Five Strategies to Use a Bonus or Raise - Update

Many companies provide some form of incentive compensation as part of their overall compensation package. In fact, 85% of U.S.-based companies paid out bonuses in 2018, according to a recent survey by WorldatWork, an association of human resource professionals.1 Many of these same companies also offer spot bonuses and raises during the year to recognize good work and motivate employees to continue to drive results.

If you’re fortunate to see a boost in your paycheck—whether it’s through a bonus, raise or promotion—it may be very tempting to spend this extra cash on a new electronic gadget or fun vacation, but using your bonus on long-term, big picture goals maylead to greater happiness in the long-run.

What should you do with your extra compensation? Start with the basics. Focus on two important objectives: catching up and getting ahead. Here are five strategies to put your money to work for you now, so you can potentially reap the rewards down the road.

1. Pay down part or all outstanding debt

If you have debt, such as student loans, car loans or credit card debt, a bonus can be a great way to tackle it aggressively. And if the interest rate on your debt is high, make this a top priority. The money you pay in interest can cost you thousands over time.

2. Boost your investment in your 401(k) and max out other retirement accounts

Hopefully, you’re already contributing to your company’s 401(k) retirement account and taking full advantage of any available company match. When you receive a bonus or an increase to your salary, consider increasing your contribution, since the more money you set aside today, the better off you’ll be in the long run, helped by the power of tax-deferred growth potential.

Also consider maxing out other retirement plans, such as a Traditional Individual Retirement Account (IRA) or a Roth IRA. There are a few key differences between the two that you should understand before setting one up or making contributions:

1.    Income Limits: Anyone under age 70 1/2 can open and contribute to a Traditional IRA as long as they have earned income; however, with a Roth IRA, there is no age limit but there is an income cap (only married couples with Modified Adjusted Gross Income (MAGI) of $193,000 or less, or a single person with MAGI of $122,000 or less) are eligible to make a full contribution. The maximum annual contribution for both accounts in 2019 is $6,000 (or $7,000 for those age 50 or older).

2.    Taxes: Funds within an IRA have the potential to grow on a tax-deferred basis. Contributions to a Roth IRA are made with after-tax money, so you can withdraw the contributions tax-free, penalty-free any time. The earnings can be withdrawn federally tax-free, penalty-free once you reach age 59 1/2 and the account has been open for five years.2 With a Traditional IRA, the contribution may have been deductible or non-deductible.3 Deductible contributions and earnings are taxed when you withdraw them. Non-deductible contributions are not taxable but the earnings are. Withdrawals made prior to age 59 1/2 may be subject to a penalty tax unless an exception applies.

Roth IRAs may be particularly well-suited to millennials and those starting their careers because of the ability to withdraw contributions without tax or penalty if necessary. Your Financial Advisor can help you make the best decision for your particular situation.

3. Contribute to a savings or investment plan

If your current financial situation is solid and your debt is under control, consider investing your newfound cash in a savings or investment plan that is earmarked for a long-term goal, like buying a home, but is also available for any short-term emergencies. Resist the temptation to invest in an ad hoc manner. Instead of picking a few hot stocks, follow your long-term investment strategy. Work with your Financial Advisor to help reduce volatility within your portfolio through diversification and asset allocation tactics.

4. Save through an education savings plan, such as a 529 plan or Coverdell ESA

The average cost of tuition and fees at a private college was $34,740 for the 2017-2018 school year, according to the College Board.4 This expense has continued to rise every year, making saving for your children’s college education a priority.

If one of your long-term goals is to send your children to college, consider allocating some of your new funds towards a savings plan dedicated to covering these expenses. A 529 Plan and a Coverdell Education Savings Account can both be excellent college savings vehicles because they are both tax-free when used for college. There are important differences between the two—specifically age, income and contribution limits—so do your homework before determining which program is best for your family’s needs and goals.

5: Invest in yourself

If all your necessities are covered and your long-term goals are on track, think about using some of your enhanced compensation to accomplish an important short-term goal. For instance, if you’re focused on making healthier choices, you may want to consider investing in a gym membership or a wellness group. And if you're striving to slow down your lifestyle, you may want to book a meditation retreat or learn yoga. This way, you reward yourself for a job well done, while achieving an important goal.

Making the Most of Your Money

Earning and receiving a bonus, raise or promotion is very satisfying, and can help you advance your financial well-being. Speak with your Financial Advisor about how the money can help you reach your future goals. 

1 Source: WorldatWork 2018-2019 Salary Budget Survey, July 2018.

2To be a federal income tax-free qualified distribution, the distribution must (a) occur after the Roth IRA owner’s 5 tax-year holding period, and (b) be made on or after the owner reaches age 59 1/2, due to the owner’s death or qualifying disability, or for a qualified first-time homebuyer purchase ($10,000 lifetime maximum). The state income tax treatment may differ.

3An individual who is not an active participant in an employer plan can make fully deductible contributions. The deduction is phased out for active participants in an employer plan whose Modified Adjusted Gross Income (MAGI) exceeds certain amounts. An individual who is not eligible to make a deductible contribution to a traditional IRA may make a non-deductible contribution. If you file IRS Form 8606 in each year that you make a non-deductible contribution, the portion of a distribution attributable to the non-deductible contribution will not be taxed.

4 Source: The College Board.


This material does not provide individually tailored investment advice. It has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. The securities discussed in this material may not be suitable for all investors. Morgan Stanley Smith Barney LLC recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a Financial Advisor. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. This material is not an offer to buy or sell any security or to participate in any trading strategy.

Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.

Tax laws are complex and subject to change. Morgan Stanley Smith Barney LLC (“Morgan Stanley”), its affiliates and Morgan Stanley Financial Advisors and Private Wealth Advisors do not provide tax or legal advice and are not “fiduciaries” (under the Internal Revenue Code or otherwise) with respect to the services or activities described herein except as otherwise provided in writing by Morgan Stanley and/or as described at . Individuals are encouraged to consult their tax and legal advisors regarding any potential tax and related consequences of any investments made under an IRA.

The 529 Plan Program Disclosure contains more information on investment options, risk factors, fees and expenses, and potential tax consequences. Investors can obtain a 529 Plan Program Disclosure from their Financial Advisor and should read it carefully before investing.

Investments are subject to market risk and may fluctuate in value. Before investing, investors should consider whether tax or other benefits are only available for investments in the investor’s home-state 529 college savings plan.

Investments are subject to market risk and may fluctuate in value. Before investing, investors should consider whether tax or other benefits are only available for investments in the investor’s home-state 529 college savings plan.

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