7 ways to use your bonus effectively this year

Young black woman receives year-end bonus from her manager in front of applauding audience of her co-workers and teammates.
January 04, 2023 | Lois Sullivan

An employee bonus is a form of compensation that isn't necessarily guaranteed but often gets paid after a particular event is completed. Some employers issue a year-end bonus or holiday bonus, while others tie extra compensation to achieving goals or completing projects. Still others provide a discretionary bonus, with managers or executives deciding who receives one. If you're one of the many American workers who qualifies for a bonus, you may be considering how to spend the extra cash. We've compiled seven ways to use your bonus effectively this year.

Pay down your debt 

The first tip to use your bonus more effectively is to pay down your debt with the extra money. According to data presented by Zippia, the average bonus is 11% of the salary of exempt employees and nearly 7% of the salary of non-exempt salaried employees. Hourly employees who receive bonuses take home an average of 5.6% of their annual salary. Just over 40% of U.S. workers receive bonuses that aren't tied to production. The most common types are year-end, holiday and profit-sharing bonuses.

Regardless of your bonus type or size, it's worth using at least a portion of it to pay down your debt. High-interest debt can significantly dampen your ability to move toward financial freedom, as you're constantly tied to the money you owe. Credit cards tend to have the highest interest rates, although certain types of loans can also come with high rates. Look at all your debt and determine where the funds would be best utilized to make a dent in what you owe. 

Build an emergency fund

An emergency fund is a sum of money you can fall back on if you hit hard financial times. You may need this type of fund if you lose your job, experience a medical issue requiring costly treatment, or face an emergency that costs a lot to resolve. Since inflation reached an all-time high in 2022, many people dipped into their emergency funds to cover everyday costs. But if you don't have a fund just yet, it's smart to use your bonus to build one.

It's best to have enough money in your emergency fund to cover six months of your living expenses, including housing, utilities, food and transportation. You can choose what type of account you want to keep the extra funds in, although it should be accessible. Tying up your emergency fund in a certificate of deposit doesn't make sense, as you won't be able to use it when the need arises. A high-yield savings account is a good option, as it will earn extra money while it's safely stored in the bank. 

Consider an investment

Investing your bonus money is a smart way to make it work for you. After you've paid off any high-interest debt, you can consider a lower-risk investment like an index fund. Index funds are investment funds based on pre-selected stock indexes. The stocks within these indexes are highly diversified, covering a broad range of industries. Investors who purchase shares of the fund own a small piece of each company within it. 

If you're new to the investment world, putting your money into an index fund is a good way to get started. The average historical return on this type of investment is 10%, making it a much safer way to invest in stocks without getting into the complexity of the market. You also don't have to worry about analyzing individual stock purchases or sales, as you maintain your ownership of the index fund over time.

Other investment opportunities to consider include: 

  • Real estate
  • Short-term government bond funds
  • Short-term certificates of deposit
  • Short-term corporate bond funds
  • Treat yourself (within reason)

Treat yourself (within reason)

When you work hard and earn a bonus, it makes sense to give yourself a reward for your efforts. But it's easy to go overboard, so decide how much of the bonus you want to spend on something for yourself or your family. Aim to spend no more than 10-15% of your total bonus on a luxury expenditure, whether it's a new item to add to your wardrobe, a night out or a vacation.

Establish an educational savings plan

When you have children, you may be considering their financial futures and taking steps to prepare. One smart investment is to establish an educational savings plan, also known as a 529 plan, for each of your kids. This type of plan allows you to save for education expenses on a tax-free basis. When your children start college or even attend a costly private K-12 school, they can use the money in the account without incurring penalties, as long as all expenses meet the requirements. 

A 529 plan is a smart investment because it doesn't experience the effects of the market's volatility as much as other investment accounts. It also helps your kids prepare for their future educational needs and their costs. Funding a 529 plan tends to fall close to the bottom of the priority list for a lot of people, especially when they're already feeling financially stretched, so it's wise to split extra funds across your kids' accounts when you get them.

Invest in your personal or professional development

Another way to invest your bonus is to spend some money on your own development. If you've always wanted to learn a new skill or become certified in a way that would benefit your career, consider spending some or all of your bonus money on personal or professional development opportunities. Investing in a skill or degree that can improve your career prospects could turn that bonus into a better position with a higher salary.

Before you spend your own money on professional development, check with your employer to verify whether you qualify for any company money. Many employers include development opportunities in their benefits packages, especially for employees they value and want to keep.

Investing in your personal aspirations is also a worthwhile use of your bonus money. You might take lessons to learn how to play a musical instrument, practice your language skills or even spend some time absorbing a new culture.

Max out your retirement contributions

Retirement accounts have contribution limits that apply annually. If you haven't made the maximum contribution to all of your applicable accounts, use your bonus money to do so. Many companies match employee contributions up to a salary percentage, so you could stretch your funds even further by getting more matched. Saving for your future can also help you feel more prepared for when you reach retirement age and start living off the money in those accounts.

Although spending a bonus as soon as it clears your account is tempting, you may want to make a different choice this year. By taking a smarter approach to managing your finances, you can improve your situation and feel more comfortable as you look to the future. At Alliant, we can help you make the most of any extra money you receive, whether you're putting it into a high-yield account or paying down debt.

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While the information provided is based on our understanding of current tax laws, and has been gathered from sources believed to be reliable, it cannot be guaranteed. Federal tax laws are complex and subject to change. This information is not intended to be a substitute for specific individualized investment, tax or legal advice. We suggest that you discuss your specific situation with a qualified tax, legal or financial advisor.

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