Personal Finance

Why Your Year-End Bonus Won’t Save Your Retirement (Unless You Do This)

Rich Duprey

Published: December 17, 2024 11:47 am

Ah! The Christmas bonus. We all look forward to receiving these year-end windfalls that can often amount to thousands or even tens of thousands of dollars. This “found money” can help you achieve your retirement planning goals, but don’t think it will solely be your salvation.

Far too often, bonus recipients use the money to splurge on themselves or others. You’ve worked hard all year long and you deserve a little something yourself. It’s much too easy to spend on your short-term desires instead of focusing on your long-term goals.

While a small reward for your diligence can certainly be worthwhile, as it can motivate you to achieve even better things in the year to come, beware the temptation to think only of your immediate wants and not your ultimate goal.

24/7 Wall St. Key Points:

• A year-end bonus should not be see as an opportunity to splurge on yourself or others, as that would be a missed opportunity to achieve your financial goals.
• There are numerous ways to use that windfall to supercharge your retirement goals, even if it doesn’t get you all the way there.
• Before deciding how to best allocate your bonus, define your financial goals and meet with a financial planner to craft the optimal course of action for your situation.
• Are you getting worried about falling behind on your retirement plans? Take this quiz to see where you stand. ^(Sponsored)

Steps to take today

Now I’m not a financial planner, so these are only my opinions, but here are several better ways to use the year-end bonus to ensure you have a comfortable retirement.

Max out retirement accounts. If you haven’t already reached the contribution limits for your retirement accounts, consider using your bonus to max out your 401(k) or IRA. For 2024, the contribution limit for a 401(k) is $23,000 (or $30,000 if you’re over 50) For an IRA, the max is 7,000 (or $8,000 for those over 50). This not only boosts your retirement savings but may also reduce your taxable income.  

Max out an HSA. If you have a high-deductible health plan, max out your Health Savings Account (HSA), which can serve as a retirement health fund and are triple tax-advantaged: contributions are tax-deductible, lowering your income; earnings grow tax-free; and withdrawals for qualified medical expenses are tax-free as well.

Pay off high-interest debt. If you have any high-interest debt, such as credit cards or auto loans, use your bonus to pay them off and free up more of your income for future savings. It is an immediate return on your investment, while reducing debt can also improve your financial health.

Invest in a taxable brokerage account. If you’ve maxed out your tax-advantaged accounts, a taxable brokerage account is perfect for additional investments. While you’ll pay capital gains tax on profits, long-term investments can benefit from lower tax rates on capital gains and offer more invest choices and flexibility.

Build an emergency fund. While you should always have an e-fund of at least three to six months of living expenses, the year-end bonus can fund it to provide financial security and prevent you from needing to dip into retirement savings in the event of an emergency.

Contribute to a 529 plan. If you have children, funding a 529 college savings plan can provide tax advantages and help you save for future educational expenses.

Consult with a financial planner. A financial advisor can help create a personalized retirement strategy, ensuring your bonus is used in the most tax-efficient and impactful way for your particular situation.

A real-world example

Let’s say your annual bonus is $5,000. You take that money every year and buy an S&P 500 index fund such as the Vanguard S&P 500 ETF Trust (NYSEARCA:VOO). If it grows at 7% a year (the historical average return of the benchmark index minus inflation), at the end of 25 years you will have amassed over $316,000, not including reinvested dividends.

You only need to find one Nvidia (NASDAQ:NVDA), Broadcom (NASDAQ:AVGO), or even a Walmart (NYSE:WMT) stock in your investing career to set you up for life. A single $5,000 investment in Walmart at its IPO would be worth over $20 million today.

But you don’t have to swing for the fences. Racking up singles and doubles over your investing career could create fabulous generational wealth.

Key takeaway

A year-end bonus is a terrific windfall that can help you achieve your financial goals, especially when it comes to retirement planning. Invest it in tax-advantaged accounts, pay down or pay off your debt for immediate returns on your investment, and put aside money for emergencies. 

Taking those steps in partnership with a financial planner while avoiding the desire to splurge will help give you the comfortable retirement nest egg you seek.