There are few things better than having a little financial wiggle room. But unless you receive an unexpected gift or win big on a scratch lottery ticket, extra cash doesn't usually surprise you out of nowhere. Whether it's a bonus you learn about during a review with your employer, or you close a big commission-worthy sale, you can usually assess what's coming before it actually hits your bank account.
So, Grownups, if your wallet is feeling a little heavy after a year-end bonus or you're anticipating a tax refund, it's time to make a plan. It's a new year, and we know it's tempting to splurge mindlessly with that extra cash, but think twice! What's going to get you closer to your goals?
In no particular order, here are five Grownup ways to approach your extra money:
1. Start an Emergency Fund
It's good practice to maintain an easily accessible account with enough savings to cover between three to six months of your expenses. Having such an account can help you through any short-term financial emergencies (think job loss, health issues, inability to work, or unanticipated expenses like your car breaking down). Additionally, having this cash set aside avoids racking up credit card debt or tapping retirement accounts. Consider opening a separate high-yield savings account and jump-start these savings by earmarking a chunk of your hard-earned reward toward this goal. Helpful tip? Nickname this account "emergency savings." This will create an emotional tie to the money and make you think twice before withdrawing $500 for NFL playoff tickets.
2. Save Toward a Specific Goal
Give some thought to the future—what near-term financial obligations and opportunities exist? Perhaps you plan to travel in 2018 for family events or friends' weddings, want to adopt a dog, or need a new car. Consider using a bit of your bonus or refund to establish a "travel," "dog," or "car" account to make these expenses more manageable when the time comes to take action. Similarly, think about your longer-term priorities. If homeownership, starting a small business, or other big-ticket items are on the horizon, consider stashing a bit of your excess cash flow toward one of these goals. This will help kickstart your savings, and segregating the money into separate accounts will enable you to track your progress toward each pursuit. If investing is your thing, having separate accounts for these long-term goals also allows you to implement different strategies for different goal timelines.
3. Pay Off Debt
Perhaps you'd rather tackle a student loan, credit card, auto loan, or other debt before you start stashing money toward a specific goal. Prioritize this based on how you personally feel about your debt: Is it keeping you up at night, or does it fit comfortably in your budget as a monthly expense and you'd rather focus on other savings goals? Keep in mind that each debt has a unique impact on your overall financial health. For example, carrying a large balance on your credit card can negatively impact your credit score, and high-interest rates mean more money paid over time. Student loans, on the other hand, may be your longest standing credit account and actually make your credit score healthier.
If you decide that paying down debt is a priority for your bonus money, first get organized. Write down each loan type, interest rate, minimum monthly payment, and remaining balance. Then, consider implementing an "avalanche" or "snowball" approach. In the avalanche method, you attack the debt with the highest interest rate first, resulting in less interest paid over the life of the loan. In the snowball method, you attack the debt with the lowest remaining balance (for example, the $500 balance on your Target credit card). Doing this enables you to fully pay off one debt—which will feel good and ultimately create momentum to tackle the next when you can. Both methods are effective ways to decrease your overall debt. Want to learn more? Check out our debt repayment calculator.
4. Contribute to an Individual Retirement Account (IRA)
You have until April 15, 2018, to contribute to an IRA for the 2017 tax year. Retirement may seem far away for some Grownups, but making it a priority to start saving early can prevent you from having to catch up later on in your career. As long as you have earned income (wages, tips, salaries, self-employment earnings, etc.) and are younger than 70 ½, you can contribute to a Traditional IRA up to the IRS limit of $5,500. (Individuals older than age 50 may contribute an additional $1,000 per year.) For Roth IRAs, due to their favorable tax treatment, the IRS imposes additional limits: If you are single and had income of more than $118,000 in 2017 (or $186,000 married filing jointly), the amount you can contribute to a Roth IRA is reduced, and if you earned more than $133,000 (or $196,000 married filing jointly), you cannot contribute at all. These income thresholds have very marginally increased for 2018.
As it relates to a year-end bonus, if you did not elect to defer a portion of it directly to your 401k, or perhaps you've exceeded the 401k contribution limit of $18,000 in 2017, you may find yourself wishing you had contributed more of your total compensation toward retirement. IRAs are a great solution for this. Plus, they have slightly different rules than employer-sponsored plans and offer more flexibility for how you manage and invest the funds. IRAs also offer numerous exceptions to the 10 percent penalty imposed on early withdrawals (pre-age 59 ½), including withdrawals for qualified higher education expenses, a first-time home purchase, and some medical expenses. Be mindful that you will still owe income taxes on any distribution from a Traditional IRA, regardless of your age or reason for withdrawal.
5. Do Something Fun!
Debt, emergency funds, retirement… while these things are important, they don't exactly scream excitement. Leave room for that playoff game, weekend trip, or coveted wearable as you start to parcel out your bonus or tax refund mentally. After all, you work hard for your money, and allowing small indulgences will enable you to stay on track with your other priorities. Taking a holistic look at all of your goals will provide helpful context for how much you can afford to splurge, while still taking meaningful steps towards the things you deem important. It's all about balance and staying in tune with your values.