Have you ever blown a bonus and felt guilty you didn't set any aside for savings? In this episode we discuss how to allocate those lump sums like annual bonuses or tax refunds so you can treat yourself without worrying about saving for the future.
[00:00:00] Welcome to the More Sense Than Dollars podcast, where your hosts Nick and Harry.
[00:00:10] Hello, listeners.
[00:00:17] It's time for another episode.
[00:00:20] I think this is episode 63 of More Sense Than Dollars.
[00:00:25] Welcome back.
[00:00:26] We got a good one for you.
[00:00:28] Ready, Nick?
[00:00:29] Of course.
[00:00:31] This episode is coming out during the typical bonus season and also around tax refund season.
[00:00:39] So as you saw by the episode title, we're going to talk about what to do when those
[00:00:43] sorts of checks come in.
[00:00:47] This methodology and advice we go through does apply to other lump sums that come
[00:00:54] in, but for the most part we'll be sticking with bonuses and tax refunds because those
[00:01:00] are some of the most common non-paycheck big checks that come in.
[00:01:06] Right.
[00:01:07] If you're getting an inheritance or a sizable amount through that, or you won the lottery,
[00:01:14] some other massive sources of lump sum, the percentages you're going to apply are
[00:01:19] definitely going to be different than what we're going to go through here, but it's
[00:01:22] going to be the same approach, same type of thinking that you would use.
[00:01:28] Yeah.
[00:01:29] We're focusing more on everyday year-to-year scenarios for most people.
[00:01:33] The goal is how do I spend it?
[00:01:35] Well, feeling somewhat responsible but also not so guilty that I'm spending it all
[00:01:41] on something that I want or something impulsive.
[00:01:46] So we'll go through how to balance those things.
[00:01:49] First, what's on your mind?
[00:01:51] Say your piece.
[00:01:53] So mine's a follow-up to a previous say your piece where I mentioned the potential for
[00:02:02] me to switch budgeting apps from You Need a Budget to Monarch Money.
[00:02:07] So I'm still going through my trial period, but it's looking more and more like the
[00:02:13] switch is going to happen.
[00:02:15] That's good.
[00:02:16] Which is a pretty big deal.
[00:02:17] The one hang up right now is needing to import historical information because I'm not willing
[00:02:23] to give up the seven plus years of tracking and data.
[00:02:29] Particularly from the net worth perspective, I don't want to start that tracker over again.
[00:02:34] Is it doable?
[00:02:35] Does Monarch let you import?
[00:02:37] Yeah, yeah.
[00:02:38] It is doable, but it's going to take some manual effort.
[00:02:41] It's not a...
[00:02:42] I'm going to have to export each account.
[00:02:45] Things need to be exported from You Need a Budget and then reformatted to match Monarch's
[00:02:50] format and then imported there.
[00:02:52] Kind of annoying, but at least it's possible.
[00:02:54] So it's not an easy lift, but looks like that's going to happen.
[00:02:59] Pretty excited about that.
[00:03:01] Another time where our research on an episode helps us too as the hosts.
[00:03:10] Mine is more of a piece of advice.
[00:03:12] I think everyone should be taking advantage of loyalty programs.
[00:03:18] We don't really want these companies to have all of our data and things, but they have
[00:03:22] it anyway.
[00:03:23] So you might as well get some benefit out of it.
[00:03:26] If there are places that you frequent, like retailers or food places, you get a
[00:03:32] lot for some of these loyalty programs.
[00:03:36] But even things like Sweetgreen, Cava, Chopped, 7-Eleven, Banana Republic, Gap, Old Navy.
[00:03:47] A lot of these companies give you a lot of points and things for shopping there.
[00:03:51] And so if you are a frequent shopper anywhere, definitely do it.
[00:03:57] That's my piece.
[00:03:58] Okay.
[00:03:59] So you just got whatever it is.
[00:04:03] Hopefully it's a lot of money.
[00:04:04] A few thousand dollars either from a bonus because you did so well at your job this
[00:04:09] year or you got your tax refund.
[00:04:13] That was a few thousand.
[00:04:16] I want to buy something really nice for myself, but I know I should be responsible
[00:04:20] and probably save some of it.
[00:04:23] The question is how do I do both of those things and balance them?
[00:04:26] Yeah.
[00:04:27] Where do we start?
[00:04:29] Step one is how you think about these types of anticipated lump sums.
[00:04:37] You generally know that bonus season is coming up or that you may be getting a tax
[00:04:41] refund soon.
