There are certainly worse dilemmas than how to spend a windfall of money.
Still, when that year-end bonus hits your bank account, deciding its fate can cause a fair amount of anxiety: Should you act responsibly and save it? Should you splurge on something you really want? If you are in this position, you may want to consider some of the following options.
Retire credit-card debt. You’ve heard this one before, but it bears repeating. One of the most financially responsible moves anyone can make is to pay off credit card debt. Credit card interest rates—currently upwards of 15% or more—far outweigh what all but the riskiest investments bring in. Long-term, eliminating that debt means a whole lot more for your bank account and less for the lenders.
Consider refinancing your mortgage. With rates on 30-year mortgages are still at extremely low levels, and refinancing can make lots of sense for those with higher-rate mortgages. The one thing that has stopped some people from refinancing is owing more than their homes are worth. Now that housing prices in many areas have recovered significantly, a year-end bonus might help push your mortgage loan above water.
Save for college. If your future includes paying for college—for yourself, your spouse or a child—then a college savings program such as a 529 plan might be a good place to put that bonus. According to the College Board, the average cost of tuition and fees for the 2013–2014 school year was $30,094 at private colleges, $8,893 for state residents at public colleges, and $22,203 for out-of-state residents at public universities. The more you can save now, the less interest you will owe on future student loans. And that can mean a huge reduction in overall costs. What’s more, a 529 plan allows you to take a tax deduction now and pay no tax on distributions from the plan later, as long as the money is used for qualified education expenses.
Boost your retirement savings. If you haven’t reached the contribution limits on tax-deferred retirement plans—your employer-sponsored 401(k) or traditional IRA—then putting your bonus here can have multiple benefits. You can defer paying taxes on the amount contributed, build your retirement savings, and compound those savings with future investment earnings. You might even be able to increase the effective size of your bonus with employer matching contributions.
Finally, splurge … but don’t go overboard. It’s important not to take deferred gratification too far. Enjoying our achievements is a healthy part of success, after all. But be careful: Once the spending spigot is turned on, if can be hard to turn off. So budget a portion of your bonus for a little instant gratification, and use the rest, ideally most of it, for something that will benefit you in the long run.