Five Tips to Make Your Money Work for You
You were recently awarded a bonus – fantastic! Now what? You have an opportunity to decide whether you will use that “extra” money to pay down debt, add to your savings and/or investments, or spend on something fun. The following tips can help you maximize the benefits of your bonus.
Tip #1 – Consider your tax planning opportunities
Before you do anything else, consider the tax implications of your bonus. Depending on your bonus amount, the implications can be significant; however, there are several ways to reduce your tax liability. If the bonus amount is enough to push you into a higher tax bracket, you may want to consider deferring the bonus to the next calendar year, if this is an option. Also, if you donate to charities each year, you may consider establishing and funding a donor-advised fund (DAF) with a portion of the bonus.
Tip #2 – Emergency planning should be your first priority
While paying down debt is an important consideration, it should not take priority over establishing an emergency fund of at least three to six months’ worth of expenses. As we’ve seen all too clearly over the last year, anything can happen. It’s important to make sure your family’s needs are covered should you lose your job or be unable to work. Having an emergency account in place will allow you to continue to pay the bills in an unexpected situation.
Tip #3 – Say “yes!” to free money
After shoring up your emergency fund, make sure you are contributing enough to your employer-sponsored retirement plan to take full advantage of any matching contributions. Regardless of the amount of your employers’ match, it’s wise to maximize every cent.
Tip #4 – Pay down bad debt
Begin with a review of your current debt with an eye toward identifying “bad” debt. Bad debt is any debt that charges an interest rate higher than what would be considered a reasonable long-term rate of return from an investment, generally 6 to 8 percent. If you carry bad debt, such as a credit card with an 18 percent interest rate, use as much of your bonus as possible to pay it down or (hopefully) pay it off.
Start with the loans that carry the highest interest rates. If necessary, consider using some of your emergency funds to pay them down. If you have an emergency before you have a chance to replenish your emergency account, you can resort to using the credit card again if necessary, while saving considerable money on interest payments in the meantime.
Tip #5 – Decide whether to save or spend
After building your emergency fund and knocking out bad debt, you get to make a fun decision. Will you save the bonus or spend it? Ultimately, the art of financial planning is in finding a healthy balance between what you spend today and what you save for future spending.
Let’s assume that, because you have a financial plan in place, you know that you are not yet on track to meet your goals. Your bonus, especially if you weren’t counting on it, is a great way to close the gap in your financial plan. Common ways to invest a bonus include a Roth IRA, traditional IRA, employer-sponsored retirement plan and other nonqualified investment accounts. Each account has different tax consequences and eligibility rules, but they are all powerful tools that can help you work toward your personal financial goals. Here’s how:
Contributions to a Roth IRA or a traditional IRA are limited to $6,000 in 2020 (an additional $1,000 catch-up contribution is permitted for those age 50 and older). It is possible to contribute to both a Roth IRA and a traditional IRA, but the combined contributions cannot exceed the limit. In addition, your ability to make Roth IRA contributions is reduced once your income reaches $124,00