What’s the best way to use your year-end bonus?

Illustration depicting Santa Clause handing a present to a businessman — Be smart about that extra cash

(Image credit: Prasong Maulae / Getty Images)

A bonus can be a cherry on top of the salary you are already earning. But just because it is extra money outside of your expected income does not mean you should skip giving some extra thought to how you spend it. Used mindfully, a bonus can actually make a meaningful difference to your financial situation.

Think about it this way: On average, a bonus is about “2.8% of total compensation,” which “means an employee earning $80,000 might receive roughly $2,240, while someone making $120,000 could see closer to $3,360,” said Kiplinger, citing data from Northwestern Mutual. That could mean an extra couple thousand knocked off your credit card balance or deposited into your emergency fund — money you will be glad to have next time you inevitably need a car repair or something breaks around the house.

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1. Paying down any high-interest debt

Before you get carried away with thoughts of tropical vacations or lavish dinners out, take a look at the balances on any debt you have, particularly high-interest debt like credit card debt. Applying your bonus toward it offers a one-two punch, said Yahoo Finance: “Not only does this clear your balance faster, but it also saves you money in interest over time.” Given that the average credit card APR is around 25%, on even just a smaller balance, that could translate to hundreds of dollars in savings over time.

2. Topping off your emergency fund

The rule of thumb when it comes to emergency savings is to have at least three to six months’ worth of your living expenses stashed away. That way, if the worst happens, such as a layoff or an unanticipated slew of medical bills, you can come out on the other side still standing.

“Dedicating 25-50% of your bonus to emergency savings can make a huge difference. For example, if you get a $3,000 bonus and put $1,500 toward your emergency fund, you’ve potentially just added a month of financial security without changing your day-to-day lifestyle,” said Hanna Horvath, CFP and Bankrate managing editor, to Bankrate. Ideally, you will put that money into a high-yield savings account, so it is earning interest while it sits there waiting for whenever you may need it.

3. Putting a little more toward retirement

Already have your debts settled and your savings well-stocked? Consider topping up your retirement account if you have not already maxed out contributions for the year. Leveraging your bonus in this way can be extra beneficial, as with retirement accounts like 401(k) plans and IRAs, “you can contribute pre-tax dollars, which allows you to lower your tax bill in April (or get a bigger refund), as well as defer taxes until you make withdrawals,” said Yahoo Finance.

Becca Stanek has worked as an editor and writer in the personal finance space since 2017. She previously served as a deputy editor and later a managing editor overseeing investing and savings content at LendingTree and as an editor at the financial startup SmartAsset, where she focused on retirement- and financial-adviser-related content. Before that, Becca was a staff writer at The Week, primarily contributing to Speed Reads.