Morgan Stanley
  • Wealth Management
  • Mar 25, 2021

Five Strategies to Use a Bonus or Raise

Have extra money coming in? Here are ways to put your money to work for you now, so you can potentially reap the rewards down the road.

Many companies provide some form of incentive compensation as part of their overall compensation package. In fact, 85% of U.S.-based companies paid out bonuses in 2018, according to a recent survey by WorldatWork, an association of human resource professionals.1 Many of these same companies also offer spot bonuses and raises during the year to recognize good work and motivate employees to continue to drive results.

If you’re fortunate enough to see a boost in your paycheck—whether it’s through a bonus, raise or promotion—it may be very tempting to spend this extra cash on a new electronic gadget or fun vacation, but using your bonus on long-term, big picture goals may lead to greater happiness in the long-run.

What should you do with your extra compensation? Start with the basics. Focus on two important objectives: catching up and getting ahead. Here are five strategies to put your money to work for you now, so you can potentially reap the rewards down the road.

1. Pay Down Part or All Outstanding Debt

If you have debt, such as student loans, car loans or credit card debt, a bonus can be a great way to tackle it aggressively. And if the interest rate on your debt is high, make this a top priority. The money you pay in interest can cost you thousands over time.

2. Consider Boosting Your Investment In Your 401(k) and Maxing Out Other Retirement Accounts

It’s a good thing to contribute to your company’s 401(k) or other employer-provided retirement plan and taking full advantage of any available company match. When you receive a bonus or an increase to your salary, consider increasing your contribution. Most money experts agree the more money you set aside today, the better prepared you’ll be in the long run, helped by the power of tax-deferred growth potential.

Also consider maxing out other retirement plans, such as a Traditional Individual Retirement Account (IRA) or a Roth IRA. There are a few key differences between the two that you should understand before setting one up or making contributions:

  • Income Limits: With a Roth IRA, there is an income cap (only married couples filing jointly with Modified Adjusted Gross Income (MAGI) of less than $198,000, or a single person with MAGI of less than $125,000) are eligible to make a full contribution.2 The maximum annual contribution for both accounts for the 2021 tax year is $6,000 (or $7,000 for those who will be age 50 or older at any time during the tax year).3
  • Taxes: Funds within an IRA have the potential to grow on a tax-deferred basis. Contributions to a Roth IRA are made with after-tax money, so you can withdraw the contributions tax-free, penalty-free any time (subject to certain rules). The earnings can be withdrawn federally tax-free, penalty-free once you reach age 59 1/2 or meet one of the other specified distribution events and have met the five-year requirement.4

With a Traditional IRA, the contribution may be deductible or non-deductible.5 Deductible contributions and earnings are taxed when you withdraw them. Non-deductible contributions are not taxable but the earnings are. The taxable portion of withdrawals made prior to age 59 1/2 may be subject to an additional 10% federal tax unless an exception applies. 

Roth IRAs may be particularly well-suited to millennials and those starting their careers because of the ability to withdraw contributions without tax or penalty if necessary. You should discuss with your legal and tax advisor when considering your options. 

Manage your Wealth

Find a Financial Advisor, Branch and Private Wealth Advisor near you

3. Contribute to a Savings or Investment Plan

If your current financial situation is solid and your debt is under control, consider investing your newfound cash in a savings or investment plan that is earmarked for a long-term goal, like buying a home, but is also available for any short-term emergencies. Resist the temptation to invest in an ad hoc manner. Instead of picking a few hot stocks, follow your long-term investment strategy. Work with your Financial Advisor to help reduce volatility within your portfolio through diversification and asset allocation tactics. 

4. Save Through an Education Savings Plan, Such as a 529 Plan

The average annual cost of tuition and fees at a private four-year college was $49,870 for the 2019-2020 school year, according to the College Board.This expense has continued to rise every year, making saving for your children’s college education a priority.

If one of your long-term goals is to send your children to college, consider allocating some of your new funds towards a savings plan dedicated to covering these expenses. A 529 education savings plan can be an excellent college savings vehicle because earnings grow tax-free and withdrawals are tax-free when used for qualified education expenses..

5. Invest in Yourself

If all your necessities are covered and your long-term goals are on track, think about using some of your enhanced compensation to accomplish an important short-term goal. For instance, if you’re focused on making healthier choices, you may want to consider investing in a gym membership or a wellness group. And if you're striving to slow down your lifestyle, you may want to book a meditation retreat or learn yoga. This way, you reward yourself for a job well done, while achieving an important goal.

Making the Most of Your Money

Earning and receiving a bonus, raise or promotion is very satisfying, and can help you advance your financial well-being. Speak with your Financial Advisor about how the money can help you reach your future goals.