Feb 13, 2023
Here are the smartest things to do with that bonus check
At a certain time every year, bonus checks start landing on the desks of many corporate executives and managers. While a lot of people will have anticipated this cash windfall, many don’t have a clear plan on how to best save, invest and spend the money.
And, unfortunately, some will choose to make a large purchase that may provide some short-term pleasure, while eating away at their long-term financial health.
Let’s start by remembering that your bonus is a reward, so don’t be afraid to spend a portion of it on something—or someone—that brings you joy and happiness. It’s also important to allocate a portion of this money to meet short- and long-term financial goals.
While everyone has different goals, most of us want to be financially independent and enjoy a comfortable lifestyle throughout those retirement years. As a rule, for every $1 million of investments in your nest egg, you can expect to withdraw an estimated $40,000 per year, before taxes.1 Your investment portfolio, plus Social Security, and—if you’re lucky—pension income, are likely important elements for a financially independent retirement.
With financial independence as the end goal, here are six recommendations on how to best allocate your bonus check:
Set aside enough money for taxes
While many companies withhold taxes from bonus checks, others don’t, and many don’t withhold enough. In addition, many executives may have exercised stock options or had other payouts during the year. If insufficient taxes were deducted from these transactions, you’ll need to cover this amount with part of your bonus.
Replenish your emergency fund
Set aside a few thousand dollars to cover unforeseen major expenses, ranging from car repairs to a new roof or even pet surgeries. A good rule of thumb is to have three to six months of living expenses in that fund. Also, if you don’t have a home equity line of credit, consider getting one. While there are still risk factors to consider, it can help provide short-term cash to cover any major expense not covered by your emergency fund.
Pay down debt
Knock off a chunk of high-interest rate credit card debt and amounts owed on home equity lines of credit, especially if any new debt was incurred to pay for holiday expenses. Interest charges alone can eat up hundreds of dollars each month, sucking money out of your paycheck and leaving less for essential expenses.
Map out projected expenses for major items
Begin allocating enough money for your upcoming big-ticket expenses, such as property taxes, home improvement projects and vacation plans. You don’t want to get into a cycle of borrowing to pay these bills.
Know your number for financial independence
Most people have a retirement objective: they want to retire with $1 million, $5 million or more. Once you know this number, take advantage of your bonuses to help attain that goal.
Keep in mind that your annual savings goal includes any amount you’ve contributed to a 401(k) plan. For example, if you contribute $22,500 to a 401(k) plan—the maximum amount allowed in 2023—and you want to save a total of $40,000 each year, you’ll need to invest $20,500 elsewhere.2
It’s also important to explore investment options outside of the 401(k)—whether it’s an individual retirement account, Roth IRA or a taxable investment account. In some cases, there may be an opportunity to contribute to a Roth IRA, which has tax-free growth.
Fund your children’s college education
As tuition costs climb, we believe saving early by starting or contributing to a 529 college education savings plan is one of the most important decisions any parent can make. A 529 plan is a college savings account that’s exempt from taxes.3
Many states also offer tax benefits for those contributing to 529 plans. For example, married Georgia residents can contribute up to $8,000 per beneficiary to the state’s 529 plan and receive a state income tax deduction. This could equal hundreds of dollars in savings on their Georgia income taxes.4
Making good use of your bonus can be an integral part of achieving your goals. Since they typically only come once or twice a year, it’s paramount to develop a solid strategy on how to spend and invest it.
Being intentional with your bonus may not only put you on a path to be diligent in saving and investing throughout the year, but it may also provide guidance for how to invest future bonuses and set you up down the road for financial independence.
1 https://www.investopedia.com/terms/f/four-percent-rule.asp
2 https://www.irs.gov/newsroom/401k-limit-increases-to-22500-for-2023-ira-limit-rises-to-6500
3 https://www.investopedia.com/terms/1/529plan.asp
4 https://ost.georgia.gov/divisions-offices/georgias-529-college-savings
ABOUT THE AUTHOR
Ryan Halpern, CPA, CFP®, PFS
Ryan is a Certified Public Accountant, CERTIFIED FINANCIAL PLANNER™ practitioner, Personal Financial Specialist, and has earned the CFA Institute Investment Foundations™ Certificate. He received his Master of Accountancy and his Bachelor of Business Administration in accounting with honors from the University of Georgia.
Ryan joined Brightworth in 2013, and is now a partner at CI Private Wealth. Ryan started his career at Ernst & Young, concentrating on the taxation of high-net-worth individuals. He continued his career on the tax team at a multi-family office, broadening his experience with individual tax, charitable, and estate planning.
Ryan’s articles on tax and other financial strategies have been published on CNBC.com, Kiplinger.com, in Financial Advisor magazine, and in the Atlanta Journal-Constitution. Ryan is a member of the American Institute of Certified Public Accountants, the Georgia Society of Certified Public Accountants, and the Financial Planning Association.
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