It's always great to get a raise or bonus. But it's even better when you use the extra cash to make smart financial moves that can increase its value exponentially over time.
"A bonus or raise is cause to celebrate, and the lucky recipient can certainly spend a small amount of that bonus or raise on a special meal or new outfit," says Evelyn Zohlen, president of Inspired Financial, a financial-planning firm in Garden Grove, California. "However, the rest of the windfall needs to go someplace that will benefit you long after the day of the good news."
This is one of those wonderful, all-too-rare opportunities to improve your financial situation without having to tighten your belt. You get the extra cash that can finally help you lower your debt, boost your savings and leave you with much more money than you're getting right now.
Here's how to supercharge your raise or bonus:
Pay Off High-Interest Debt
This is the perfect opportunity to pay off credit-card debt you just can't seem to shake, which may be costing you hundreds or thousands of dollars in interest payments every year. For example, if you have $4,000 in credit-card debt at 18 percent, you can save more than $5,600 by paying the full balance now rather than just paying the minimum until the loan is paid off.
Start an Emergency Account
Build up three to six months' worth of living expenses in a separate kitty. This helps you avoid landing in high-interest debt, paying penalties to access retirement money or raiding your long-term savings if you have unexpected bills or lose your job. Keep the money in an accessible money-market account that earns some interest. Search for rates at Bankrate.com.
Beef Up Your Retirement Fund
It's easy to stretch the money by boosting your retirement savings. If your employer matches your 401k contributions, you'll get free money, making your raise or bonus worth even more. And since the money is deducted pretax, it won't lower your paycheck nearly as much as you'd expect.
For example, if you're in the 25 percent tax bracket, get paid $5,000 per month and contribute $500 to your 401k, your paycheck will shrink by only $375, not the full $500. If your employer matches your contributions up to 3 percent of your pay, you'll get an extra $150 per month -- $1,800 per year of free money. So you end up contributing $650 per month while lowering your take-home pay by only $375, totaling $7,800 per year for only $4,500 out of your check. If you start investing that $650 per month in a 401k when you're 37 and continue at the same pace until retirement, you'll have more than $900,000 by the time you're 67, if your investments return 8 percent per year.
Invest in a Roth IRA
For 2010 tax returns, the maximum contribution to a Roth IRA is $5,000 ($6,000 if you're 50 or older) if you're single. If you invest a $5,000 bonus in a Roth IRA every year and your investments earn 8 percent annually, you'll end up with more than $566,416 in 30 years, and you can withdraw it tax-free in retirement.
Save for Something Fun
You can set aside a little money from your raise or bonus and painlessly finance a big vacation in just a few years. Saving $300 per month in a money-market account earning 3 percent can add up to more than $7,400 in two years. "Here's a way to save for everything ahead of time -- plane fare, hotels, food -- and when you come back, you don't get the ugliness of a huge credit-card bill," says Brian Jones, vice president of Cooper, Jones and McLeland, a financial-planning firm in Fairfax, Virginia.
Don't Forget Taxes
Those pesky taxes we all have to pay can leave you with a smaller windfall than you realized. Stuart Ritter, a certified financial planner with T. Rowe Price in Baltimore, says many of those who get a raise or bonus end up blowing more than they're actually getting. "Sometimes they'll know they're getting a $1,000 bonus and go out and spend $1,000, but when they get the check, it's just for $600 because of taxes," he says.
Articles in This Feature: