If 2015 is like last year, 78% of workers can hope for some kind of year-end bonus from their employers. Few will get anything like the average $172,860 Wall Street bankers can expect in their stockings. But a holiday bonus is still an opportunity to reduce debt, pad savings and otherwise do the right financial thing.
Alternatively, you could do the wrong thing.
Making a mistake with a year-end bonus is just as easy as making a smart move, warns Joe Roseman, a financial planner in Charlotte, N.C. The first thing you should not do with your bonuses is spend it all. “Don’t blow it on Christmas,” Roseman says.
The second thing you should not do is use it for a down payment on a new car. “You’re still going to have the payments next year,” Roseman points out.
“Don’t pay extra on your mortgage,” he adds. “You are taking away your tax deduction.” While paying down a mortgage will save future interest, at today’s low mortgage interest rates that savings is modest, and the benefit is further reduced by the tax deduction.
Finally, Roseman adds, “You shouldn’t count on a bonus every year.” By that, he means don’t spend next year’s year-end bonus on next year’s summer vacation. Many employers pay bonuses when times are good and then cut back or eliminate them if business contracts. If you charge a vacation to a credit card thinking you’ll pay it off with your bonus, you could find yourself in a high-interest hole next New Year’s.
So what should you do with it? A really smart move is to sink at least some of it into a retirement savings account, suggests Scott A. Stratton, a financial planner in Dallas. “If someone 25 years old took $5,000 of their bonus and invested it until they were 65 and earned 8%, they’d end up with $108,622,” Stratton notes.
The younger you are, the smarter it is. For instance, if a 35-year-old socked away the same $5,000 bonus until age 65, also earning 8%, the ending balance would total just $50,313, according to the Security Exchange Commission's calculator at Investor.gov. “You’d end up with half as much just by waiting ten years,” Stratton says.
While getting started on retirement saving is important, it is not only important financial use for a year-end bonus. Because the compounding effect of interest you are paying is just as powerful as interest you are earning, consider paying off all or part of any debts that charge steep interest rates.
“If you’re carrying a balance on any credit cards, that’s got to be a high priority,” Stratton says. “And a lot of people want to look at paying down their student loans, especially those that are higher interest.”
Next after that is an emergency fund. “You need six to nine months of living expenses set aside,” Stratton specifies. If you have trouble getting traction on an emergency fund, a year-end bonus can help get you started.
The final thing you should consider doing with your year-end bonus is spending part -- not all -- of it on something that isn’t necessarily financially whip-smart. Say, a nice vacation, or a piece of jewelry. How much? Roseman suggests 25%, but it depends on the size of the bonus.
But whatever you do or don’t do with your year-end bonus, remember to treat yourself to a little extravagance. “Everybody, when they get a pile of money, deserves to spend it on something they’ve always wanted,” Roseman says.