The best 4 ways to use your annual bonus, according to a financial planner

If you’re set to receive a bonus this year as part of your total compensation, it’s important to have an idea of what you’ll do with that cash before you receive it. Whether you are looking to make a big purchase, save for retirement, or just get ahead on your bills, there are a few things you should keep in mind.

1. Use your bonus to pay off your debts

As priority number one, consider whether you have any unsecured debts, such as credit cards or personal loans. These types of debt tend to come with higher interest rates and are a great candidate for an aggressive pay off strategy that includes a portion of your bonus. Otherwise, the money you pay in interest can cost you significantly more over time. And don’t forget about any student loans you might have. Even if you’re fortunate enough to have had your student loan payments frozen since the onset of the COVID-19 pandemic, it is important to remember that those payments will inevitably resume. Though it may not feel like it in the moment, it could be advantageous long-term to reduce a portion of your principal balance now while you have the cash on hand to do so.

2. Save your bonus for retirement

If you don’t have any unsecured debts to worry about, or if you’ve managed to pay them off and still have additional dollars to work with, the next place to look is your retirement savings accounts. Aside from the benefits of compounding returns, workplace retirement accounts provide a dollar-for-dollar reduction in taxable income on your entire contribution, up to IRS-allowable limits. Some employers even offer the ability to make excess contributions beyond the annual maximum using after-tax dollars. And depending on your income level and seniority within the company, you may even have access to a supplemental executive retirement plan. These plans are generally contributed to through payroll deductions and allow you to invest in the same mutual funds or company stock that is available in the main retirement plan. If you’ve already maxed out your 401(k) or other workplace retirement account, consider contributing to a Roth or traditional IRA as well. Either of these account types would allow you to ramp up your retirement savings and make good use of a portion of your bonus. Just be aware that contribution limits and the tax deductibility of those contributions will be based on your overall household income, and in some cases, you could even be excluded from participating altogether.

3. Invest your bonus in your goals and yourself

From here, it’s important to consider the rest of your long-term goals and which of them is your highest priority. For instance, if you are looking to purchase a new home within the next couple years and already have a savings target in mind, then that would be an obvious best use of those funds. However, if saving enough to send your child to college is higher on your list, then allocating some of your bonus toward a savings plan dedicated to covering these expenses would be a good idea. A 529 education savings plan can be an excellent college savings vehicle, because earnings grow tax-free, and withdrawals are tax-free when used for qualified education expenses. If your current financial situation is solid and you don’t have any other immediate financial needs, consider investing it. Investing can help grow your money over time and provide long-term security, as well as supplemental income in the future. Resist the temptation to invest in an ad hoc manner. Instead of picking a few hot stocks or day trading, follow a more methodical approach meant to earn better returns than a bank account, but not so volatile that it keeps you awake at night. Rather than investing in traditional stock and bond investments, another smart way to use your bonus is to invest in yourself and your career. Consider taking classes that can help you advance professionally. This could include anything from industry-specific certifications or trainings to courses related to skills such as public speaking or project management. Not only will investing in yourself help boost your professional value today, but investing in your career prospects now can pay off later when it comes time to negotiate a salary increase or promotion.

4. You can splurge some, but stick to 10%

You may be tempted to spend the money on something fun and inconsequential, but it’s worth considering ways to get more value out of those dollars. It’s important to see the bonus as part of your total compensation, rather that treating it as “found money.” You worked for it. You didn’t win the lottery. With that said, it’s just as important to treat yourself as it is to invest in your financial future. Be sure to carve out 10% of the money you receive as a bonus to buy yourself something as a reward for all of your hard work and diligence. This can mean purchasing something you’ve been wanting for a while, such as an expensive piece of jewelry or article of clothing. It could also mean taking a weekend vacation to somewhere new and exciting. This kind of self care is important and helps to make sure you stay motivated to keep up the good work.