Here’s an email I recently received from a reader:
Dear ESI Money,
I’m wondering if you and your readers can provide some advice on the best way to invest a large annual bonus.
I moved several years ago into a sales production role in which a good portion of my compensation is paid in a lump sum once a year. I’ve had good fortune and have built my book of business up to the point where my annual bonus amount now eclipses my base salary.
Here are some details about me, my goals and where I am at this time in my life…
My wife and I purchased our primary home 11 years ago and had twins shortly thereafter. They’ll both be entering college (or graduating high school and moving to their next phase) in just over 7 years. My wife stopped working outside of the home when we had our twins, and we’ve been happy with that decision as it’s allowed her to be very involved in their growth and development.
We live in a community with a good school district and don’t have any plans to leave anytime soon. I work from home and my job would permit me to live just about anywhere on the East Coast but we plan to stay where we are at least until the kids are 18.
My company also affords me a couple of other perks for which I am grateful. First, I get a company car which has reduced my automotive spending (we own my wife’s minivan in full after financing it for 0% a few years ago). Second, I travel regularly for work and the rewards points I generate allow our family to enjoy roughly one vacation a year where we fly and stay in hotels for free.
Being the sole financial provider for my family has not been without its drawbacks. I managed to navigate through challenging conditions at two previous companies which led to temporary income reductions within the past decade. We felt the impact of those income reductions when they occurred, and they prevented me from investing as much as I would have liked during those times. But I find myself now at 44 at the peak of my lifetime earnings (so far) and becoming more and more a believer in developing financial independence.
I love my role in business development and can’t say that I’m interested in retiring at 50, though having the option at 55 with my primary house paid off had been my goal as my kids would be due to graduate college by then should they choose that route. My current retirement savings between my Vanguard account and current company’s 401k account is approximately $675k total.
I had a slight complicating factor develop in the past two years. My Mother-in-Law’s health started deteriorating, as did the state of the 40-year-old home that she was in. It became clear that my wife and I needed to help her retire, and getting her into a home with a first floor master bedroom along with other senior living amenities became of paramount importance.
We ended up opting to help her buy a home in her dream location of a beach community. She essentially transferred the value of her old home into the new property, and we agreed to pay for the rest (as well as the comparatively low local taxes) by picking up a mortgage. While we co-own this property with her now, the long-term benefit is that we’ll take full ownership eventually (she’s had her will changed to reflect this). Short term, our family gets to use the house as a vacation property with the added benefit of having Grandmom there. But I did pick up the financial obligation of an additional monthly mortgage which I hadn’t been planning for two years ago.
I’ve spoken with my parents, and they should have more than enough savings to carry them through their golden years. In addition, they plan to contribute annually to my kids’ college funds. They currently contribute roughly $4k a year to each, but that rate may increase over time. They also have my kids built into their will, though I’m not comfortable relying on my kids inheriting my parents’ money as a primary driver of their college savings.
All of this comes at a time when my efforts to build a name for myself in my industry over the course of 15 years have started to show real signs of traction. My book of business has built up to the point that my annual bonus for this past year was greater than my salary.
The total bonus before taxes came in at just over $200k this year for which I am grateful. After taxes, maxing out my 401k, paying off some recent and unexpected credit card debt (I know – not good), taking care of some needed home improvements (new HVAC, generator, etc.) and adding to our rainy day fund (now standing at $40k in cash reserves) we have about $80k left to invest for this year.
I’d like your thoughts (along with your readers) on which of these items (or combination of items) you’d look to put the $80k (and future bonus money) into first:
1) Pay down my primary home’s existing 20-year fixed mortgage with $255k left on it at a 3.375% interest rate. We have just over 14 years left on this 20-year fixed mortgage.
2) Pay down the 30 year mortgage on the beach property we bought for my Mother-in-Law which serves as her retirement home and we use as our vacation house. We have $108k left on a 30-year loan at a 4.125% interest rate. We just took the loan out last year with the original intention of paying it off in less than 5 years.
3) Make larger contributions to the 529 plans of our soon-to-be 11 year old twins. We currently have roughly $88,000 in each of their accounts which feels light for the 7 years we have until they graduate high school.
4) Reinvest the money in low-expense Vanguard Target Retirement Date index funds with the expectation that they’ll generate more than the interest I’m paying on the two houses less the home ownership tax incentives. In addition, this would allow me to increase the total of $675k that I currently have on hand for retirement.
I’m forecasting to have a bonus at least as large as this one moving forward for the next several years. Anything can happen in life, but I’d also appreciate thoughts on how you would invest an annual bonus of at least $80k-$120k after taxes moving into the future as well so we can plan a bit better for next time.
Best Regards,
A Loyal ESI Reader
What is your advice for him?
