What Should You Do with a Large Cash Bonus?
Professionals in the financial services industry work hard all year long to help meet client needs, and one of the common ways to reward them for their performance is a sizeable cash bonus at year-end or perhaps early in the following year. This type of monetary recognition of the year’s accomplishments is great, but now, some big decisions must be made.
Here are five potential actions to consider as you decide on your next move(s) for your bonus:
- Replenish your “rainy day” fund. As is the case for most people, financial professionals should aim to allocate a certain amount of cash in their savings account for potential emergency situations (e.g., job loss, serious illness, significant repairs for home or vehicle) that may require immediate access to a large sum of cash. The general rule of thumb is to set aside roughly six to nine months of regular expenses for a single-income household and about three to six months for a dual-income household. Building up funds for a rainy day isn’t the most exciting way to use some of your cash bonus, but if an emergency arises you’ll be glad the money is there when you really need it.
- Invest in the market. Financial professionals recognize the benefits of investing to create long-term wealth. Meeting future cash-flow needs and keeping pace (at a minimum) with inflation is key to helping you sustain your desired lifestyle for years to come. With regard to your cash bonus, should you invest a certain amount all at once or spread it out over time? There’s merit to both strategies. Academically speaking, investing all at once tends to be the ideal choice. Markets typically move higher over time, so investing everything in one shot can take advantage of this general trend and put your money to work immediately to help maximize compound growth. However, markets face some degree of volatility, and committing to a lump-sum investment can be emotionally challenging. That’s why some people prefer to invest a set amount at regular intervals to help offset the negative impact of volatile markets. Whichever way you choose to invest, stay disciplined and keep your eye on the long-term prize. That’ll help you avoid making irrational investment decisions that could erode your future wealth potential.
- Pay off (or reduce) high-interest debt. Especially in an environment of high inflation and rising interest rates, we believe it’s important to manage your debt levels so you’re not saddled with massive interest payments. If you hold a variable-rate loan or have debt, such as a mortgage that’s reached the end of its term and is up for renewal, you may be shocked by how much it costs these days to service these debt obligations. The sooner you can pay off or reduce your debt, the stronger your finances can be going forward. Consider using a portion of your cash bonus to lower your high-interest debt.
- Let your cash make its own money. The point above highlights the perils of holding debt in an environment of high interest rates, but the opposite is also true: with rates higher than they’ve been in decades, you have an opportunity now to take advantage and park some of your bonus in interest-yielding securities like money market funds, high-interest savings accounts and other short-term fixed income products. Keeping all your cash in low-yielding savings or checking accounts won’t grow your assets much, so consider relatively safe alternatives that can generate an income.
- Tax-saving opportunities. As year-end quickly approaches, it’s a good time to review your finances and make sure you’ve utilized all available tax-saving strategies with the excess cash you’ve just received (or are about to receive).
- Determine if you’ve maxed out your 529 plan contributions for your kids’ education. Depending on where you claim residency, your state may offer a state tax deduction for 529 plan contributions.
- If you participate in a high-deductible health plan, have you maxed out your health spending account (HSA) contributions up to the allowable family limit? The HSA can be a great savings vehicle because the contributions you make are tax-free, your distributions are tax-free, and whatever earnings you accumulate are also tax-free.
- With a Roth contribution, you will pay taxes on the money you contribute, but unlike a traditional pre-tax contribution, you won’t be taxed when you withdraw the funds.
- As mentioned above, investing some of your cash bonus may be a sound strategy. It’s also a great time to consider making charitable donations by gifting appreciated securities (i.e., ones that have gained in value from the original purchase price) to your preferred charities. You’ll receive a tax break for your donated securities, while the charity can put to good use the full value of this donation. Conversely, if you sell the securities, pay capital gains tax and then donate the remaining proceeds, the charity won’t benefit as much. Lastly, donating appreciated securities and using new cash to re-establish higher-basis security holdings in your investment portfolio can “reset the clock” on future capital gains, reducing your tax obligation down the road.
ABOUT THE AUTHOR
Matt is a Partner, Wealth Advisor in our Itasca, IL, office. He serves as the personal CFO to families, private equity professionals, investment bankers and asset managers. Matt loves to help make the complex simple and help clients enjoy a full life.
This information is for educational purposes and is not intended to provide, and should not be relied upon for, accounting, legal, tax, insurance, or investment advice. This does not constitute an offer to provide any services, nor a solicitation to purchase securities. The contents are not intended to be advice tailored to any particular person or situation. We believe the information provided is accurate and reliable, but do not warrant it as to completeness or accuracy. This information may include opinions or forecasts, including investment strategies and economic and market conditions; however, there is no guarantee that such opinions or forecasts will prove to be correct, and they also may change without notice. We encourage you to speak with a qualified professional regarding your scenario and the then-current applicable laws and rules.
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