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 their effort is with a cash bonus at year-end or perhaps early in the new year. Monetary recognition of the year’s accomplishments is great, but it also means some big decisions must be made.

Here are five potential actions to consider as you decide on your next move(s) with your bonus:

1. Replenish your “rainy day” fund. Like most people, financial professionals are wise to allocate a certain amount of cash to their savings accounts for potential emergency situations like job loss, serious illness, or significant repairs to a home or vehicle. The general rule of thumb is to set aside 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 your cash bonus, but if an emergency arises, you’ll be glad the money is there when you need it.
2. Invest in the market. Financial professionals recognize the benefits of investing to create long-term wealth. Meeting future cash-flow needs and staying ahead of inflation are 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 may 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 short-term investment decisions that could erode your future wealth potential.
3. Pay down high-interest debt. We think it’s smart to manage your debt so you’re not paying more interest than necessary. If you hold a mortgage or other debt that’s reached the end of its term and is up for renewal, you might find that the cost to service your obligation has increased considerably. 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.
4. Let your cash make its own money. Interest rates have fallen in recent months, but they are still elevated compared to just a few years ago. You have an opportunity now to take advantage of this 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.
5. Tax-saving opportunities. As year-end 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.
   • Consider making a charitable donation to your preferred charity by gifting securities that have gained in value from the original purchase price. You’ll receive a tax break for your donated securities, while the charity can put to good use the full value of this donation. If you instead sell the securities, pay capital gains tax and then donate the remaining proceeds, the charity won’t benefit as much. Donating appreciated securities and using your work bonus to re-establish a new investment at a higher basis can effectively “reset the clock” on future capital gains, potentially reducing your tax obligation down the road.

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