[00:04:42] So I would say step one, or maybe even step zero, is to not include those payments
[00:04:50] as part of your annual long-term financial planning.
[00:04:57] You don't want to be in a position where you justified maybe a higher rent by an
[00:05:03] expected bonus.
[00:05:04] Maybe you said, okay, I'm going to get a $5,000 bonus.
[00:05:08] If I break that down per month, that's like an extra 800 bucks a month.
[00:05:12] I can splurge a little more on my rent.
[00:05:15] Do not do that.
[00:05:16] Yeah, they're not guaranteed.
[00:05:18] The company any year could say we're not paying bonuses this year and they
[00:05:23] don't owe it to you.
[00:05:24] That's why it's called a bonus.
[00:05:27] If you plan for it in your expenses, you're screwed.
[00:05:33] Right.
[00:05:34] So don't necessarily count on it as being something that goes towards your needs or
[00:05:40] your goals.
[00:05:41] Right?
[00:05:42] So that would be step one.
[00:05:45] But step...
[00:05:48] That would be step zero.
[00:05:50] You're kind of a prerequisite.
[00:05:52] So then what do you do when that money actually comes in, hits your account, you find out
[00:05:56] how much you're getting from your bonus or your tax refund?
[00:06:00] Treat it like it is a regular paycheck.
[00:06:07] Work it into your budget using the same 50-30-20, 80-20, 60-40, whatever methodology
[00:06:13] you're using to break down your income for your budget, apply that same logic
[00:06:18] to the bonus or the tax refund.
[00:06:22] Yeah, I think it's good to...
[00:06:24] It's probably going to come into your checking account.
[00:06:27] So get it into while you're doing this math, get it into your savings account so that
[00:06:33] you're making some interest on it while it's sitting.
[00:06:36] Hopefully you're not doing something super impulsive right away and you may be taking
[00:06:40] a few weeks to decide what you want to buy or where you're going to put it.
[00:06:45] Get it over into a high-yield savings account and then do these calculations.
[00:06:52] And hopefully if you listen to Nick and did not put this towards your needs or did
[00:06:59] not budget for this in your needs, then you're going to have 50% of this that you
[00:07:05] don't need for rent or groceries or things.
[00:07:09] So if...
[00:07:10] Yep, for minimum payments or any of that.
[00:07:13] How I would think about it, we're using that 50-30-20 framework.
[00:07:17] Break it down, spend 30% of that on wants, get something nice for yourself, maybe a
[00:07:23] vacation, maybe save it towards a future vacation.
[00:07:27] Any of those things could fit into that wants category and then put 70% of it
[00:07:32] towards goals.
[00:07:35] That's like the really...
[00:07:36] It's like Fast and the Furious nitrous in the gas tank of your financial goals.
[00:07:44] Right.
[00:07:45] 70% of a big check going towards the flow chart in the last episode we talked about
[00:07:52] or whatever goals you have at the moment, you've accelerated those by...
[00:07:57] I don't know.
[00:07:58] A bonus could be a few months worth of pay, right?
[00:08:01] Yeah.
[00:08:02] Depending on what kind of work you're in.
[00:08:04] It could vary dramatically, but take that 30% for yourself and then plug the other
[00:08:11] 70% into the flow chart and see which bucket money ends up in.
[00:08:18] You could zip down a few levels of the flow chart, right?
[00:08:22] But it's like I put it all into my emergency fund and I've still got some
[00:08:27] left and I'm able to pay off my credit cards.
[00:08:31] Yeah.
[00:08:32] Maybe you're in a position, your first job out of college, you haven't had a chance
[00:08:35] to save much, you're still working towards that one month of emergency fund.
[00:08:40] You know there's an employer match that you're not getting, but you really want
[00:08:44] to make sure you have that one month emergency fund built up before you start contributing
[00:08:48] to the 401k.
[00:08:50] You could knock out that entire emergency fund potentially with the money from your
[00:08:55] bonus.
[00:08:56] Yeah.
[00:08:57] You are free to immediately start taking advantage of the employer match and say you're
[00:09:04] doing a 6% to get the full match of 3%.
[00:09:07] I'm just using average numbers here.
[00:09:10] That alone is 9%.
[00:09:12] Nine out of the 15% that you are aiming to save could be well within your reach
[00:09:20] within a month because you put a bonus payment towards your emergency fund.
[00:09:25] Yeah.
[00:09:26] And think of the peace of mind that then comes with that.
