While there are unfortunately few "nice problems to have" in life, here's one: you need to decide what to do with unexpected or bonus cash. We all would love to have this problem more often! If you're receiving a year-end or holiday bonus, first, take a little time to enjoy the feeling. Second, let's talk about smart ways to use the extra money.
Of course, just spending bonus money on your whims sounds great. However, that happy feeling won't last, especially when the money's gone and you see no change to your unpaid bills or savings. The responsible course of action is to put bonus money toward endeavors that will advance you financially. To avoid feeling deprived, allow yourself to spend up to 20% of your bonus, then use the rest in a smart and financially responsible manner.
1. Cover bills first
Hopefully, it goes without saying that if you're behind on monthly bills, such as rent, mortgage, or utility payments, you must use your bonus money to catch up on those first. No, it's not fun, but falling behind on bills triggers a snowball effect and fees that are even less fun. Make sure you're current on all your obligations before spending money anywhere else.
2. Pay down high-interest debt
Once your outstanding bills are paid, you should pay off debt, beginning with whatever debt carries the highest interest, usually credit cards. You'll see big savings on interest when you eliminate high-interest debt. Here's an example.
|Credit card balance||$5,000|
|Years to pay off balance at minimum monthly payment||13|
|Interest paid over life of balance||$3,183|
If you were to put your bonus money toward credit card debt like this, you'd save thousands in interest! Even if you can't pay off an entire balance with your bonus, any extra payments you make will save you significant money on interest.
3. Fund emergency savings
You've probably heard it before: we should have six to eight months of living expenses in the bank, for use after a job loss or in another emergency. Of course, it's difficult to accumulate such a large sum, but your new bonus check will make saving much easier. Put your bonus in the bank and don't touch it unless or until you encounter a true emergency, such as losing your job or suffering an injury that prevents you from working. While using your bonus this way may seem like a letdown, think of what a relief it will be to have this stash when you really need it.
4. Save for retirement
Putting your bonus toward retirement savings makes it work especially hard for you and your future. While saving for retirement is always a good idea, a bonus makes it easier to save enough to receive your company's maximum match. If you don't contribute enough to get the maximum match, you're giving up free money. Also, saving your bonus in a 401(k) retirement account means your bonus not only grows over the years, but you'll save money on taxes by investing pre-tax dollars. If you've already contributed enough to get your company's match in your 401(k) or your bonus has been taxed already, consider funding a Roth IRA, which offers tax savings on account earnings.
Related reading: Is Your Retirement Savings on Track? [Infographic]
5. Set aside money for college
Another way to gain additional financial advantages from your bonus is to use the money to fund a 529 college savings plan, a tax-advantaged plan that allows you to save money for future college expenses. With a 529 plan, you set aside money in investment accounts and later withdraw amounts without paying taxes on the fund's earnings. You can accrue funds for any beneficiary, including your children, grandchildren, yourself, or a non-relative. Your employer may even provide matching funds if you enroll in an employer-sponsored plan.
6. Pay extra toward your mortgage
Just like with credit cards, anytime you can pay extra on your mortgage, you'll pay less in interest over the life of the loan. If you've paid your other recurring bills already and don't have high-interest debt, consider putting your bonus money toward your mortgage to save yourself money in the long run. As an example, a single extra mortgage payment of $2,500 on a mortgage loan of $200,000 at 5% interest could save more than $6,000 in interest!
As we hope you've seen, putting bonus money toward debt and savings can bring far greater returns on your funds. If you're receiving a year-end bonus, there's no better way to spend it than to put yourself in a better position for the future. For additional financial and savings tips, download our ebook.