If you're fortunate enough to receive a holiday bonus, consider the best way to use the money before it disappears.

After many years of school, I now have my first job and I expect to receive a year-end bonus somewhere between $5,000 and $10,000. What should I do with my bonus check? What kind of saving options do I have? (I will already have maxed out my 401k.) –Angie

Congrats on getting year-end bonus check this holiday season. Not everybody’s employers engage in the once-expected tradition of dispensing Christmas bonus checks or a year-end bonus for a job well done.

Treat your bonus like a paycheck, not a jackpot

When you get a year-end bonus, the first thing to do is try to see it as another paycheck, not a sudden windfall. Because bonuses comes all at once, we’re apt to view it as a windfall rather than earned income, making us more likely to spend it, according to a study by University of Chicago Professor Nicholas Epley and colleagues.

That’s not to say you can’t spend some of a year-end bonus on something that makes you happy; after all, the extra money does come at a “shoppy” time of year. But if you’re savvy, you’ll have a plan for saving the majority of your Christmas bonus check even before you receive it. The plan will make it that much easier to cash the check, set aside an amount you want to spend, and quickly sweep the remainder towards your designated savings goals.

Make a plan and prioritize

Without knowing your entire financial situation, it’s hard to give a definite recommendation, so I will follow my 6 1/2 steps. You’ve done a great job by maxing out your 401(k) this year, but there may be other good places to use your bonus.

The obvious target is any credit card debt, if you have it.

My second recommendation would be to save the remainder as a cash emergency fund equal to six months of monthly expenses. Although unglamorous, the best place for this money is in a safe and liquid online savings account.

With credit cards paid off and six months expenses in the bank, you’ve got options. If your annual income falls below the limits, you might consider putting up to $5,500 into a Roth IRA.

Otherwise, it’s time to invest or save the money for your chosen goals: Travel, your next home, a new car, your wedding, starting a business, or whatever other dreams you have.

Choose higher-yielding investments for longer-term goals

Depending on when you need that money, you have options as to where to put it, but to get any chance or earning a decent return on your money, you’ll want to invest, rather than save, in stocks, bonds or even real estate.

Betterment provides a way to invest in stocks and bonds that’s as simple as opening a savings account. You can get started at any of our recommended investment accounts. Finally, these five mutual funds are good options to begin investing on your own.

What about you? What do you do with your bonus check?

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About the author

David Weliver
Total Articles: 353
David Weliver is the founder of Money Under 30. He's a cited authority on personal finance and the unique money issues he faced during his first two decades as an adult. He lives in Maine with his wife and two children.

Article comments

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I like to think a lot of jobs/careers that do offer a large bonus are somewhat commission based (thus resulting in a lower salary/hourly wage) so these bonuses should be considered income. Pay off debts and spread out over your investment portfolio. If you have some money left, splurge. We can’t be too hard on ourself and finances all of the time.

Charles says:

I received my first bonus this year as well. Automatically, I put 70% of it into my high-yield online savings account with Ally. My emergency fund is already capped. The rest went into my checking account to help facilitate an upcoming move. Whatever remainder I have left after the move will go toward setting up my new dwelling (I’ve had my eye on a new TV, and possibly a dog). Where your bonus is spent is largely dependent upon your personal situation. If your debts are paid off and you’ve already contributed to a savings account / 401k, I’d look into mutual funds.

Peter says:

I really like this article. My bonuses come quarterly, which makes them seem more like a paycheck than when it is a giant lump sum at the end of the year. Colleagues of mine that receive annual bonuses often fall victim to the spending temptations that a large sum of money can make anyone feel.

I agree that a 401(k) or other defined contribution plan is the first priority, followed by non-deductible debt, and then emergency savings. I’ve had no problem following this formula with bonus checks and frequently preach it to others.

A slightly more complicated issue I’ve run into is when someone is given a large gift from a family member for the holidays. It’s harder for people to treat this as income because they didn’t earn it, but that doesn’t mean it shouldn’t be mostly put towards savings goals. In this case, I believe saving 90% and spending 10% of a gift is a good rule of thumb.