[00:09:30] Oh yeah, if you have, say you've just been able to make your minimum payments on credit
[00:09:34] cards and you racked up some credit card debt and all at once you can wipe them
[00:09:39] out and pay off the whole balance.
[00:09:42] That's pretty nice.
[00:09:43] Peace of mind.
[00:09:44] Yeah.
[00:09:45] So a big piece of this is the psychological part of it.
[00:09:51] It's a lot easier to do what we're saying to put that 70-30 split on your bonus into action.
[00:09:59] If you have already experienced or know the satisfaction or peace of mind that will
[00:10:04] come with hitting some of those goals.
[00:10:07] Yeah, the initial thought is well it's unexpected income.
[00:10:12] I don't need it to pay my rent so I should just take 100% and buy something nice.
[00:10:19] Yeah, and guilt will follow.
[00:10:21] Yeah, I've definitely been there and especially if you've always been in a situation where
[00:10:28] money is exclusively a source of stress.
[00:10:33] It can be very tempting to take the opportunity to get something nice or more of a distraction.
[00:10:39] But really think about is that all it is?
[00:10:43] Is it just a distraction?
[00:10:46] This is something that I've experienced personally.
[00:10:49] The first time, I said before, I got a little bit pretty manageable amount but I got into
[00:10:54] some credit card debt right out of college.
[00:10:56] The peace of mind or the sense of calm or the lack of stress that came with paying
[00:11:01] that off was a huge learning moment for me in realizing how money can contribute
[00:11:10] improve or do the opposite towards your mental health and realizing, oh, getting this financial
[00:11:18] albatross taken care of or feeling more comfortable in my financial situation is way
[00:11:23] more mentally satisfying than getting a new computer.
[00:11:31] Yeah, the problem is you take a $5,000 trip or something, say you get a tax refund,
[00:11:37] $5,000, you go take a nice trip, you come back.
[00:11:42] The $5,000 in credit card bills that you still have is still there waiting for you
[00:11:46] when you get back.
[00:11:48] You just kind of covered it up for a little bit.
[00:11:50] Yeah, you just delayed the financial stress.
[00:11:55] But if you're at a spot where you've turned the leaf, you're no longer increasing
[00:12:00] your debt, you're just struggling to pay off the debt that is there, this could
[00:12:04] be such a big opportunity to really give yourself some peace of mind.
[00:12:09] Yep.
[00:12:10] So that's part of this too, is to not...
[00:12:12] We realize it can be a little boring or a little dry.
[00:12:16] It's very responsible.
[00:12:17] Yeah, to suggest putting so much of that bonus or tax refund into something, not
[00:12:26] something for yourself, really not a material.
[00:12:27] Or not the instant gratification of it.
[00:12:30] Right.
[00:12:31] But that...
[00:12:34] It's a really rewarding feeling to be financially secure and a lump sum payment like this
[00:12:43] is such a good opportunity to increase that financial security.
[00:12:47] Yeah, fast track through the flow chart to financial freedom.
[00:12:55] So I don't know.
[00:12:57] I think I've tried this before with tax refunds.
[00:13:01] I've done it...
[00:13:03] Let's be honest, I've done more 50-50 a lot of the times by myself, something nice
[00:13:09] with half and saved half.
[00:13:10] But I'll try to go to 30% on the next one.
[00:13:13] That can be fine too.
[00:13:14] And I see the logic, or we're being a little aspirational where we're saying,
[00:13:17] okay, that 30-20 in wants and goals is already taken care of.
[00:13:21] We're going to take all 50 of the needs and put it towards the goals.
[00:13:28] Maybe you don't do all 50, but it really depends on your financial situation.
[00:13:34] If you are still...
[00:13:35] That's true.
[00:13:36] I do that with already having an emergency fund and no credit card debt.
[00:13:42] Right.
[00:13:43] Maybe we would technically be better to add a little more to the emergency fund,
[00:13:46] but you could justify it.
[00:13:48] If you have no emergency fund at all, you should really be using it for this.
[00:13:52] Or if you have a lot of high interest debt, we could make the argument on the other side
[00:13:59] that 100% of the bonus or tax refund should go towards the high interest debt because
[00:14:05] of the difficulty that comes with climbing out of that.
[00:14:09] Because every month that that's still sitting there, it's adding more and that's going
[00:14:14] to eat into the payments you're making towards it.
[00:14:17] You could dramatically speed up the amount of time it's going to take to get out of
[00:14:21] that debt with a big lump sum payment.
[00:14:25] That's true.
[00:14:26] In that case, even the 30% you'd use on a shopping spree is not worth it compared
[00:14:32] to paying off the high interest debt that you have.
[00:14:37] Right.
[00:14:38] It depends on where you're at.
[00:14:41] These are easy guidelines.
[00:14:43] We're talking specific numbers.
[00:14:44] You can punch that into a calculator, have an exact breakdown of how to spend or at
[00:14:51] least which portions of your budget to put that money towards.
[00:14:55] What is really important here is having the mental fortitude or the personal finance
[00:15:03] discipline to know that the reward, the dopamine hit, the sense of peace or lack
[00:15:13] of stress you will get from being responsible with the money is actually significantly
[00:15:19] higher than what you would get from a short term splurge.
[00:15:22] Right.
[00:15:25] It's hard.
[00:15:26] You see a big number come into your bank account and you want to treat yourself.
[00:15:34] But I've definitely been there and I did that for a while.
[00:15:38] But then, like you said, once you actually save it a few times, it gets easier with
[00:15:45] each time I think.
[00:15:47] Yeah.
[00:15:48] Because there was always a little bit of guilt that would creep in.
[00:15:49] Yeah.
[00:15:50] I was like, I really shouldn't.
[00:15:51] You can't enjoy the thing as much.
[00:15:55] The first time after I had really committed to the 50-30-20 budget and actually used
[00:16:03] the bonus or tax refund in that way.
[00:16:07] It's guilt free, right?
[00:16:08] I felt a lot better.
[00:16:09] You know, it was still enough to get a little something with that 30 percent.
[00:16:15] But there is a...
[00:16:17] I was able to fully enjoy it.
[00:16:18] I didn't feel like I had to justify it or play any mental gymnastics.
[00:16:22] I was able to just say, yeah, I earned this.
[00:16:24] I got something nice for myself and I shored up my emergency fund.
[00:16:30] I added another month to the emergency fund.
[00:16:33] Something like that.
[00:16:34] It's a really rewarding feeling and it's something that compounds.
[00:16:39] You know, if you train yourself to look forward to the rewards of being
[00:16:44] responsible with your money, you can find those opportunities in other areas.
[00:16:49] And you're training your brain to be rewarded when you make those
[00:16:55] responsible decisions instead of it being something you have to convince
[00:17:00] yourself to do.
[00:17:00] Now you're evangelizing our listeners to be like us and be really into
[00:17:05] savings and personal finance.
[00:17:06] And it's...
[00:17:09] Yeah, well, it can be a light bulb moment.
[00:17:12] True.
[00:17:12] I think it was for me when I was like, oh, I could do both.
[00:17:15] I can do both.
[00:17:16] And it feels better this way.
[00:17:21] Another thing I was going to say just as some pitfalls to avoid.
[00:17:26] We've gave some generalizations about maybe not how not to spend the money
[00:17:30] or how to break it down.
[00:17:32] One thing I would 100% say to avoid in all situations, at all costs with a
[00:17:39] lump sum like this is avoid invest or not invest, but avoid spending the
[00:17:46] money on something that is going to come with recurring expenses.
[00:17:50] Oh yeah.
[00:17:51] Then you're actually spending a lot more on it than what you might.
[00:17:54] Right.
[00:17:55] Even if it's with that 30%, don't...
[00:17:58] You're using a one-time payment as a justification for something that is
[00:18:07] going to become a monthly payment going forward.
[00:18:11] Something like it may be a pet, an animal.
[00:18:17] There's a designer dog.
[00:18:19] You've really wanted a golden doodle, something like that.
[00:18:23] And you use this as a justification to buy the pet or maybe a more expensive
[00:18:30] car, you trade your car in, you combine that with the money from your bonus.
[00:18:35] You get a nicer car.
[00:18:36] You've just added to your needs basically, right?
[00:18:39] Like your obligations for the next month.
[00:18:41] I don't get a bonus next month too, but I do have more expenses.
[00:18:46] Yeah.
[00:18:47] So take into account the implications, the ramifications of your decision
[00:18:53] because using a one-time payment like this to generate monthly recurring
[00:18:59] costs is going to take what could have been, like you said, the nitrous,
[00:19:04] the pedal to the floor boost to your personal finance journey.
[00:19:09] You could actually set yourself back with the decisions you make
[00:19:14] when a lump sum like this.
[00:19:15] Good point.
[00:19:16] Comes about.
