It’s your annual review. You exceeded your goals (good job!), so you know you’re going to get a bonus. Or maybe you took on new responsibilities, your company had a great year, and you have a feeling that a nice raise is coming.
Maybe this year it’s a cost of living increase.
Whether you’re getting a large or small raise or bonus, here’s what we recommend.
Plan Before It Hits Your Paycheck
If you have an idea of what your raise or bonus will be, make a plan for how you’re going to handle it before it happens. If you don’t have a firm idea, plan for different scenarios.
Okay, you received a 3% raise. It may not seem like much, but there’s a lot you can do with smaller incremental increases. We recommend bumping the percentage you put in your 401(k) or other retirement account by at least half as much as your raise. For example, if you currently put 5% of your salary into your 401(k), and you get a 3% raise, increase your 401(k) allocation to 7% of your salary. At the end of 30 years that modest increase will mean 50-75% more in your retirement account. If your employer matches a portion of your 401(k), you’ll see even more.
At a minimum, increase your 401(k) reduction to max out your employer match. That’s free money, and you want to get as much of it as you can. If your employer doesn’t match your retirement contributions, or the match is fairly modest, strive to put at least 10% of your salary into your retirement plan. After that, consider your most pressing financial priorities and allocate some of your raise to one or more of them: paying off debt, saving for a house, whatever your top priority might be.
If you’re in sales or another occupation where bonuses are tied to specific financial targets, you may already know what your bonus is going to be. If not, depending upon how your organization works, plan for three scenarios, say a 10%, 20% or 30% bonus.
Then, choose your top three financial priorities: paying off a credit card, putting a dent in your student loan, saving for a car or house, maybe putting more away for retirement. Finally, decide how much of your bonus you want to allocate towards each priority. (Don’t forget that bonuses, like salaries, are taxable; that $10,000 bonus will be significantly less after taxes.)
The key is to have a plan. You’re much more likely to be smart about your money if you have a plan for it before you receive it.
Hey, it’s not all about saving for the future or wearing sensible shoes. You deserve a reward for that raise or bonus. Spend a little bit of it on something fun. Depending upon how much you received and the things you like, take yourself and someone special out for a nice dinner, plan a weekend getaway, book a family vacation at the beach, whatever. You worked hard for that money, and you’ve earned a little fun.
Have questions? That’s why we recommend talking to a CFP® Professional, who can serve as a trusted guide and provide you with the expertise and insight you deserve in all facets of your financial life.