What To Do With Bonus Money: 6 Smart Options For Extra Income

It’s the end of the year, and you’ve just received a well-deserved bonus. Of course you have! You’re a dedicated team player, and you’re integral to your company’s success. No matter how welcomed some extra cash may be, however, it does present you with a few new challenges. Throughout the year, the majority of the decisions you make around your finances are pretty routine. But go and toss a delightful wrench into the gears like a hefty bonus and suddenly you’re anxious about making the right decisions and wondering what to do with the bonus money.

In this article we’ll discuss how to wisely incorporate bonuses and other windfalls into your everyday spending. We’ll highlight what to consider when deciding how to use your bonus, and how to find balance between planning for tomorrow and enjoying today.

What To Do With Your Annual Bonus

Chances are, you’ve already established a good foundation of healthy financial habits. You diligently contribute to your 401(k) and set aside a monthly amount for your non-retirement investment account. And certainly nobody’s complaining about getting some extra cash. But a sizable bonus or any other type of unexpected income can be a bit disorienting. It disrupts your established system for allocating your money. 

For most of us, the immediate reaction to a bonus is, “It’s extra money, a little gravy on top.” It’s tempting to jump into some well-deserved indulgence like a new car or a vacation – which is completely understandable because you worked hard for this recognition and your regular income already covers your monthly expenses and savings. 

That said, if your bonus makes up a considerable portion of your annual income, you might come to rely more heavily than someone that’s getting a 5 or 10% bonus payout.  If that’s the case, you might want to hold onto that cash to live off of throughout the year, which requires strategic planning and budgeting. 

For some people, that works just fine. Others, however, may accrue debt throughout the year, and then rely on that bonus to pay it off. This approach can work, but think about what happens if the bonus check doesn’t come as expected. What’s the saying about counting chickens before they’re hatched? Don’t!

If you have debt, especially high interest credit card debt, you’ll want to pay that off first. Otherwise, depending on the size of your bonus, you can use part of it to plan for tomorrow and some of it to enjoy today. If you love your work and aren’t looking to retire early, the goal is not going to be to invest every cent right now.

How to Allocate Extra Income

Here are some steps to take when deciding how to spend or allocate your bonus:

1. Wait A Beat

   Let your emotions settle so you are able to give full consideration to your current financial outlook, goals, and value system before making a decision. And remember, you don’t have to put discretionary cash all in the same place.

2. Assess Tax Withholding

   Make sure you set aside enough to pay the taxes your bonus might incur. Bonuses, gifts, inheritances, winnings, and found money have different tax treatments. It’s critical to understand how and when windfalls are taxed so that you can plan accordingly, avoiding any surprises come tax time.

3. Emergency Fund

   You probably already have a savings account strictly for emergencies. If not, an annual bonus is a great way to get this foundational piece of financial security going. Discretionary monies can be the foundation of this fund, or a way to top it off. Aim for savings of at least three to six months of regular expenses or salary, but you may want to aim for a different target depending on career stability or personal preferences. 

4. Pay Off Debt

   Whether student loans or credit card debt, your financial freedom hinges on paying those off completely. Depending on your debt’s interest rate, paying off debt before allocating money to savings is often a wiser choice. It is highly likely that by paying off debt, you save more money in interest not accrued than you would earn through savings account earnings. It’s crucial to ensure that significant debt balances, especially on credit cards with interest rates hovering around 19-25%, are promptly paid off. That said, if you’ve got low-interest debt like student loans, you may be better off investing your money if you feel the return would be higher than the interest you’re paying on your loans. Give yourself permission to consider the “feel good factor.” That is, even if it may make financial sense to hold onto some debt, if it’s keeping you up at night, prioritize paying it off.

5. Plan Ahead

   You may be able to set your bonus aside for later with a deferred compensation plan, or get a head start on maxing out your 401(k). Both options could provide some tax savings. This could be a great way to supplement your retirement savings. If you feel good about your retirement savings, you could work towards other financial goals. Consider starting a fund for your children’s education, or for something fun like a family trip or a second home. Yes, it’s important to plan for the future, but it’s also important to enjoy today. 

6. Support A Cause

   Yes, charitable contributions are tax deductible, but more than that, they give you the opportunity to use your success to support causes that truly mean something to you. Consider taking a portion of your bonus and giving it to an organization doing work you care about. 

The Bottom Line 

After making sure you’ve set aside enough for taxes and your emergency fund is in good shape, take a look at your debt situation and see if your bonus can help you pay down anything you owe. When your bonus makes up a large portion of your yearly income, it’s best to plan how to spend the bonus so that it sustains you throughout the year. If you’re fortunate enough not to have immediate financial concerns, think about incorporating the bonus into your overall financial plan. If you normally invest 20% of your regular income, for instance, keep at it with your bonus. If you’re in a situation where you don’t have any high-interest credit card debt, and you feel otherwise financially secure, go ahead and use part of your bonus for something fun. Remember, living your best life is why you work so hard in the first place. 

Conclusion

Bonuses are exciting, but they can lead to some uncertainty. Thoughtful planning and an understanding of your overall goals and financial situation will help you determine whether to spend, save, invest, or pay off debt. Finding the middle ground between treating yourself and maintaining a healthy financial approach is key. To avoid emotional decisions, have a plan for your bonus ahead of time. Consulting with a qualified financial advisor or tax professional can be helpful in making informed decisions in order to make sure you get the most out of the extra income. 

If you’re looking to change your strategy a bit and give yourself permission to spend a bit more of your bonus, we recommend Bill Perkins’ book, Die with Zero: Getting All You Can From Your Money and Your Life. This may provide the new perspective you need to loosen your purse strings a little bit. 

Sometimes, financial planners get a bad rap for wanting you to squirrel away every last dollar. We believe that it’s important to enjoy today as well. At SK Wealth, our financial advisors are all about helping you make informed choices regarding your income and how to plan for your financial future. For 25 years, we’ve honed our financial planning process, The Integrated Financial Advantage™, in order to offer recommendations that are personal to you, your lifestyle, and your goals so that you may live with intention, tomorrow and today.

Click here to find out more about SK Wealth’s specialized financial planning and investment management services.