Laurie@ThreeYear says
Congratulations on building up such a large income over time! I think I’d recommend that you figure out what’s most important to you first. Is it more important to be totally debt free, be able to retire, or send your kids to college anywhere they want to go?
It looks like you have about $365 in mortgage debt at a relatively low interest rate. Is it important to you to pay that debt off and be debt free? Are you otherwise debt free? You’ve got two kids who have almost $100K each in college funds going to school in 7 years. Is it your goal to fully fund their college anywhere they want to go? If your bonuses continue to be large you could probably pay those costs out of pocket and if you put a lot more money in your 529s it’s stuck there–you can’t use it for retirement if the kids don’t end up going to as expensive a college or get scholarships.
Reading between the lines, it looks like you’ll need to bolster your retirement savings quite a bit to match spending in retirement. You could consider opening taxable accounts. You might consider a plan where each year you’d receive the bonus, you’d earmark a small portion for a special trip (or similar “splurge”), one half for paying off your mortgage debt, and the other half for the taxable accounts. You’re also the sole income earner, so you may consider an entire year’s worth emergency savings, as a super-secure backup.
I would take the time to really think about what your goals are first, though. When do you want to retire? How much do you spend per year? How much would you spend with no mortgages? Where are your kids going to go to school? How much will you really need? Are they likely to get scholarships? How important is it to be totally debt free? (Feelings are sometimes more important than math when answering the pay-off-the-mortgage question). In any case, this is always a good problem to have! 🙂 Good luck!
TheHardenedInvestor says
I agree. Seems like you just have to figure out what your top priority is as you already have a solid understanding of the types of things you could do with the money. The only thing I would add is that I’d probably skip funding the 529 more heavily. Here’s an article about 529 plans from GCC…
https://www.gocurrycracker.com/why-gccjr-has-no-529/
That option seems more like a limiting option in my opinion. Again, if that’s your priority who am I to say otherwise though?
As long as your option isn’t to waste the money, then I think whatever you decide it will ultimately work out just fine. Applying 25% of the bonus to the 4%+ mortgage and then investing the rest in the low cost Vanguard fund would likely be my play. Although I would struggle not investing it all as that is my natural proclivity. Bottom line, you have a good problem to have.
RonS says
Link to Go Curry Cracker doesn’t seem to work or GCC.com not operative.
ESI says
It works for me…
sendaiben says
Pay off the higher interest mortgage. That will give you a guaranteed 4%+ return (after tax) as opposed to whatever the seemingly overheating stock market will give you.
You can then invest the money you would have been putting toward the mortgage once it is paid off.
DD says
With years of similar bonus amounts I followed a clear plan. First invest such that tax exposure may be reduced. In CANADA this means investing in one’s retirement savings plan; think of this as the first $25K. From there it was simply a balance between debt reduction, and investment. This balance would shift by 10% as I allowed for some thought to impact (example, the market smells overheated, go 60% toward debt reduction).
Hindsight indicates investing would have been better. However, the sheer pleasure found in paying off a mortgage can not be understated. Not sure hindsight is a friend!
Bernd Doss says
It appears from reading your post that you have given these issues a great deal of thought. However, asking for investment advice will only bring more thought and confusion, in my opinion. One thing I did not read was your intentions to cover health costs as you mature. Basic health care may be covered by some small insurance policies, by company benefits, or your emergency funds, but it almost is never enough. My recommendations is you sit down with your spouse and consider future potential health issues and develop a reasonable and viable plan that will support your future retirement and any health issues that you, or your family may come upon. Good Luck.
Gerard says
I have not done the math, so this is just guessing advice, but why not split the bonus 4 ways and contribute 25% of the bonus to each of the 4 options?
Chadnudj says
I’d rule out paying down your primary mortgage — it’s at a good low interest rate, at your income level you get some tax relief from it (although that may have changed with the new tax laws), and $80k on the $255k remaining balance wouldn’t really reduce your monthly payments all that much if you recast the mortgage.
I’d also rule out the 529s — you/your parents are continuing to contribute to them, and they already have $88k in each of them. Even with no growth at all, $4k per year per account (which is just your parents’ contribution!) for the next seven years will push them over $116k, which should pay for at least 2-3 years of college (which is a nice leg up to your kids); if there’s some growth, it could pay for more/all of it. And you could always cash-flow it later.
That leaves the mom-in-law’s mortgage (which you could almost wipe out), and taxable account. Both of these would be a good choice, but I lean towards the taxable account. Here’s why — if you invest in the taxable account, you leave ALL of the other options still on the table. If you feel like “hey, I want to pay down one of the mortgages” you can do that, or move all the money into the 529s. Sure, you may have gained/lost some money during that time invested (more likely gained, since the long-term arc of the stock market is up; and yes, that’s true even in today’s supposedly “overheated” market!), but the liquidity of the account is its own benefit.
