Seven tips for how to spend your bonus with the future in mind.
Just got a year-end bonus? First, spend some of it. Go to Vegas, buy an iPad, whatever it takes to take your mind off Press Ganey scores and the grueling night shifts. (I bet you haven’t heard that from a financial advisor before.) Once you’ve taken care of that piece, here are a few options for spending what remains.
Send Uncle Sam a Bonus
I know this one doesn’t sound very appealing, but most people don’t know the exact amount of the bonus. So if you’re an independent contractor and you’re about to receive a year-end bonus, remember that not all of it is yours. The IRS owns part of it, so make sure you increase your 4th-quarter estimated taxes to reflect the higher income you have to report on April 15th from the bonus.
Send Uncle Sam a Christmas Gift
This is the first year when you can convert your traditional IRA to a Roth IRA regardless of income. If you’ve had a traditional IRA sitting around for a while and want to convert to a Roth IRA, you generally have to pay taxes on the amount you convert. Use part of your bonus money to pay the taxes on the conversion to make this tax hit less painful than having to pay it out of the money that’s already in your checking account.
Create an Instant Emergency Fund
If you don’t have an emergency fund, now you do. Take the entire amount of your bonus and put it into a separate money market account at your bank. Voila! You’ve just set the record for the fastest emergency fund ever created.
Breathe Life into your IRA
I bet your IRA hasn’t seen much action in years. You probably forgot about it after residency. But you can actually contribute $5,000 to a traditional IRA regardless of your income. You just can’t take a tax deduction for it. If you’re above age 50, you can make a $6,000 contribution.
Fund it to the Max
You hear this all the time, and you probably think it only applies to people who make $50,000 a year. Wrong! I know EPs who make 10 times that and who don’t max out their SEP IRAs. No excuses here folks. If you have a SEP IRA, $49,000 is the limit this year. With an employer-sponsored plan, your contribution maxes at $16,500. Simple plan: take bonus, dump into SEP or 401k account, wait 30 years, retire happy.
Kiss High Interest Debt Goodbye
Even doctors are prone to credit card debt. But what’s the point of having a checking account paying nothing and then paying 10 to 15% interest on credit card balances at the same time? Here’s some motivation: if you pay off your credit card balances with your bonus, it’s like getting a guaranteed double digit investment return. Try doing that in the stock market.
Get Back on Target
Still scared of investing during the Great Recession? Or maybe you’ve built up some confidence after a spectacular September stock market rally. Whatever the reason, your portfolio is probably off balance and you’re either taking too much risk or not enough of it. Take your bonus money and rebalance back to the right mix of investments (asset allocation) for your unique risk tolerance.
Bonus tip for your bonus money: Ask your group for an even higher bonus now so you can shift more income into 2010 since income tax rates will likely go up for most EPs in 2011.
Setu Mazumdar, MD practices EM and is the president of Lotus Wealth Solutions in Atlanta, Georgia