactively created a strategy around what they would do before they received them and that has set them up for tremendous success.
Creating a plan for what to do with your end-of-year bonus should be largely driven by your own personal financial plan and goals, but let’s start by looking at some of the things that you could do with the extra cash influx.
Pay Off Debt
One of the main financial pain-points that keeps people from accomplishing their financial goals is their debt. It’s hard to get ahead if too much of your take-home income goes toward paying down debt each month.
If you have debt, see what interest rate you’re paying on it and consider using your bonus to prioritize paying off high-interest debt. For example, if you have unpaid credit card balances, chances are you’re paying interest rates in the high-teens or even twenties. If that’s the case, it may be best to cut-back or stop any investing or excess spending until that is fully paid off.
It makes less sense to invest in something that could potentially grow by 6%, 8%, or even 10% per year when you’re paying the bank 18% on your credit balances. The higher the interest on your debt, the more you should prioritize paying it down before tackling other financial goals.
Even if your debt doesn’t have a high interest rate, it can make sense to pay it off. If debt feels like a weight on your shoulders, consider paying it off to free up your cash flow for other purposes. Be sure to consider other options first and any potential opportunity costs, but generally, paying down debt is a smart move.
As we go into a new year, how nice would it feel to begin debt-free?
Save for Retirement
It can be hard to find the extra cash flow needed to adequately save to your retirement goals. Bonuses are great one-time opportunities to supplement any existing retirement contributions.
I often help clients calculate how much they need to invest each year in order to reach the point of financial freedom. Sometimes that number is hard to reach if you are only investing from your regular cash flow, but a bonus can go a long way in supplementing that.
Let’s say you need to invest $18,000/year to reach your retirement goal, but you’re only able to save $1,000/month, or $12,000/year. Taking the remaining $6,000 needed to hit your goal from your year-end bonus will help you stay on track with your retirement goal.
Doing so may also help you save money on taxes. Keep in mind that your bonus is fully taxable. In the same way you pay federal, state, and payroll taxes on your regular salary, you can expect those same taxes to come out of your bonus. Getting a $10,000 bonus? After taxes are withheld, you may end up receiving closer to $6,000 or $7,000 depending on your tax bracket.
By allocating part of it into your 401k or IRA you could be saving yourself a good chunk of money in taxes, especially for higher earners who have their bonuses taxed at a higher rate. Investing in retirement accounts creates the dual benefit of saving money on taxes while also helping you to prepare for the future.
Save for a Large Purchase
Retirement isn’t the only big life event you want to save for. There are plenty of other things that require consistent savings to accomplish.
Maybe you’re saving for a home, for your children’s college, or to take a sabbatical. As exciting as they are to consider, they’ll all require intentionality with your saving habits. Consider using your bonus to jump start your progress toward reaching these goals.
Maybe you’re saving $2,000 per month for the next 4 years to buy a home. If you receive a bonus of $10,000 and apply it to your home savings fund, then that cuts five months off your original timeline.
Take a look at the things you’re saving for… your bonus could help to get you there even faster!
Or at least part of it. Financial planning is about balancing future goals with current goals.
There are many times when it makes sense to mindfully spend part of your year-end bonus. The key word here is mindfully. Buy something or an experience that will bring you joy, as opposed to something that will collect dust in a couple of months.
That could be a vacation for your family, a gift for a friend or loved one, or the toy that’s been sitting in your wishlist for ages. This is especially the case when you’ve done a good job with your finances and you’ve already paid off debts, saved for retirement, or saved for other goals.
Be sure to be thoughtful. If you choose to save your money now, you can always spend it later. However, if you spend it now, there’s no going back and saving that money at a later date. Your spending decisions should always feel like they fit into your overall financial plan.
Time to Celebrate!
Your unique financial situation and goals dictate the best way to use your bonus.
Whether you save it, spend it, or pay off debt, keep your financial plan in mind. The above options are examples of things I encourage my clients to do depending on where they are in their financial journey.
Your financial plan is a reflection of what’s most important to you. Celebrate your well-deserved bonus by putting it towards your goals. Act proactively by taking the time to think of what you’ll do with the money before you actually receive it.
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Real financial planning should pay off today, and in 10 years' time.