Use bonuses to bolster finances, not to go on a spending spree

Dear Pete,

I’m excited to say I’ll be receiving a bonus at the end of this year, and it’s a sizable amount. After taxes and whatnot, I’ll have about $50,000. I have to admit, I’m a bit paralyzed as to what to do. I max-out my 401(k) (I have done so my whole career), my house will be paid off in about 10 years, and I have a full emergency fund and a great start on my kids’ college funding. My 10-year-old son has $52,000 in his college fund and my 7-year-old son has $37,000. I’m committed to doing something very smart with this money, and now I just need you to point me in the right direction. What would you do?

–Julie, Noblesville

Now that’s a bonus. It’s certainly better than the jelly-of-the-month club gift I’ll likely receive.

Anytime I break down a financial life, I explore three distinct areas. I look for long-term financial stability, midterm financial stability and, you guessed it, short-term financial stability. By doing this, I’m able to direct available resources to the squeakiest wheel.

Despite not knowing anything about your finances, other than what you’ve provided, I know your long-term future is set. Why? Because you’ve been maxing-out your 401(k) throughout your career, which I figure probably spans 10 years or more. Once people start maxing-out their retirement plans, they’re highly unlikely to stop doing that, and the result is nothing short of a giant pile of money. On top of your giant pile of money sits a person with no mortgage payment in retirement. I can’t think of a better combination.

Your short-term finances are solid, too. No matter whether you consider an emergency fund a three-month supply of money or a six-month supply of money, yours is full. And by the way, I find a three-month supply to be sufficient for young families, but a six-month supply is much more prudent for families of college-age kids or households that are matriculating their way through their 50s. By the time retirement rolls around, your emergency fund should approach at least $100,000 because it needs to last you the rest of your life. As a working person, you can always replenish your emergency fund. But as a retired person, you cannot.

How about your midterm finances?

They’re good, but let’s set them on the road to great.

Split the $50,000, with $25,000 going into each son’s college fund. By doing this, you’ve more or less pre-funded a public college education for both boys.

The $52,000 balance for your older son instantly becomes a $77,000 balance. And then after earning a reasonable 6% average return over the next eight years, it becomes $124,000. Your youngest son’s account goes from $37,000 to $62,000, and after 11 years of growth becomes $120,000.

Assuming you’ve used a 529 college savings plan for college funding, you will need to switch things up going forward. First, continue to earn the Indiana state income tax credit of $1,000 by contributing at least $5,000 in a calendar year. By maxing-out the state tax credit, you will deposit roughly $208 per month in each son’s account. Your older son will end up with a balance of about $150,000. And your younger son’s account will end up around $158,000 by the time he gets to school.

Going forward, if for some reason you want to set aside more than $5,000 in a given year, deposit the excess into a Roth IRA. You’ve got so much in college funds that I’d prefer your deposits in excess of $5,000 annually go into a more flexible vehicle. If you end up not needing the money in the Roth IRA for college, you still win. You’ll have the money available for your own retirement.

I like what I see. Not only do you seem to subscribe to my personal mantra of “make tomorrow easier,” but you also understand the concept of eliminating financial obligations. I can’t begin to tell you the number of people I’ve seen turn their five-figure bonus into obligations.

If you play your cards right with this bonus, you can officially secure stability for your short-, mid- and long-term finances.•

Peter Dunn is CEO of Your Money Line powered by Pete the Planner, an employee-benefit organization focused on solving employees’ financial challenges. Email your financial questions to askpete@petetheplanner.com. Opinions expressed are those of the author.