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The Best Ways to Use Your Year-End Bonus Check

For many companies, giving a year-end bonus is an annual tradition that lets them show employees that they are valued and appreciated.

For many, year-end bonuses couldn’t come at a better time.

The end of the year brings holidays.

Holidays mean buying gifts, paying for expensive trips, and generally spending more than you usually do.

Many people who receive a year-end bonus wind up spending it almost immediately during the holiday season.

There are smarter ways that you can use your year-end bonus that can help you secure your financial future and see a long-term impact from that money.

1. Fund Your IRA

One of the most important things that a worker can do is start saving for retirement.

Unfortunately, it’s also something many Americans are not doing well enough.

The median household under the age of 35 has just $12,300 set aside for retirement.

Even households in the age range of 45 to 54, when retirement is getting close on the horizon have just $82,600 set aside for retirement.

With the average American retiring at 63 and living to about 85, that leaves you 22 years to spend down your savings.

Depending on where you live, you could easily spend your way through hundreds of thousands of dollars during your retirement years.

And:

Relying on Social Security won’t give you a good quality of life or secure finances in retirement.

Every dollar that you save towards your retirement can make a big difference in the end.

This is doubly true if you’re young, as your money will have more time to grow.

If you can set aside $1,000 at the age of 25 and leave it to grow at 8% per year until you turn 65, you’ll have $21,724.52 when you retire.

Setting your year-end bonus aside for retirement each year is a great way to start building a retirement nest egg.

2. Pay Down Debt

Paying down debt is also a great way to use your year-end bonus.

The average American has credit card debt totaling $6,375.

With credit cards charging 10%, 20%, or more in interest the average American is paying an incredible amount of interest every year on credit cards alone.

If you can put even some of your year-end bonus toward paying down your debt, you can save a lot of money in the long-run. It will also put you that much closer to being debt-free.

Carrying debt involves dealing with the psychological burden of knowing that you owe someone money. It also restricts your ability to spend your money, as some of your income is tied up in monthly bills.

Removing those burdens from your life can make handling your finances much easier.

If you don’t have credit card debt, you can also use your year-end bonus to pay down some of your other debts.

You can make a dent in your:

  • mortgage
  • student loan
  • car loan

Regardless of the debt that you choose to pay down using the bonus, you’ll be bringing yourself closer to financial freedom.

3. Build an Emergency Fund

An emergency fund is a vital financial backstop that everyone needs.

Unfortunately:

Very few people actually have one.

Nearly 60 percent of Americans don’t have enough money in the bank to cover a $500 emergency. That means that they would need to take on expensive credit card debt to handle an unexpected expense.

Not having an emergency fund brings a number of negative effects.

Of course, having to go into debt to handle an emergency is one of them. Not having an emergency fund can also make you more risk-averse in other parts of your life.

For example, if you don’t have the backstop of having money in the bank, would you be willing to leave your job for a different, less secure one that you might enjoy more?

One common question that people have is how large an emergency fund they should have.

The answer to the question depends on each person’s situation, but there are good rules of thumb to follow.

You want to make sure that you have enough set aside to handle any unexpected expense. This includes handling day-to-day expenses if you wind up losing your job.

Ideal Size of an Emergency Fund

To start... Ideal goal... Super safe...
$1,000 3-6 months of essential expenses 12 months of expenses

A good target to aim for:

Between 3 and 6 months’ expenses set aside.

Exactly how many can depend on how secure your job is, whether you live in a one or two-income household and whether you have any dependents. That amount should be sufficient to handle most reasonable, unexpected expenses.

If you ever deplete your emergency fund, you should work to rebuild it over time.

Year-end bonuses are a great time to do that.

4. Save for Education

If you have children, there’s a good chance that you want them to pursue an education that will hopefully help them find a good job.

Rising college costs mean that getting a degree is an incredibly expensive prospect, so saving for education is an important thing for parents to do.

One thing you can do with your year-end bonus is to start or add money to a 529 plan for your child.

These 529 plans are tax-advantaged education savings plans.

Depending on the state that you live in, money that you contribute to the account will reduce the taxes that you owe in that year. When you make withdrawals from the account, you won’t pay any taxes on the earnings as long as the money is used for qualified education expenses.

In many ways, 529s can be more flexible than they appear.

For example, you don’t have to use a 529 to pay for college. It can also be used to cover expenses for trade school.

You can also change the beneficiary of a 529 plan. That means that if one of your children does not pursue higher education, you can use that money to pay for another’s expenses.

Even small amounts can make a dent in college costs, so setting aside part or all of your bonus is a good way to start.

5. Save for Other Goals

Most people have a number of financial goals that they want to work towards.

Paying off debt, buying a new car, saving for a down payment, or going on vacation are all common financial goals.

Regardless of what your financial goal is, the money you receive from a year-end bonus is a great way to make progress towards that goal.

You might be saving a specific amount each week, month, or paycheck. Putting some or all of your bonus towards the goal can cut a huge amount of time off of your timeline.

Using your bonus towards one of these goals is also a great way to get back on track.

If you wanted to take a vacation but had a bad month or two and forgot to save for it, this is your opportunity to get back on schedule.

If you have multiple goals in mind, take the time to consider which are most important to you. You don’t have to commit all of your money to a single goal.

You can split it between multiple goals so you can get closer to accomplishing each of them.

Don’t Forget About Taxes

One thing that many people fail to think about is taxes.

Nobody likes paying taxes but they’re a reality that everyone has to deal with.

The good news is that the vast majority of employers will handle tax withholding for you. If your bonus comes as part of your regular paycheck, some of the bonus will automatically be withheld as a tax payment on your behalf.

The danger is that tax withholding for bonuses can be inaccurate or tricky sometimes.

If you receive a year-end bonus, you should take the time to do some quick math and determine whether enough money was withheld to cover taxes.

The last thing that you want to happen is to find out that you owe hundreds in taxes on your bonus, having already spent it all or put it all into savings.

If your bonus isn’t paid as part of your paycheck, then taxes may not have been withheld.

For example, if your employer gives you a cash bonus, you are still legally obligated to report that cash as income.

However, your employer is unlikely to have withheld any of that money as a tax payment for you.

That means that you’ll have to set aside some of the money on your own so that you are ready when you file your tax return.

Conclusion

Year-end bonuses are a popular tradition at many companies, and many people wind up using them to fund holiday trips or expensive gift shopping sprees.

While treating yourself to a nice gift isn’t a bad thing, take the time to consider how you use your bonus.

You might find that you can use it to better your financial situation or to get closer to one of your financial goals.