Help a Reader: What to Do with a Bonus

Here's an email I recently received from a reader:

I'm a recent law school graduate who has spent the last year working for the federal government; in a few months, my job will end and I'll begin working for a corporate law firm. Along with the salary increase ($60k to $175k), I'll be getting a $50k bonus from my new firm for having spent the last year in the government position. My question for you and your readers is how to use the bonus, which after taxes will be $30-40k. Let me give you some background:

First, I have about $150k in law school debt. I haven't consolidated the loans yet because I'm in an income-based repayment program and consolidating would've negatively affected me for that purpose, but when I leave the government full repayment will kick in and I'll be making monthly payments of between $1500 and $2000. That's obviously a lot but manageable given my salary. The worst loan—by both principal and rate—is around $50k at 8%; the others are lesser in amount and rate.

Second, my wife has a trust in her name with around $150k in it that distributes fully upon her 35th birthday, which is two years from now. We plan on using the bulk/entirety of that for a down payment.

(Aside from the trust, which we can't get at yet, we have about $10-12k available cash, and no credit card debt/car payments.)

Third, we've recently discovered we're that expecting twins. This is awesome, but also complicating, as it will knock out my wife's salary for a while, possibly permanently. So the increase in my salary, while great in absolute terms, ends up being only about $50k more than our two current salaries combined.

So what do you think the best use of the bonus is? Should we use it entirely for my loans? I plan to consolidate the loans, but using the bonus to first pay down a big chunk of the loan with the worst terms could significantly improve the results of consolidation. Should we lump it in with the trust for a bigger down payment (which in all likelihood would not mean bigger house but instead smaller mortgage)? Should we keep it as cash on hand for unforeseeable but inevitable baby expenses? Split it up into, say, thirds, and put $10k toward each option? Some other option altogether that I'm overlooking?

What's your advice for him?

Comments

[Ivy]

Congratulations on both the new job and the twins. A couple of major lifestyle changes all at the same time.

You have a pretty low emergency fund, not sure what is your lifestyle and expenses, but with a big change coming up, I would personally opt to keep the $50K aside for a while and see if everything goes well with the twins, and what decision you take on your wife continuing to work. Once you have clarity on these and other factors, it will be easier to take a decision. For example, if she continues to work, and if your combined cash flow allows for the day care expenses, then I would put the funds against the 8% loan. If she stays at home, or if you have unforeseen medical expenses, I would deal with that from the fund, and not worry about the loans. Worst case scenario, use part of the trust fund in 2 years to knock off the debt and postpone the house purchase.

So option 3 for now, and eventually maybe option 1. Definitely not split it, that doesn't solve anything really. And I wouldn't prioritize the house yet, until all is settled post pregnancy and you have cleared the loans a bit

[Your Daily Finance]

Well for it just depends! You have a lot going on at once. Before I worry about what to do with the bonus I would come up with a plan with you spouse. Determine what you two want to accomplish as far as savings and living arrangement. Well she be working or will she stay home for the most part. Do you have money to cover hospital bills for the twins (congrats by the way). When you figure those things out then determine if you want to put you bonus towards your student loans. If you make 2K monthly payments and put 50k towards it you are looking at 75k within one year towards the loan.

[BJ]

First, let me say congratulations on graduating from law school, the new job, and most importantly the babies you and you wife are expecting. I must say all your problems are good problems. If you don’t complicate things, very soon you will be debt free.
The first question you have to ask yourself is can you earn 8% on the bonus or other money you have currently have?I bet you might just earn 1% max if the money will be sitting in a savings account. Even if you were to purchase treasury bills or municipal bonds which I won’t advice, the max you can earn is 2-3%. So in essence, you are losing anywhere from 4-7% just on the high interest loan. That is $2,000-$3,500 yearly. Over 5 year period, that is anywhere from $10,000 - $17,500. Please don’t hesitate in knocking off that high interest loan at 8%. Some would say what about emergency fund. Well, I believe the wife is still working and the husband too should be working for another 2-3 month. They can easily refill that $10-12K for emergency fund. I would advise you save more if you don’t have a good health insurance. Then you can consolidate the rest of the loans, have a lower monthly bill on the loan and attack it aggressively.
Please, having a child is a good thing and not as expensive as advertised especially if the child is healthy. I believe since you currently have good insurance, most of your hospital bills should be covered. When you get your trust in 2 years, decide if you want to knock off the rest of the loan. I am assuming after you start your job, you wife stops her and you consolidate the loans, you will aggressively attack the balance of about $90k-$100k. By the time you apply yearly bonuses or tax returns or extra money, your loan will be paid off in 5 years rather than losing at least $17,500 or more. All the best.

[Mc]

I had twins....no way does it mean your wife automatically has to quit her job--I think its a pretty weird idea actually. Enjoy your kids! But feel free to continue doing the rest of your life too.

[Paul]

As other posters said, 8% is just so much higher than anything else you could do with the money. I would keep it to beef up that emergency fund, then use 1/3 of the wife's trust for the 8% loan and the rest for down payment. Then you still have a large e-fund, a large down payment, and no 8% loan.

Don't buy more house than you can afford, and your mortgage will be fine.

[BH]

I vote pay down the 8% loan. You probably have credit cards that could cover you in the event of an emergency. And since you have a $150k trust, you have an 'emergency fund' there as well. Get out of debt, save for the house and get a modest mortgage. Lastly, as I'm sure you know, so few people are truely happy in big law, so maybe try to avoid lifestyle inflation by focusing on paying off the student loan debt entirely then getting a modest mortgage. I have so many friends who, 5 years out of law school, make $200k + per year but still have six figure student loan debt and now big mortgages and car payments - they literally feel like slaves to their lifestyle and don't seem terribly happy with life, but they are sort of trapped in the life they've created.

