If you have a job that you’re lucky enough to receive year end bonus, then I’m sure you can hardly wait for that bonus to be deposited into your account. You might be dreaming of getting a bigger and better TV that would look great in your game room or laying on some beach on a nice deserved vacation. But to take advantage of your bonus, simple financial planning is in order.
Don’t count your chickens before they hatch
Your bonus may seem like it’s in the bag and that the plans you make on based on what you think you’re going to get. Words of wisdom don’t plan on the money until it’s in your account.
Factor in income tax
When you get your bonus expect it to be smaller than what your boss quoted you. A bonus is taxed the same way as your regular income, but the withholding from your paycheck might be different. According to the IRS bonuses are considered “supplemental income”. Which means the IRS suggests a flat withholding of 25% from bonuses.
Formulate a plan and stick to it
When you know for sure exactly how much you are going to receive, you can make some concrete plans with your money. You need to have clear intentions about how to spend a bonus.
Top up your retirement savings plan (401k)
Directing your bonus to your retirement saving is a great idea. But before you do check with your employer about how bonuses are handled. In some cases, your company may not allow you to do so. Still the good thing about this idea is that income tax will not be deducted until you take it out of your retirement plan so you don’t have to deal with number 2 above. It’s also a good way to shore up your retirement. In short, investing it can make you happier over the long run.
Pay down your mortgage
Just one extra payment per year can decrease your interest payments significantly over the life of your mortgage.
Pay off debt
If you have outstanding debt. Whether its credit card debt or student loans, decreasing your debt is always a good idea. However, please keep in mind that not all debt is bad. Paying off a loan is like getting a guaranteed rate of return equivalent to the rate of your loan. Guarantees are good.
Try to remember to use your bonus in a way that you feel good and that you did something that can improve your overall financial life. You don’t have to direct your entire bonus to one area. Also remember that most companies are not raising salaries, meaning more are using bonus funds rather than raise you salary. This means you are on you own to make sure your money is going to the right places. But reserving a certain percentage for “fun money” can be a good idea, too.
Image credits to Matthew Anderson