9 Smart Things To Do With Your Annual Bonus

If you’re expecting to get an annual bonus this year, it can be tempting to think about everything you want to buy or start planning for an extravagant vacation.

But before that extra direct deposit hits your checking account, take some time to consider how you want to use it. No matter the size of your hard-earned bonus, you should think about how it can best serve you and your goals in both the short and long term.

Here are nine ways to use a bonus to extend its benefits into the new year and beyond.

1. Pay off debt

If you have high-interest debt looming over you, bonus money can be a way to make a dent in the balance — and possibly pay off the debt entirely.

Credit card debt is likely to cost you the most in interest, so that’s a great place to start. “The higher the interest rate, the more beneficial prioritizing that debt payoff will be,” says Stephen Kates, CFP, financial analyst at Bankrate. “Unlike your normal paychecks, a bonus isn’t usually spoken for by regular expenses. With proper planning, earmarking that bonus for debt repayment can be a significant step forward.” 

Credit card debt is most households’ highest-cost debt, notes Ted Rossman, Bankrate senior industry analyst. “With an average interest rate of around 20 percent, every dollar you pay down has a guaranteed, tax-free return that far exceeds what you could reasonably expect to earn on your investments,” Rossman says. “This is why using some, or all, of an annual bonus to pay down high-cost debt is a wise choice that can improve your financial well-being.”

2. Max out your retirement accounts

Paying down your debt is a great first step, and the next best step is to consider socking away some of the windfall into your retirement accounts. You’ll get some great tax breaks and may be able to cut this year’s tax bill, too, putting even more money into your pocket at tax time.

First, if your company offers a “match” for the money that you contribute to a 401(k), make sure you’re contributing at least enough to get the full amount of the match. That’s an easy way to make money with minimal effort.

If you’ve maxed out your 401(k), then you might turn to an individual retirement arrangement, or IRA, for additional savings. It offers similar tax benefits to a traditional 401(k) — a tax break today and tax-deferred gains — and you can invest it in a wide variety of assets, too.

Investing in a retirement account is an easy way to turn your bonus into even more money.

3. Invest in an index fund

After your high-interest debt is wiped clean and you’ve maxed out any free money with a 401(k), look into investing the remaining money in a taxable account. One of the easiest ways to invest is by buying an index fund, especially one that’s broadly diversified.

An index fund is an investment fund based on a pre-selected index of stocks, such as the Standard & Poor’s 500 Index. The S&P 500 is probably the most widely followed index in the world, and it contains hundreds of stocks across virtually every industry, so it’s diversified. Many investors make this index fund a cornerstone of their portfolio, because each share of the fund owns a tiny piece of all of those companies.

Investing in a broadly diversified fund such as the S&P 500 can be an attractive alternative for investors who have little experience in the stock market. By buying the fund, you get the index’s return — which has historically been an average of 10 percent annually over decades — and you essentially own a slice of the broad stock market, or at least a reasonable facsimile of it.

And with an index fund you don’t have to analyze individual stocks. You buy and then hold the index through good times and bad, and ideally add more over time.

Your bonus could be a great way to kick-start your portfolio or add to an existing one.

4. Check in on your emergency fund

If you took a hit from some unexpected expenses this year or haven’t yet built an emergency fund, use your bonus money to ensure you’re covered.

Experts recommend you should work to save up to six months’ worth of expenses in an accessible savings account in case of unexpected emergencies, such as a job loss, natural disaster or car trouble. This can give you peace of mind and a backup plan for anything unexpected that may come your way in the new year. It can also help you prepare for a recession.

Stash your emergency (or bonus) cash in one of Bankrate’s best high-yield savings accounts and let the interest add up.

5. Contribute to a 529 plan

Another way to be proactive with your bonus money is to open or contribute to a 529 college savings plan, especially for people with younger kids who can let their 529 plans grow without worrying too much about current market volatility.

529 plans are also great vehicles for your bonus money because they often fall to the bottom of priority lists, behind retirement accounts and other investments.

6. Invest in yourself

Is there a skill you’ve always wanted to learn? A skill you need to develop for a job? Using your bonus to develop that skill could be a great way to invest in your future.

By investing in a job-related skill, you may be able to set yourself up for a better job later, turning your annual bonus into one that improves your earning potential, too.

Personal skills can be a great source of life satisfaction, too. Learning to play a musical instrument, developing programming skills or becoming fluent in a foreign language can all be great ways to make your life more fulfilling.

One point of advice: If you’re interested in a skill and don’t yet know much about it, see what free resources are available. Often libraries or a great internet resource — especially for language learners — can provide enough information for you to determine whether a subject interests you. If it does, then you can invest some of your bonus on honing that skill. If not, then you can save your money for a skill that will prove more valuable for you.

7. Move that bonus into a high-yield account quickly

The longer you let your money sit in your checking account, the more likely you are to spend it without thought. Just don’t leave the reserve where it’s easily accessible and tempting. Instead, open a high-yield savings account online in minutes, and consider moving your bonus into it. And while you’re at it, move the rest of your money earning a pittance at your traditional bank, too.

Another option is putting the bonus into a CD, such as in Bankrate’s list of best six-month CDs or best five-year CDs. CDs typically pay higher interest rates than what you’ll find in a savings account, and you’ll lock up your money for a period of time, keeping you from spending it. You can choose to invest your money in a CD term that matures at a specific time when you’ll need it, such as a future trip or wedding.

8. Save for your next vacation

Have you always wanted to go to Paris? Rome? Madrid? You could also use your bonus as a down payment — or maybe a full payment — on your next vacation. Save the money now while you’ve got it, rather than paying for the vacation when you get back, and beat the stress.

While you’re waiting for your vacation, stash that bonus in a high-yield online savings account or a short-term CD so you’re earning some extra dough. Then also consider opening a travel rewards credit card to help take the edge off costs and stash away that extra bit of rewards.

9. Defer your bonus

It’s not an obvious move, but you might want to try deferring your bonus, if it makes sense. The point of deferring your bonus is to push any tax payments on it into the next year. So if you usually receive a bonus in December, you might be able to push it a few weeks, if you ask your employer. You’ll still get to use the money almost as soon.

This technique would work especially well for those whose income comes in lumps or is otherwise less regular than what’s offered in a typical nine-to-five job. If your income might be less next year, you might be able to push the bonus and pay less overall tax on it.

Bottom line

Depending on the size of your bonus and its relative value compared with your regular pay, it may be worthwhile to divide how you use it, Kates. 

“If your bonus makes up more than 25 percent of your total compensation, you may need to take a more strategic approach to how that money is allocated,” Kates says. “Regardless of how you choose to divide your bonus, it should supplement — not replace — what you’re already doing with your regular paycheck. Avoid relying solely on a bonus to pay down debt or save for retirement.” 

However you choose to use your annual bonus, decide on something that’s meaningful. It makes a lot of sense to use that extra money to do something that improves your future, reduces your stress around your finances and makes you feel good, too.