If you’re lucky enough to get a year-end bonus, choosing what to do with the windfall of cash isn’t always an easy decision.
For most employees, their income is paid out every two weeks or monthly, which is usually just enough to cover fixed monthly expenses like rent or car payments. A bonus is different, however, as it’s a one-time payment on top of their regular paycheck. For many people, it’s the biggest windfall of cash they’ll see all year.
That being the case, a large payout worth thousands of dollars offers an opportunity to cut back on debt, get ahead on retirement savings, and maybe splurge on something nice, too. Below are suggestions on how you can spend your bonus, as typically recommended by financial planners.
1. Pay Off Debt
Consider paying off all of your high-interest debt first, like credit cards or cash advance loans.
As a rule, you should avoid carrying a balance on your credit card, if you can — the interest costs are simply too high. This is especially true since credit card interest rates have climbed beyond 20% in the last year. At the current average rate of 20.74%, only making the minimum payments on a credit card balance of just over $6,000 would take 214 months to pay off, according to Bankrate. In that time, you’d owe just over $9,000 in interest alone.
By paying off your outstanding credit card balances now, you could save thousands of dollars beyond what you received as a bonus.
2. Boost your emergency savings
Financial planners commonly recommend a reserve of cash that’s worth three to six months of your expenses. If you don’t already have a sufficient cash reserve, consider putting at least a few thousand dollars aside, as a start.
And remember, you can still build up your emergency fund by setting aside money each month, even if it’s a smaller amount like $50. However, if you have more credit card debt than emergency savings, many financial planners recommend paying down the debt first.
3. Put the money away for retirement
Whether it’s a one-time contribution to a 401(k) or an index fund, putting money into your retirement investments is one of the smartest things you can do with a windfall of cash. That’s because with compound interest, your investments can grow exponentially over time.
Assuming that you put a $3,000 bonus into an index fund that had an average annual return of 7%, the money would grow to a total of $24,349 in 30 years. That would be quite the boost for your retirement savings.
4. Invest in education
Consider using your bonus to pay for courses, workshops or certifications that upgrade your skills and boost your career prospects.
And if you have children or plan to go to school in a few years, investing in a tax-advantaged 529 college savings plan could give you the most bang for your buck.
The great thing about this type of investment is that the contributions grow with compound interest like a retirement investment account, except that withdrawals for education expenses won’t be taxed. Qualified education expenses include tuition, computers, books, meal plans and student housing.
5. Splurge for yourself
While it’s smart to pay down debt or make contributions to your investments with your bonus, there’s nothing wrong with splurging on travel, shopping or entertainment, either. A bonus is a reward for your hard work, after all, so why not enjoy it?
That said, you could also split the bonus, so that only some of the money is spent on something indulgent. Depending on the size of your year-end windfall, you could still treat yourself to a vacation or a shopping spree after putting the bulk of the funds into investments or education.
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