[00:19:17] Did we talk about setting tax money aside?
[00:19:21] Money for taxes?
[00:19:22] Usually bonuses will, like if it's from your company, they'll just
[00:19:26] treat it like a paycheck and pull taxes out.
[00:19:28] But if they don't, or if it's a, I don't know, a really big lottery win
[00:19:36] or something where that money is getting reported to the IRS, they
[00:19:40] know that you made that money and they're going to want to collect
[00:19:44] taxes on it.
[00:19:45] If so, if you didn't pay it at the time that you got the lump sum, then
[00:19:53] you're going to have to when you pay your taxes.
[00:19:55] So just make sure you have some percentage set aside for that,
[00:20:00] which could be like 40%, depending on where you're at, your state
[00:20:08] and federal taxes and all that.
[00:20:10] But set some aside just in case.
[00:20:14] So depending on the, you know, if it's a gambling, if it's gambling
[00:20:18] winnings or something, I think slots might be around a thousand or
[00:20:24] 1200.
[00:20:25] If you win 600 on sports, 5,000 on poker, though anything above that
[00:20:32] is going to get reported to the IRS.
[00:20:34] So they will remember when it comes tax time.
[00:20:38] Taxes on bonuses can also be withheld differently than your ordinary
[00:20:45] income.
[00:20:46] When the next year rolls around and you file your taxes, they're
[00:20:53] going to be taxed and this can be a little, the nuances here
[00:20:56] can be a little confusing.
[00:20:57] They will be taxed the same.
[00:20:59] They're just included with all your other income, but that doesn't
[00:21:02] mean that they are always withheld from your payday.
[00:21:05] That they are always withheld from your paycheck at the same rate
[00:21:10] as your ordinary income.
[00:21:12] And so I've, you know, noticed this myself.
[00:21:15] Sometimes there's a flat rate that is used for withholding on
[00:21:20] bonuses instead of, you know, whatever is usually withheld.
[00:21:25] And so usually if I get, and again, the impact of that could be
[00:21:31] wildly different depending on what your ordinary tax bracket is
[00:21:35] that flat rate could be more than you would normally get withheld,
[00:21:38] which means you're going to get more back on your taxes, but it
[00:21:42] could be lower than your ordinary income.
[00:21:44] And so you're actually going to owe more because of that bonus.
[00:21:48] So one thing I've done previously is redone.
[00:21:52] And this is getting a little crazy, little nitty gritty, but
[00:21:58] a couple of years after I get my tax beginning of the year, I
[00:22:03] have recalculated my withholdings using the IRS calculators
[00:22:10] because especially when I was making less earlier in my career
[00:22:14] and in a lower tax bracket, I paid more or I had more withheld
[00:22:19] from the bonus than I needed.
[00:22:21] And so I was actually able to lower the amount withheld each
[00:22:26] paycheck because I had already paid a lot of my tax burden or I
[00:22:32] already had a lot of that withheld from my bonus at the beginning of the year.
[00:22:37] And so instead of waiting for the next year to roll around and get a
[00:22:42] bigger refund, I redid my tax forms and got a little extra on each
[00:22:46] paycheck through the rest of that year.
[00:22:48] Nice.
[00:22:49] Yeah.
[00:22:49] Then you don't have to wait for it.
[00:22:50] But that's something you can do too.
[00:22:53] If you are, this may not be a bonus in the traditional sense,
[00:22:57] but if you're an independent contractor and receive maybe a
[00:23:01] one-time lump sum payment for some reason, you know, you could be in a
[00:23:05] situation where you're receiving pretty regular wages, but do you
[00:23:10] receive a larger one at some point, maybe for a special project or
[00:23:14] a special engagement, that's somewhere you're definitely going to want to
[00:23:18] make sure you take into account the extra taxes you'll owe on it.
[00:23:22] Because you're, you know, if you're an independent contractor, you
[00:23:26] probably have no automatic withholding and you need to keep track of all that yourself.
[00:23:31] All right.
[00:23:32] So set aside taxes, buy yourself something nice for 30% of it.
[00:23:38] Use the other 70% for the flow chart.
[00:23:40] Get your credit card debt paid off, your emergency fund set out, max
[00:23:45] out your IRAs and feel good about accelerating your path towards financial freedom.
[00:23:55] That's all for this one.
[00:23:56] Thank you all very much for listening and we will see you in the next episode.
[00:24:01] Bye everybody.
[00:24:02] You've been listening to the more sense than dollars podcast.