Ask Linda: What should I do with this unexpected bonus?
/Dear Linda,
I will be receiving an unexpected bonus shortly. I want to do something smart with the money - any ideas?
Congrats! It is that time of year. Companies are wrapping up the previous year’s numbers and issuing bonuses. Here are some thoughts.
#1 Treat yourself with part of the bonus.
While it would be nice if you saved the entire bonus, it is equally important to have a healthy balance to combat burnout. You worked hard last year to earn this bonus. Decide on a portion that you could carve out for yourself. Use it towards something that makes you happy and energized to have another successful year.
#2 Use it to pay your tax liability.
It’s the end of March already and Tax Day is right around the corner. Complete your previous year’s return to confirm where you stand. If you will owe taxes, use the bonus to pay the tax bill on 4/15. Ev
#3 Pay off high-interest rate debt.
This could be credit card debt, personal loans, auto loans, or a HELOC (home equity line of credit). Knocking out a high-interest loan feels great and it will improve your cash flow.
#4 Augment your cash reserve.
If you don't already have this in place, now is a good time to start building a cash reserve that will cover at least 3 months' worth of expenses in a high-interest savings account (6 months is even better if you are single or have someone else dependent on your income). If your savings is earning less than 1%, move it. There are plenty of other options these days that will pay 4+%.
#5 Increase your retirement savings.
Whatever retirement plan you are saving to – a 401k, 403b, TSP, SEP IRA, etc - see if you can save more. If you are already hitting the IRS limit, increase your savings elsewhere.
Evaluate if a Roth IRA, Traditional IRA, or Backdoor Roth contribution makes sense.
Save to a Health Savings Account if you qualify.
Consider after-tax 401k contributions, if available. After-tax 401k contributions are different than Roth contributions. There is no tax deduction on the savings, but the money will grow tax-deferred and can be rolled into a Roth IRA (without limitation) after you leave the company. Not every company offers this option.
Save to a Brokerage account. There is no tax deduction on contributions but it is still a good option. Qualified retirement accounts (such as a 401k or TSP) are taxed differently than a brokerage account. When you have a mix of account types, you have more flexibility to utilize asset location strategies and manage your tax bill in retirement.
Save to a donor-advised fund (DAF). A DAF is an investment account for charitable purposes. You invest as you would with any investment account and when you are ready to donate to a qualified charity, use the money from the DAF. Assuming you are eligible for charitable deductions, you will receive the deduction when you place money into the DAF, not when money is withdrawn. If you are charitably inclined and expect to be in a higher tax bracket now than in the future, take advantage of the tax deduction now while it provides a greater benefit to you.
DAFs with Impact Investing Options
Save $10K to an I-Bond. I-Bonds are government bonds adjusted for inflation. You are allowed to buy $10K each calendar year per person.
Fund other goals you may have. If you are saving for a house, earmark some of the bonus for the down payment. If you are saving for a child's college education, consider a 529 plan.
originally published 5/4/2018
Linda Rogers, CFP®, EA, MSBA is the owner and founder of Planning Within Reach, LLC (PWR). Originally from New Jersey, Linda services clients throughout San Diego county and nationwide. She leads the design of PWR's investment portfolios which utilize broad, low-cost investments that integrate environmentally, socially, and governance (ESG) factors.
Planning Within Reach, LLC (PWR) is a fee-only and fiduciary wealth management firm offering one-time comprehensive financial planning, ongoing impact-focused investment management and tax preparation services in San Diego and nationwide. PWR is a woman-owned firm that specializes in busy professionals and impact investors. Planning Within Reach, LLC and their advisors do not receive commissions and do not hold any insurance licenses or brokerage relationships.