How to Make Your Annual Bonus Work as Hard as You Do
Many times, when people receive an annual bonus, they think about all of the great things they can potentially do with it. Sometimes those ideas have good intentions: Bolster an IRA account, continue saving into a child’s college fund or finally take a needed vacation. But often times, those plans get put on hold or are simply forgotten. The funds are deposited into a checking account, and before the person knows it, the money has gone to dinners out, new clothes, an unforeseen car repair and maybe even a new gadget.
So, what happened?
In a nutshell, brainstorming and dreaming of what the best course of action to take with the bonus stopped short of actually planning. In order to prevent this, below are a few suggestions to make your annual bonus work as hard as you do – and keep working long after you’ve retired.
The first thing to think about in terms of a bonus is how it could potentially be taxed. Some people think that a bonus is taxed more than your regular salary. While this may be true in some cases, it’s not that way for all.
The easiest way to think about it is that your bonus is a lump sum raise that gets added to your annual salary. This could move you up into the next tax bracket, causing you to pay at a higher rate. (And this adjustment is what gives the impression that a bonus is taxed more.)
Be aware of what that change could mean and be sure to consult a financial advisor for your specific situation. While this article should not be construed as tax advice, some of the below suggestions may offer insight into what to speak to your tax advisor about.
Maxing Out Your 401(k)
If you’re in your late 20s or early 30s and you put this money into your 401(k) plan, the money could be worth even more down the road due to compounding interest. Don’t fall into the trap of thinking that you can just play catch up later. Do it now and you won’t have nearly as much catching up to do down the road.
For example, if you get a $5,000 bonus, put it in an account earning 5 percent annually and do absolutely nothing to it, you would have more than $10,000 in about 15 years. You just doubled your bonus by not doing a thing.
See if your employer allows you to do this. Some only let you contribute up to a certain amount, and you may not get the full match unless you spread out your contributions. Check with your human resources department for more information on your situation.
Pay Down Debt
Debt, especially high-interest credit card debt, should be paid off as quickly as possible. If you have $4,000 of credit card debt at 10 percent interest and pay only $100 a month, it will take you a little more than four years to pay it off at a cost of around $900 in interest.
Alternatively, you can simply take that lump sum bonus and pay the entire bill. You can use the money you saved in interest toward a vacation for yourself instead of paying the credit card company.
If you have young children, it may seem like just when you finally get caught up paying for necessities, something else comes up. It’s easy to see your bonus as a way to cover these expenses, but it may also be a good idea to use some of it to start saving for their college education.
With a college savings plan, you can take advantage of some great tax benefits when you use the money you save toward educational expenses. Be sure to check with your financial professional for specifics on how these plans work and which might be right for you given your situation.
If you’ve taken some of your bonus and paid off debt or put it to work in some type of savings or investment account and still have a little left over, it’s still perfectly fine to use the rest as a treat.
Carve out a portion just for you or your family for a fun purchase, or better yet, a memorable vacation. More and more people have been minimizing their physical possessions and investing more in experiences, which they say makes them happier.
The Bottom Line
Everyone is going to have different needs and goals with respect to their money. Whatever yours may be, it’s best to take stock of your personal financial situation and then allocate the money toward whatever has the most leverage for you.
Start thinking about this today, and contact your financial professional for more guidance on these topics.