It’s that time of year again. Can you feel it in the air? Can you hear that noise?
It’s bonus and raise season!
Who doesn’t love getting paid a little extra money for doing the exact same job they were doing a few weeks prior?
Unfortunately, most people will take this extra money and immediately spend it. Whether it be through some big purchase they’ve been wanting for a while, or through gradual lifestyle inflation, the additional money that goes into their bank accounts, will eventually leave it.
Just because you have more money doesn’t mean you need to spend it! This is not the way to build wealth, and especially not the way towards Financial Independence.
Here are a five things you should do with your bonus or raise instead:
Pay off High Interest Debt
This should be at the top of the list for anyone receiving a bonus. If you have any credit card, student loan or high interest auto loans or mortgages, it would be wise to put this bonus towards the principle on these debts.
Doing so will help to pay these off sooner, while also reducing the amount of total interest you will have to pay.
With a raise you could simply increase the monthly payments you already contribute to the debt in order to gradually reduce the principle and pay less interest over time.
With lower interest debt, you could potentially look into other options below for potentially better returns before committing your extra dollars here.
Increase Pre-Tax Contributions (401k, HSA, etc)
If you are fortunate to get a raise, one thing to consider is increasing your pre-tax contributions. This is a great way to increase your savings while not drastically raising your taxable income.
If you get a 3% raise, you could consider increasing your 401k contributions by another 2-3% and still see a very similar Take Home pay hit your bank account. This way it’s automated and you won’t even see the extra dollars to get tempted to spend it!
The same method goes for any other pre-tax contributions. This is a great way to increase savings and pay lower taxes.
Start an Emergency Fund
For those who do not already have an emergency fund, you could put your entire bonus into a savings account to start one up. This fund would be to cover any expenses that come up in an emergency or expenses that are over and beyond your monthly budget.
If you don’t get a bonus, use the additional monthly dollars from a raise to make regular contributions into this fund to help it grow. Think of it as another line item on your budget! You have to “spend” a certain amount by putting the money into your emergency fund!
If you already have an emergency fund, you could contribute this additional money to grow it even more depending on your preference. Take care to consider what you could be missing out on with a bigger emergency fund though!
Set up and Contribute to an IRA
After you have accomplished or maxed out all the above, another place to save is in an IRA (Individual Retirement Account). You could either set up and Traditional IRA (tax-deferred) or Roth IRA (after tax).
As of 2018 you can contribute up to $5,500 into one of these each year and use this as another retirement savings vehicle. It has the added bonus of no taxes on any capital gains or dividends! Take a look at the IRS requirements and limitations for IRA’s here.
These can be set-up through any Brokerage provider. There are dozens of providers you could choose from, though Vanguard is a popular one to select for its ease of use and great selection of index funds.
Invest in a Brokerage Account
Lastly, one other option is to put your bonus or raise into a Brokerage account. These accounts are all after tax and subject to taxes on capital gains and dividends; however, they are also a great way to earn returns from the market instead of sitting in your bank account.
There are many strategies to investing, however the easiest is probably through low cost Vanguard index funds. You could also trade stocks individually, though this comes at a greater risk and would require more individual research in order to choose one which you think will succeed.
As with IRA’s, these accounts can be set up among dozens of providers. Again, Vanguard is a great option, though many others such as Betterment, Fidelity and Scottrade offer great selections as well.
At the end of the day, one of the best ways to build wealth is to save as much of your bonuses and raises as you can.
Doing so will help to avoid lifestyle inflation, increase your savings rate and put you on a faster path towards financial independence.
Unfortunately, I don’t get a bonus through my company, however, with my raise this year I hope to accomplish all the above if possible! See my 2018 goals here.
Are you getting a bonus or raise this year? If so, what are your plans for them?