I’m not sure if Angie is a homeowner or not, but a bonus of that size can make a substantial dent towards saving for a down payment on a home. A $10,000 bonus puts her halfway towards a 20 percent down payment on a $100K condo or house. Given that mortgage interest rates are low and home prices are low, she may want to consider putting her bonus towards this. (Of course, if there’s a chance she’ll move within the next 3-5 years or less, she may want to continue renting, since its hard to sell your home in a hurry, and you have to pay transaction costs when you buy and sell).

If she’s already a homeowner, she could also pay down her mortgage. That option will give her security/peace-of-mind, but it may (or may not) be the most financially savvy decision, depending on her interest rate and her risk tolerance. If she has a low mortgage interest rate, she might be able to make more by investing that money, instead. (The Roth IRA, like you said, is ideal for this).

Dan says:

Got 6k this year, 2k into the efund, 2,500 to student loans and the rest is just going to stay in my checking account, I’ve needed a little extra cushion for a while now.

I feel like this is the type of question were it is easier to point out things that you should not do. I’ve known many people who use their bonus to put a downpayment on something that has installment payments: a new car, a boat, an RV. People wrongly assume that they finally have enough money to afford a loan only to make their monthly budget more difficult.

Brian says:

Just to clarify a misconception that has been repeated several times in the comments…

Bonuses are NOT taxed at a higher rate. They are usually subject to higher tax withholding than your regular paycheck, but the tax you pay (after filing your tax return) is the same.

Dan says:

Yea, glad you said this, I was reading the comments and getting ready to correct, glad somebody did.

Eric says:

I try to not spend my bonus and put a plan down for it or treat it as another paycheck. Since bonuses are taxed much higher than marginal income, I put 1/3 of my bonus into my 401(k) to try and shelter it and let more of it grow. Doing so also puts less directly in my pocket, making it feel less like a huge windfall. Last year, which was the first year I received a bonus, since I already had my emergency fund, I used it to create my cash buffer for smaller, out-of-budget expenses. I maintain a set balance in that account until I use it, after which I put money back in on a monthly basis to bring back around the set amount.

This year, however, the part that’s not going to my 401(k) and taxes is going to the wedding fund…getting married in July and we’re paying for the vast majority of it, all in cash, no debt! Something we’re excited about, but also grateful that we have the wherewithal to do so.

Something else for me is that my company doesn’t disperse bonuses until February/April, so we miss the holiday and urge to spend it then. Whether by design or not, who knows, but it works for me.

The second I saw this question posed I thought of the Bonus vs Rebate study you mentioned, it’s really interesting! Another little nugget from the study is that even the word “bonus” causes us to spend more readily. When something is framed as a bonus we think of it as “free money” rather than money we have earned, like a regular paycheck as you mentioned. It may seem odd but renaming a “bonus” and even distributing it throughout the year (instead of one lump sum) could really help people save money and resist the urge to splurge.

Rachel says:

I received a similar bonus this year, and I just paid off my car loan today! It’s such a great feeling! 🙂

Brian says:

One item of note: Your employer match does not count towards your 401k contribution limit. So, if your 5% is equal to 17000, then you can’t contribute any further, but if your 5%+ your employer’s 10% = 17000, then you could contribute more.

Source: http://beginnersinvest.about.com/od/401k/a/What-Is-A-401k-Contribution-Limit.htm

Not saying that’s how you should be spending your bonus, but it is an option.

David E. Weliver says:

Right, thanks for clarifying that Brian. The way Angie’s question was worded it was hard to tell if she knew that and had contributed the full $17k herself or that was between her contributions and the employer match. Topping off a 401(k) with the bonus would probably be near the top of my list, though.

Andy says:

I definetly think the Roth IRA option is best, assuming your income allows you to contribute. That’s what I do with my bonuses. Also don’t forget your bonus is normally taxed at a much higher 40% – rather than as purely marginal income (depending on how your employer classifies the payment).

Kevin J says:

It all washes out when you file your 1040 though.

Denise D. says:

My husband actually received a small bonus this year, for which we were very grateful. We used most of it to pay the remaining balance on one of our smaller student loans. We also are using a couple hundred of it for Christmas shopping and travel expenses. That way, we have a little bit of splurge money, and we’ve just reduced our student loan payments by eliminating one loan entirely. If we didn’t have any debt, most of his bonus would’ve gone into our emergency fund, which is currently at 3-4 months.

Kara says:

Ahahahahahaha! A bonus? That’s a good one!