The 9 smartest things to do with your annual bonus
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If you’re expecting to get an annual bonus this year, it can be tempting to think about everything you want to buy or start planning an extravagant vacation.
But before that extra direct deposit hits your checking account, take some time to consider how you want to use it. No matter the size of your hard-earned bonus, you should think about how it can best serve you and your goals in both the short and long term.
Here are nine ways to use a bonus to extend its benefits into the new year and beyond.
1. Pay off debt
If you have high-interest debt looming over you, bonus money can be a way to make a dent in the balance — and possibly pay off the debt entirely.
Credit card debt is likely to cost you the most in interest, so that’s a great place to start.
“If you’ve run up those credit cards and you’re paying astronomical interest rates, you may want to get those knocked off as a first step,” says Dan Keady, chief financial planning strategist at TIAA.
Stephen Williams, director of advisory planning and digital innovation at Huntington Bank, adds, “Pay that down or pay it off completely with the bonus, because if you’re paying credit card interest of 15 percent, it doesn’t really make any sense to invest money in the stock market and hope you outpace the 15 percent. That’s a tough ask.”
Use Bankrate’s debt paydown calculator to craft a plan to get rid of your debt and figure out how long it will take to clear it.
2. Max out your retirement accounts
Paying down your debt is a great first step, and the next best step is to consider socking away some of the windfall into your retirement accounts. You’ll get some great tax breaks and may be able to cut this year’s tax bill, too, putting even more money into your pocket at tax time.
“Your workplace plan may allow you to designate some of that bonus or all of the bonus to go into your 401(k),” Keady says. “That’s a great way to save taxes and build your savings.”
First, if your company offers a “match” for the money that you contribute to a 401(k), make sure you’re contributing at least enough to get the full amount of the match. That’s an easy way to make money with minimal effort.
With a traditional 401(k), you contribute money to the account before you pay taxes on it, so it’s as if you’re receiving tax-free money to save for your future.
On top of this, a 401(k) allows the tax on any investment gains to be deferred until you retire, allowing you potentially decades to let your money grow.
If you’re unable to direct the bonus into your 401(k) before it’s taxed or you’ve maxed out your contributions for the year, Williams recommends building the money into your budget throughout the year and then designating more of each paycheck toward contributions.
If you’ve maxed out your 401(k), then you might turn to an IRA for additional savings. It offers similar tax benefits to a traditional 401(k) — a tax break today and tax-deferred gains — and you can invest it in a wide variety of assets, too.
Investing in a retirement account is an easy way to turn your bonus into even more money.
3. Invest in an index fund
After your high-interest debt is wiped clean and you’ve maxed out any free money with a 401(k), look into investing the remaining money in a taxable account. One of the easiest ways to invest is by buying an index fund, especially one that’s broadly diversified.
An index fund is an investment fund based on a pre-selected index of stocks, such as the Standard & Poor’s 500 Index. The S&P 500 is probably the most widely followed index in the world, and it contains hundreds of stocks across virtually every industry, so it’s diversified. Many investors make this index fund a cornerstone of their portfolio, because each share of the fund owns a tiny piece of all of those companies.
Investing in a broadly diversified fund such as the S&P 500 can be an attractive alternative for investors who have little experience in the stock market. By buying the fund, you get the index’s return — which has historically been an average of 10 percent annually over decades — and you essentially own a slice of the broad stock market, or at least a reasonable facsimile of it.
And with an index fund you don’t have to analyze individual stocks. You buy and then hold the index through good times and bad, and ideally add more over time.
Your bonus could be a great way to kickstart your portfolio or add to an existing one.
4. Check in on your emergency fund
If you took a hit from some unexpected expenses this year or haven’t yet built an emergency fund, use your bonus money to ensure you’re covered.
“That can be an ideal thing to do with that cash, because we all get unexpected expenses that can make our cash reserves go way down compared to where they should be,” Keady says.
