If you're lucky enough to work for a company that offers an annual employee bonus, and you've just received yours, you now have a question to answer: What should I do with the extra money?
The best way to use your annual bonus obviously depends on your situation, but if you're looking for some ideas on where that additional income should go, here are a few key areas that you may want to consider.
1. Pay Down High-Interest Debt
Paying down debt could be the best use of your annual employee bonus, especially if you have high-interest debt, such as credit cards. The average annual percentage rate (APR) on credit cards was over 20% as of December 2023, according to the Federal Reserve. If you're carrying a balance from month to month, especially if it's high, that's money eating into your finances at a rapid pace and possibly will continue to for months or years.
Even a small annual bonus can make a dent in your debt. Just be sure that, if you're using the money to pay down a personal or auto loan, for example, you won't be saddled with any prepayment penalties for making extra payments.
2. Build Your Emergency Fund
If you have maxed-out credit cards, it may be because your emergency fund is anemic, or you don't have one at all. Your annual employee bonus could be used as seed money to start an emergency fund.
Having set-aside savings specifically for emergencies could be a big help. Everybody has unexpected expenses, and sometimes those unplanned purchases can be pretty pricey, such as if you suddenly need to buy four new tires. But if you continually pad your emergency fund with money every month, the next time an unexpected purchase comes up, it won't wreck your finances.
Conventional wisdom says to have enough money in your emergency fund for three to six months' worth of expenses. How much of your annual employee bonus you should put into an emergency fund, preferably in a high-yield savings account, is a judgment call, but any amount is better than nothing. Automatically transferring money into your emergency savings with every paycheck can help you build your safety net even more quickly.
3. Make Additional Contributions to Your Retirement
While the emergency fund could help with your short-term future finances, you could do a lot for your long-term future if you steer some or all of the money toward your retirement accounts. Or you could open a retirement account, if you haven't already.
The younger you start, and the more you can put in at an early age, the more your retirement funds can grow over time. Just be careful that you don't contribute too much in one calendar year. There are contribution limits for employees who participate in 401(k), 403(b) and most 457 plans, as well as individual retirement accounts (IRAs). But if you're nowhere near the limit, this could be a chance to reach it. Or if you're above a certain age, you might want to consider putting money toward catch-up contributions. If you're 50 or older, the IRS allows you to put extra money into 401(k) accounts and IRAs, more than what your younger savers are allowed.
4. Contribute to Your Child's College Fund
You may want to put some of your annual employee bonus into your child's college fund or that of a nephew or niece. One of the more popular education savings strategies is to start a 529 plan, a tax-advantaged savings plan that helps families put aside money for college, postgraduate education or even K-12 private school tuition. One of the major tax benefits is that, when it comes time to pull out the money for college or an educational expense, you can withdraw the money tax-free.
5. Invest in Your Home
Your home is probably your most valuable asset. Whether you plan on selling it now or someday far off in the future, you typically can't go wrong with fixing it up and keeping it well-maintained. Home improvements sometimes add to the value of a home, but even if a home improvement project doesn't seem to add much, you're taking care of your home, and that's what matters. Houses can lose value over time, especially if you neglect them, which may make it more difficult to sell your home in the future or borrow against it if you need to.
6. Invest in Yourself
That's right—use your annual employee bonus to invest in yourself. For instance, you could put some of your windfall into getting a certification that would be helpful for your career—and may help you earn more money and get an even bigger future annual bonus. You might use the money to go toward equipment or inventory that you need to start a side business to help you earn extra income.
You could also argue that you should do something fun with the money, perhaps something that you typically wouldn't normally do because of the costs involved, such as going on an expensive vacation or getting a pet. Even these activities can be seen as investing in yourself, as they likely will improve your well-being which, in turn, will impact your work product.
The Bottom Line
Putting your annual employee bonus toward one of these activities—or spreading it among a few—could help make your overall financial life easier for the rest of the year. Choose what you think will make the most impact for your lifestyle and go for it.