If you were lucky enough to receive a year-end bonus, way to go! It can feel great to get a pat on the back that takes the form of a deposit into your account. An extra deposit begs the question of what to do with the bonus money. You may already be fantasizing about all the fabulous things you could buy with that money. But you might also consider using a year-end bonus to help you get closer to your financial goals.
Smart bonus money moves include paying down debt, funding a short-term savings goal (such as a down payment on a home or setting up an emergency fund), as well as investing the money for long-term growth.
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There’s no one formula for spending (or not spending) a bonus since everyone’s financial situation and future goals are unique. Here are some ideas for using that year-end check—or any sudden infusion of cash—that can help improve your financial well-being both now and down the line.
Related: What is a safe investment?
Allocating some money to fun
You worked hard all year, so it’s understandable if you want to put some of your bonus money toward a few wants and not just needs. As with any financial decision, it doesn’t have to be all or nothing. Taking a balanced approach to your money might help you maintain the stamina that financial goals often require.
Although the exact split is ultimately up to you, to avoid overspending, you might want to consider putting roughly 90% of your bonus towards your financial goals, and devoting about 10% to “fun money.” If you’re getting a $5,000 bonus (after taxes), for example, that means you would have $500 to spend treating yourself. The other $4,500 would then go towards putting a big dent in your money goals.
Chipping away at debt
If you have debt—whether from a student loan, car loan or credit card debt—a bonus can be a great way to start whittling away at whatever balance you have to contend with, or even wiping it out completely. Doing this can help you avoid throwing more money away just on interest charges, and if you manage to wipe out that debt, you’ll have one less financial responsibility to stress about every month.
How much of your recent influx of cash should be directed toward debt reduction is entirely personal and will depend on your situation. Some financial planners recommend that people with high-interest debt consider putting around half of their annual bonuses toward paying down that debt.
Credit card debt typically costs the most in interest. Many charge more than 16% interest. So if your goal is to ultimately build wealth, it may be smart to minimize credit card balances or, even better, pay them off completely. It would be unreasonable to expect that you could out-invest what you are bleeding out in credit card interest. The same idea goes for any high-interest or emotionally stressful debt on your balance sheet.
Saving for a short-term goal
If you don’t have an emergency savings fund, getting a bonus is a great time to beef up that financial cushion.
While many people don’t like to think about the possibility of their car breaking down, a medical emergency, or job loss, should one of these unexpected events occur, it could quickly put you in a difficult financial situation. Without backup, you can risk landing in debt should you experience a financial setback.
How much to sock away for a rainy day is highly personal. But a common rule of thumb is to create an emergency fund that has enough money to cover three to six months of living expenses. You may need more or less, depending on your situation.
If you already have a decent cushion, you may next want to think about what large purchases you are hoping to make in the not-too-distant future, say less than five years. This could be a down payment on a home, a renovation project, taking a special family vacation, buying a new car or any financial step that requires a large infusion of cash. Then consider using at least some of your bonus check to jump-start these savings goals, or add to previously established ones.
It’s a good idea to put money you are saving for a short-term goal (whether it’s a down payment or an emergency fund) in an account that is safe, earns interest and will allow you to access it when you need it. Some options include a savings account at a bank, an online savings account, a cash management account or a certificate of deposit (CD). Keep in mind, though, that with a CD, you typically need to leave the money untouched for a certain period.
Invest for the future
Bonus money can also help you start investing in longer-term goals, such as retirement or paying for a child’s education. Using bonus money to buy investments can help you create additional wealth over time. For example, a lump sum of cash can work wonders in boosting your retirement savings. Even if you’re technically on track for retirement, adding more money to your IRA or 401(k) today can leave you with a larger income stream when you’re older. If you’re already contributing to these accounts, be aware of the annual limits.
You can contribute to your retirement using your bonus in a couple of ways. Many companies will automatically deduct from your bonus for your 401(k) at the same rate as usual. You can also ask your company in advance if you can have a special withholding for your bonus. You may be able to fill out a form (or go onto the company portal) to designate up to 100% of your bonus to your 401(k).
If you can’t direct that money to your 401(k), and you’re eligible for an IRA, consider maxing that out instead. Either one can help get you closer to a great retirement–and may also help you save significantly on taxes in the short term.
People who have kids may want to consider putting some bonus money toward starting, or adding to, a college savings account, such as a 529 plan (which in some states can offer tax benefits).
For financial goals outside of retirement, you may want to look into opening a brokerage account. This is an investment account that allows you to buy and sell investments like stocks, bonds and mutual funds. A taxable brokerage account does not offer the same tax incentives as a 401(k) or an IRA, but is much more flexible in terms of when the money can be accessed.
How much of your bonus you should put toward long-term investments is an individual decision that will depend on your current financial circumstances.
No matter the size of your hard-earned bonus, it’s a good idea to think about how it can best serve you and your goals in both the short and long term. Otherwise, you might end up spending it here and there with nothing major to show for it.
Some smart ways to use bonus money include getting ahead of high-interest debt, setting up or enlarging your emergency fund, saving up for a large purchase (such as a home), as well as beefing up retirement savings and other long-term investments.
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