Experts recommend you should work to save six months’ worth of expenses in an accessible savings account in case of unexpected emergencies like a job loss, natural disaster or even car trouble. This can give you peace of mind and a backup plan for anything unexpected that may come your way in the new year. It can also help you prepare for a recession.
Stash your emergency (or bonus) cash in a high-yield savings account and let the interest pile up. Find the highest yields in the U.S. with Bankrate’s rankings of the best online savings accounts.
5. Contribute to a 529 plan
Another way to be proactive with your bonus money is to open or contribute to a 529 college savings plan.
Williams says this is an especially smart solution for people with younger kids who can let their 529 plans grow without worrying too much about current market volatility.
“If you’ve got a long-term time horizon, some younger kids and you want to put some money into that 529 plan, have it grow 10, 12 years tax-deferred and then take it out for qualified college expenses,” he says. “That certainly would be a good strategy at this time.”
529 plans are also great vehicles for your bonus money because they often fall to the bottom of priority lists, behind retirement accounts and other investments.
“Right now, you’ve got that money,” Keady says. “It would be a great way to fund that 529 plan, with those extra dollars.”
6. Invest in yourself
Is there a skill you’ve always wanted to learn? A skill you need to develop for a job? Using your bonus to develop that skill could be a great way to invest in your future.
By investing in a job-related skill, you may be able to set yourself up for a better job later, turning your annual bonus into one that improves your earning potential, too.
Personal skills can be a great source of life satisfaction, too. Learning to play a musical instrument, developing programming skills or becoming fluent in a foreign language can all be great ways to make your life more fulfilling.
One point of advice: If you’re interested in a skill and don’t yet know much about it, see what free resources are available. Often libraries or a great internet resource — especially for language learners — can provide enough information for you to determine whether a subject interests you. If it does, then you can invest some of your bonus on honing that skill. If not, then you can save your money for a skill that will prove more valuable for you.
7. Move that bonus into a high-yield account quickly
The longer you let your money sit in your checking account, the more likely you are to spend it without thought. Just don’t leave the reserve where it’s easily accessible and tempting. Instead open a high-yield savings account online in minutes, and consider moving your bonus into it. And while you’re at it, move the rest of your money earning a pittance at your traditional bank, too.
Another option is putting the bonus into a high-yield CD. CDs typically pay higher interest rates than what you’ll find in a savings account, and you’ll lock up your money for a period of time, keeping you from spending it. You can choose to invest your money in a CD term that matures at a specific time when you’ll need it, such as a future trip or wedding.
8. Save for your next vacation
Have you always wanted to go to Paris? Rome? Madrid? You could also use your bonus as a down payment — or maybe a full payment — on your next vacation. Save the money now while you’ve got it, rather than paying for the vacation when you get back, and beat the stress.
While you’re waiting for your vacation, stash that bonus in a high-yield online savings account or a short-term CD so you’re earning some extra dough. Then also consider opening a travel rewards credit card to help take the edge off costs and stash away that extra bit of rewards.
9. Defer your bonus
It’s not an obvious move, but you might want to try deferring your bonus, if it makes sense. The point of deferring your bonus is to push any tax payments on it into the next year. So if you usually receive a bonus in December, you might be able to push it a few weeks, if you ask your employer. You’ll still get to use the money almost as soon.
This technique would work especially well for those whose income comes in lumps or is otherwise less regular than what’s offered in a typical nine-to-five job. If your income might be less next year, you might be able to push the bonus and pay less overall tax on it.
Regular bonuses are a great treat, but Keady warns that becoming too reliant on your annual bonus can lead to trouble down the line.
“One of the things that can be hard for people who have a repeat bonus that’s relatively similar for several years is they start to look at that as an extra paycheck each year, and it’s really not,” he says. “So I don’t like to budget it into day-to-day expenses.”
However you choose to use your annual bonus, decide on something that’s meaningful. It makes a lot of sense to use that extra money to do something that improves your future, reduces your stress around your finances and makes you feel good, too.
— Bankrate’s Kendall Little and René Bennett also contributed to this story.