The holiday season comes with an extra shot of financial joy, for employees lucky enough to receive a bonus. If you have that nice supplemental check coming to you soon from your employer, you will have a tough choice to make. Many individuals are tempted to splurge the money on the latest flat screen TV, a tropical vacation, or another luxury purchase. Rather than spending the money on things you do not necessarily need, consider the value of investing and/or paying down debts with that extra cash flow. Don't think it's a big deal?
Well, either way Americans are struggling when it comes to financial decisions. USA Today points out that only 18% of Americans actively contribute to IRAs and have 401(k) balances of just $96,288. There's a case for investing the money in your future. However, the same article notes that the average American household with debt owes a staggering $132,529. So, should you invest or pay down debts?
The Case for Paying Off Debt
The first thing to consider if you are going to pay off debt, is math. You need to sit down and figure out which number is greater: the return on your investment or the interest you currently pay on debt. If you are paying more in interest than you could hope to earn by investing, you are likely far better off paying down your debts. It is important to get these figures straight before you make any decision because as US News & World Report notes, you could also be sacrificing investment earnings on the power of compound interest if you pay off debt that has low interest just to lower your credit score.
These are just the financial considerations of the matter though. You are also going to need to consider alternatives, the cost of maintaining that debt, and the downside of risks over a given timeframe. Beyond those, you will face emotional considerations. Will you feel better having paid off the debt? How will you feel if you forgo investing? What happens if the investment does not work out? These emotional questions are just as important as the financial questions and warrant equal consideration.
Investing in a 401(k)
Many, but not all, employees have access to 401(k) plans through employers. If you do have this option, it is one of the best moves you can make with your annual bonus. Why? Here are two good reasons to invest in your 401(k):
- Employers often match a percentage of your 401(k) contributions, which is free money to you if you invest!
- Contributions to 401(k) plans are tax deductible, which saves you money on the backend come tax time.
Before you follow this route though, check with your employer on the details of your 401(k) plans. You will want to be sure that they offer matching contributions before you put your bonus check into your retirement plan.
Invest in an IRA
Even if you are already investing in a 401(k) or another employer-sponsored plan, you can still contribute to a traditional or Roth IRA. You are free to spread your money across these various plans as you and your financial advisor see fit. The IRS notes that:
You can contribute to a traditional or Roth IRA regardless of your participation in another retirement plan through an employer or business. However, you might not be able to deduct all your traditional IRA contributions if you or your spouse participates in another retirement plan at work. Roth IRA contributions might be limited if your income exceeds a certain level.
It is also a smart idea to open a personal or joint investment account with a spouse. You can invest additional money here aside from IRAs and 401(k) plans for long-term growth. What you do with your bonus money in the end is, of course, up to you. Splurging the entire amount is not a financially responsible option. Investing can help secure your future, while paying down debts can also protect your financial future.
What to do with your bonus is up to you, but splurging is not really a healthy option for your future. Investing is great option to come up with more to fall back on and retire with and paying off debts also helps in the long run. For more assistance in coming up with a plan that works for you, we at Manhattan Ridge Advisors are more than happy to help you find the best option when receiving a bonus, windfall, or raise!