Your Bonus Arrived! (Part 2): How to Make the Most of It
Photo by Kenny Eliason on Unsplash
In Part 1 of this quick two-part series on bonuses, we looked at how to deal with the uneven cash flow aspects of receiving large bonuses.
In this installment, we’re going to go into more detail about different ideas of what to do with the money.
First things first
First of all, nice work, you.
If you’re fortunate enough to work for a company that offers a good bonus structure, and you’re getting a big bonus, that means you’ve worked hard, pleased the higher-ups, and otherwise have done excellent work.
The fact you’re getting a bonus is a blessing. So let’s just take it in for a minute and be thankful.
Second things second
Okay, enough patting yourself on the back, let’s get down to business.
When you get an infusion of cash, you need to decide, well, what to do with it. The temptation may be to dream big, spend it all, and have a grand ol’ time. But I think we both know that’s probably not the wisest thing to do. (Right?)
So, what to do?
I tend to think about this in the following terms, in order of priority:
Fund any “deficit spending”
Shore up your savings
Spend or give away the rest
Let’s take a closer look at each.
Priority #1: Fund any deficit spending
If you normally receive large bonuses, there’s a decent chance you’ve incorporated them into your spending. So much so that your normal monthly spending outpaces your salary that comes from your (non-bonus) paychecks.
That’s what I mean by “deficit spending”. You’ve become dependent on your bonuses to cover your routine annual spending. I wrote about it in more detail in Part 1.
I am not saying deficit spending is bad necessarily. It can either be bad or just fine. If your bonus structure is relatively stable and predictable, and you have a healthy cash position (emergency fund), then it can be just fine and not a big deal at all.
If you do indeed fall into the deficit spending camp, then priority #1 when you receive a bonus is to erase the deficit.
That could take the following two forms:
First, paying off debt you took out to fund your previous spending. Maybe you put that last vacation on the credit card, knowing your bonus was coming in the next few months. This is the type of deficit spending you want to avoid. But if it describes you, then you need to use your bonus to pay it off.
Second, putting money aside to cover deficit spending for the upcoming 12 months. This is the type of deficit spending that I think is okay. That’s because you’re not going into debt. Instead, you’re prefunding future spending with the cash from your bonus.
So, again, this is priority #1. If you take care of this and there’s still money left over from your bonus, you can move on to the next category.
Priority #2: Shore up your savings
Your next task should be to make sure you’re saving enough money.
This can take a variety of forms, so we can go in many different directions with this. But let’s take a look at a few.
Cash position: Do you have enough cash put aside? I’m not talking about the amount from the previous section about covering deficit spending. I’m talking about having enough cash to be able to weather unforeseen storms such as job loss, replacing the roof to your home, having to unexpectedly purchase a car, etc. If you don’t have a strong cash position, you should consider beefing it up with your bonus.
Debt paydown: Are you carrying any debt with a high interest rate? If so, you should consider paying it down. Stat. Mind you, I don’t think all debt should be paid down ASAP. For example, mortgages can be fine to keep as is, or other debt with a relatively low interest rate. But if you’re carrying credit card debt or anything else with a high interest rate, get rid of it. Destroy it.
Retirement accounts: Do you need to put more money towards retirement contributions? Perhaps you should max out a Roth IRA (or do a Backdoor Roth IRA if you make too much money for a Roth IRA contribution). Or you could increase your 401(k) contributions at work. Putting money aside in retirement accounts is a very powerful move from a tax perspective.
Taxable brokerage accounts: Putting money in non-retirement brokerage accounts doesn’t carry the same tax advantages as retirement accounts, but they make up the gap with other advantages. Having money in these types of accounts gives you so much flexibility and future opportunities. In fact, with my working-age clients, we tend to call this type of account an Opportunity Fund, as it creates space for you to take advantage of future opportunities. Receiving money from a bonus creates a perfect chance to put major money into this type of account.
Education accounts: If you have children, you might be motivated to save for their education, perhaps in the form of making contributions to 529 accounts. This can be a great gift to your children.
In terms of how much of your remaining bonus amount to put towards these accounts, and in what proportions, is more art than science. It depends on your goals, level of motivation, desire to retire early, etc. This is an area where I work closely with my clients to figure this out.
The “right” answer might be to put all of your remaining bonus money towards these accounts & goals. But I think it’s completely fine, in fact it’s a good thing, to put money towards the next section.
Priority #3: Spend or give away the rest
I encourage you to find a fulfilling balance between saving (priority #2) and spending/giving (priority #3).
I liken it to acknowledging, and loving, two versions of you: Present You and Future You. Take care of them both.
Note also that this category isn’t just about you. You can also give some money away in a way that is fulfilling to you, whether it’s a charitable gift or giving to loved ones.
As far as what to use your remaining cash for, you’re in a better position than me to make that decision. But, because I can’t help myself, here are a few categories I see people prioritize, with varying degrees of cost:
Home improvement projects
A super sweet vacation
A really nice meal out
A new car
Exercise equipment
A down payment for a home
Doing any of the above for someone else, perhaps your children
Making a substantial gift to a charity you respect
Putting money in a 529 account for a grandchild’s education
Closing thoughts
A large bonus is a wonderful opportunity to enhance your financial situation, but it’s important to approach it with a plan, balancing the needs and wants of Present You and Future You.
By following these steps and making informed decisions, you can turn your bonus into a powerful tool for achieving your goals.
At Spencer Financial Planning, we’re here to help you navigate these decisions and create a strategy that works for you. If you’re ready to make the most of your bonus, reach out to us today.