What I’d do is invest it in taxable, and then take all dividends from the account and just plow them into the 529s or paying down one/both of the mortgage when they come in. But that’s me….
Millioinaire 14 says
I agree totally with this approach.
M22 says
Agree with chadnudj….Your mortgage interest rates are very low cost. Don’t pay then off any faster than the bank requires. Instead use these bonuses to invest in low cost ETF or mutual funds for S&P 500 or Total Market. Let these funds grow and you will always have the option later to determine what to do with the money. A great problem you have and sounds like you are doing everything well financially and with your family. Congrats!
millionaireJason says
I agree, but I think those target date funds are not optimal compared with other taxable options like pure index funds
Sean @ Frugal Money Man says
I come from the Dave Ramsey mindset of destroying your debt before investing. Although your mortgages aren’t considered consumer (bad) debt, they are still a monthly payment that takes a certain % of your income.
I would pay off the vacation home with the higher interest, and then throw the rest at the your primary residence. By owning the vacation home in full, it would free up your monthly take home pay, which would free up even more money to throw at your primary residence. It seems like you can knock both of these mortgages out in the coming years, and once those are both paid off, retirement will start becoming even more of a reality.
You could also take 15% of that bonus off the top, and invest it in whatever Vanguard index fund you wish (Target Date, 500, Total Stock Market). Once you trim that 15% off the top initially, then you can throw the remaining bonus at the vacation home and your primary residence.
Good luck!
mtzabor says
I would pay off the vacation home as fast as possible.
BADGER says
I would first consider all avenues of funding tax deferred accounts. Have you fully funded retirement accounts at work? Is there anything in addition to the 401? Have you funded IRA or Roth for yourself and your wife, and possibly the kids if they can achieve earned income. IRA can be used for education. I would then consider splitting the money between Grandma’s mortgage and emergency fund. You are the breadwinner, I hope you have some form of disability insurance as well.
Aloha Jim says
How about funding Roth IRA and also do Mega Backdoor Roth IRA? Then, you’ll have the flexibility to use this money in the future for college education or something else, while letting it grow in tax-free environment.
Millioinaire 14 says
Agree with Badger and Aloha Jim as well — but I believe the income is too high for Roth IRA funding (I have the same problem). But if you can do the Backdoor Roth IRA, that’s the way to go. Fully fund any retirement/tax-advantaged accounts you are allowed to before investing in any taxable accounts….and based on your current mortgage rates and any tax advantages of those, I would wait to pay those off until your overall retirement nest egg is a bit larger…you can always pay off the beach house with next year’s bonus if it materializes as you expect, but if anything happens, you can’t reverse the mortgage payoff and add to your retirement portfolio at that point. You have 11 years until you want the “option” of retiring at 55, and I don’t know that a current value of $675K in retirement funding will get you there, especially considering the other readers’ very valid comments about health insurance etc. I’m 52, with grown kids, and with a portfolio of just over $2.2M, I’m thinking it’s “just enough” to retire at 55 (no option, I’m going!)
Josh says
Mathematically speaking, if you don’t need the money for 5+ years you’re better off putting it all in the market. But if it makes you feel better and sleep easier at night to have your mortgages paid off by a certain time, I’d figure out how much you need to pay off per year to get you there and then put the rest in a low cost index fund. And start with the higher interest mortgage rate. I wouldn’t put any of the bonus in the 529, it’s already well funded and should grow in the next 7 years, and if you have too much in there it’ll cost you to get it out.
Lily | The Frugal Gene says
I like the options of 2 & 4. I think in 7 years with 2 boys will be totally fine for college. $88k is decent. It doesn’t hurt to make them share some of the costs just to tease in financial lessons but even then I don’t think it’s necessary unless they both go to very pricey schools 🙂
Jason@WinningPersonalFinance says
I think Laurie gave some great feedback at the top.
Setting your goals is going to be key. Since you already have a nice chunk saved for college, do you know for sure you will need more? The tax advantages of investing in a 529 are nice when compared to a brokerage account but that money is less flexible. Determine your planned college contribution is a key step.
The big red flag here is that you had accumulated some credit card debt. I’m a bit confused how that happened if you already had a rainy day fund. If you have not already done so, I’d first put together a budget to make sure that this does not happen again. If your spending outpaces your non-bonus income, keep some in a liquid risk-free account to cover the difference. Avoid paying high interest on credit cards.
The best-projected return on your money is probably to invest (in 529 or taxable account). Assuming you are able to cash flow the mortgages, paying them off early would be a piece of mind decision more than an optimal financial one. Only you can determine how much that piece of mind is worth to you.
