You’ve just been informed by your supervisor that you have a tidy bonus coming to you soon for all of your hard work this year. (And, of course, you totally deserve it.)
But whenever a large sum of money falls in your lap, you need to have a plan for it, so you don’t wake up a month or two later and realize that it’s all gone.
That’s no way to reward yourself for a job well done.
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What You Shouldn’t Do
Rack up credit card debt in advance of your bonus expecting to pay it off.
Use it to treat your family and friends to oversized Christmas gifts.
Spend it all on electronics and clothing for yourself.
Count your chickens before they hatch. Even if you’ve been told how much your bonus is, it will be taxed like regular income. Because of all the factors that play into it, don’t assume you know exactly how much will land in your account.
Plan your finances around the same bonus showing up next year.
Before visions of Jimmy Choos and digital cameras go dancing through your head, here are step-by-step instructions from Certified Financial Planner, Stephany Kirkpatrick, on how to handle that chunk of change for maximum happiness.
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1. Get It Out of Your Checking Account
OK, so your bonus has officially arrived. Before you do anything, put the bulk of it out of sight and out of mind until you know exactly what you want to do with it. That means moving it out of your checking account and right into your savings account. You don’t want to make it easy for yourself to whip out your debit card and blow all that money on a whim.
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2. Pay Off Bad Debt
Now that your money isn’t burning a hole in your checking account, let’s figure out how best to use it. Personal loans and credit card debt have high interest rates, which means you should keep them to zero if possible. So your first priority is to take that bonus and pay off any outstanding debt you have.
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3. Emergencies and Retirement
If you have bonus money remaining, you should split it toward your next two financial priorities: having six months of expenses in an emergency savings account, and maxing out on your retirement contribution for the year.
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 if you can have a special withholding for your bonus. You’ll fill out a form to designate up to 100 percent of your bonus to your 401(k). This will not only get you closer to a great retirement, it will save you big in taxes. If you can’t direct that money to your 401(k), and you’re eligible for an IRA, consider maxing that out instead.
If you’re financially healthy in these areas and have some of your bonus left over, congratulations! Move on to step four.
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4. Have Some Fun!
You’ve been busting your butt all year, and this is your reward. So think about what will make you the happiest. Perhaps you could splurge on a massage, take a weekend away with your sweetheart or have a nice dinner out. As long as your finances are zipped up, we say you can spend up to 20 percent of your overall bonus in pursuit of some relaxation time. And hey, if Jimmy Choos are in your budget and they’ll put a spring in your step, there’s nothing wrong with that, either.
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5. Pay Off Your Good Debt
This is the lower interest rate debt like student loans. If you have good debt, allocate what you have left to paying it down faster so that you can save on interest.
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6. Other Ideas
If your bonus has been allocated by this point, that’s perfectly normal. But there are many other things you can do if you’re still flush.
Charity: Not only does this time of year lend itself to the good feelings of donating to a good cause, but you’ll also get a tax deduction with your donation.
Savings Goals: You can also contribute to a long-term savings goal, like your future home or opening your own business. If you haven’t yet started your child’s college education fund, this could be a great way to jumpstart it.
Large Expenses: Look ahead to the next year and think about any large expenses coming in. Is your refrigerator about to die? Perhaps you’ll need dental work. Set aside money for those large, irregular expenses so you don’t stress when they come.
Mortgage: Depending on the size of the bonus, consider paying off your mortgage more quickly. A lump sum contribution could reduce how much interest you pay over time, bring the mortgage down to a level where you can refinance it, or drop it from a jumbo loan to a conforming loan, which would drastically lower your monthly payments.