If you had to choose which to pay off first, the vacation property seems obvious. It has both the higher interest rate and the lower balance. The caution here though is to make sure your future ownership of the property is guaranteed. You do not want to put over $100K into a property that can get tied up in some sort of inheritance dispute.
ArmyDoc says
I second this. If MIL has other heirs besides your wife, what are they getting when she passes? Spell it out! Does the house get sold? If so do you get what you put in plus 1/x of the reminder? Does your portion account for the interest, taxes, and insurance you may be paying? All of this should be spelled out now (and maybe shared with wife’s sibs) to avoid family or legal issues later. If you don’t want to address this then I would invest in other options first.
getagrip says
One comment is that if you are saving for college and are not receiving a tax break for the 529 other than making it “hard to get to” there is no reason to be pushing a ton more money into the 529. I feel you would be better served with putting the money, earmarked as college in your mind, in taxable accounts. We all assume our kids will go and complete college. Based on my own, friends, and coworkers experiences, while finishing college may generally be the case, it isn’t always. I’ve seen the reasons for failing to continue to include joining “start-ups”, forming a band, college wasn’t for them, taking a gap year to find themselves and then not going back, as well as dropping out and asking for all “their” college money to start their “life journey”. So to me having a significant amount for college outside the 529 can make a fair bit of sense.
Nicholas says
My .02 cents. Why not put 20k into each of the 4 ideas listed above, and continue to do this for the next 3 or 4 years.
Chadnudj says
I also love this idea, FWIW.
Too often folks get caught in a trap of thinking they have to pick the sole optimal choice, when in reality they could diversify their approach (much like diversifying their asset allocation) and make some progress on a bunch of fronts all at once.
(I’ve been blessed to receive from rather large bonuses in the past, and I’ve frequently divided it between fun money for travel, debt paydown, and taxable investing….no regrets at all).
Julie says
Congrats on growing your income so high!
As Laurie mentioned above, being the sole income earner, I would put enough into your rainy day fund to bring it up to a full year’s expenses; then either invest the rest in retirement accounts or pay down the vacation home mortgage. From experience, 2 of my 3 kids did not go to post-secondary (or at least not long enough or in time enough to access their education savings plans).
Mike at Balanced Dividends says
Thanks for sharing and congrats.
From my recent experience (albeit with likely a much smaller amount): do nothing. Sit on hit for a while (a few weeks maybe) and pretend you don’t have it.
You’ll then consider a few things that are needed and/or wanted.
I tend to make over elaborate plans and schemes (not the villain-in-a-cartoon kind, but complex movements to various buckets) long before I even have the capital.
Sitting for a bit is good. It enables a clear mind.
Jason says
Another congrats on your income. I personally would finish off the 529 plans and have that box checked. Then you can take future bonuses and put them on the house or invest.
David D says
I’d put it all towards the mortgage that is just over 100k. It should feel so good to have that almost gone and knowing it will be completely gone in another year.
Mr. Rational Buck says
First of all, congratulations on the large bonus. I must say, that would be a nice problem to have ;).
I may just be starting on my own financial journey, but I figured I’d add my two cents. Personally, I’d look at re-investing a large portion of it and using a small portion to pay down debt.
I think I would forego adding a large sum to the college fund. I say that simply because they each already have $88,000 saved for them…I’m a recent graduate from a great public university, and believe that sum would go a very long way.
No, it would not cover an education at an out-of-state or private school. However, it would most likely pay for 4-6 years at a great in-state public university, depending on their major. I think another 7 years of steadily paying into the funds will cover just about anything they’d like to do in college.
As a personal anecdote, my fiancé just graduated from an awesome public university master program that cost approximately $40,000. She now makes a really great salary in one of the most satisfying (according to Glassdoor’s “top jobs” list) careers there are. Her undergraduate at that same university most certainly did not cost $48,000.
Plus, you have to wonder nowadays if universities really are the way to go, when there are so many cheaper – and just as viable – options out there.
However, if they are dead-set on becoming a doctor or lawyer, you may want to allocate the funds there after all ;).
Sorry for the rant!
Joe K says
I don’t have too much to add to the above, other than my personal experience. I was in a similar place to you in my early 40’s – earning bonuses and long-term incentives that exceeded my salary. We lived off of my salary (one income only) and used bonuses to 1) give generously to church, ministries, and charities 2) pay down mortgage debt and 3) fund 529’s. This is in addition to maxing out 401K and HSA’s. In my late 40’s/early 50’s (now) my career got “complicated” and I have had periods of unemployment. It was a great blessing to know that we had no mortgage payments and that our kids did not have to think about “plan B” for their education during these transitions.
All the best to you!