[SR]

Congrats on your great salary for a first year associate (or any attorney). I assume you are going to be practicing in big law somewhere like New York, so be prepared to work a lot!

If I was you I would hold on to the bonus money until the babies arrive healthy. After a few months with the babies, then sit down with your wife and make a plan and set a few financial goals. In my view, you should prioritize paying off the student loans because without focused intensity, those things can linger.

Also, don't forget to work out your withholding for your new job or you could be hit with a huge tax bill next spring.

Congrats again.

[Daniel]

Hard to know exactly what to suggest without knowing your full cash-flow situation. You probably need a little more in emergency reserves, but I would also suggest getting the 50k loan paid off as soon as possible. It would be a huge interest savings, as well as an increase in cash flow once that balance is paid off. With the new job/salary, if you keep your expenses low for a bit longer, you can probably knock out some of those debts quickly.

[John S @ Frugal Rules]

Congrats on so many bit life events! With the trust coming due soon I do not think saving some of the bonus for housing should be an issue. I would likely split the bonus in half and throw one part at that 8% student loan and the other half for unexpected needs for the babies. If you do not spend all of that second half you could save/invest it or throw it at the loan.

[Sarah]

Where do you live? If NYC, that bonus will probably be in the $25K-$30K range, rather than $30K-$40K.

With two kids incoming, you're going to want to keep some flexibility. Be strategic about the loans. 8 percent fixed is terrible and you would benefit from getting rid of that one ASAP. Some of the others with lower rates might be tolerated for a while. Part of the problem is that you don't know how you'll react to the Biglaw lifestyle. Some people find they need to get out ASAP, others don't. If you're in the latter group, the loans definitely won't help. So, again, waiting a bit might be worth it.

Finally, $150K is only a downpayment on a $750K apartment in NYC--a low-end 2-bedroom or a nice-ish one-bedroom in Manhattan (I assume SF is similar). With twins, that's going to get crowded right quick. So preparing to supplement the downpayment wouldn't be a bad idea, either.

You may find it difficult to consolidate the loans at all. Banks have little interest in that these days.

[Ross]

Thanks for all the replies, everyone. There's a lot of helpful advice. Using the bonus to pay the debt strikes me as the most prudent path by and large. But as much as it galls me to pay the interest, it is equally as frustrating to write monthly rent checks. I think the interest on the loans outstrips the premium on rent, but not by all that much...

For those who asked, the job is in DC, which while a notch or two below NYC/SF still means we're in a superheated housing market with relatively high taxes. $750,000 goes a fair amount further in DC than NYC, but still we expect to supplement the down payment, thought not all that much more (or not as much as in NYC, at any rate).

And for Daniel (and whoever else asked), one of the difficulties in this planning is trying to pin down what our cashflow will be. We'll be experiencing a big salary increase at precisely the same moment we experience a huge (though very welcome!) increase in household expenses. So both income and expenses are a bit uncertain, though both are going way up. But setting aside the bonus, our incoming cash from my salary alone should be $8k+/month. My wife certainly expects to rejoin the workforce at some point, but to be prudent we are planning based on the assumption that she won't be, at least not for several years.

As for an emergency fund, we have already adopted the plan that BJ mentions, which is concentrating on pumping it up in the remaining 2-3 months that we are both working. I submitted this question a few weeks ago, and in that time (through extreme frugality) we've bumped it up closer to the $15k range. We have no real expenses now other than rent/food (I'm a federal employee for the time being, so while we have lots of medical expenses, they are all presently covered), so we've resolved basically to spend the next 3 months binging on Netflix at home and otherwise saving all of the rest of our discretionary budget. By the time the kids arrive, there could be another ~3k in there.

Lastly, thanks for all the congratulations!

[JimL]

I think you need to reconsider. Your wife will stop working for some time and, as a father of four, I can tell you that you will have many surprise expenses with children. I would save the bonus for your emergency account and then make sure you are living comfortably off of your salary alone. It would be great to use the $150k from the trust to pay off the debt, but can understand the resistance to do so. Therefore, set it aside for a future home purchase and focus all your energy on paying off the debt. When buying a home, the expenses really add up and you could quickly get into financial trouble when you have student loans and a new mortgage.

[so]

From a Biglaw alum: Pay off the debt as soon as you can. Babies are cheap if you don't do daycare; better to clean up the balance sheet with your increased salary and trust while the little ones are younger.

On the housing tip, good housing stock will still be available in 3 years or so, and you'll have a better idea of what will make your life and your family's life more convenient. Plus, having no SL debt will increase your borrowing capacity.

Also, the average tenure in Biglaw is pretty short and it is generally stressful. I found that paying off my student loans early made me feel "square with the house" in terms of my legal career, and once I had fully paid for my legal education, I was more comfortable exploring other opportunities. While I didn't take advantage of other opportunities immediately, I found having the option to do so provided a level of freedom which reduced my stress at the firm and made me more successful.

[Apex]

"But as much as it galls me to pay the interest, it is equally as frustrating to write monthly rent checks. I think the interest on the loans outstrips the premium on rent, but not by all that much..."

Are you sure there is a premium on the rent? Everyone assumes this but it is often not really true in the reality of what happens after people buy their own place.

Interest on a Mortgage, property taxes, insurance, maintenance, etc, are all 100% equal to rent in their complete lack of purchasing you anything of value. I do not know where you are renting now but if its an apartment they tend to be cheaper than renting houses. People buying houses often buy larger than the place they are renting as well. Most people usually end up with payments that are higher than rent when they are done but they justify it by saying they are not "wasting" their money like they are on rent. They are building equity. Except that 95% of everything they pay is either interest, property taxes, insurance, maintenance, etc. (And that's in addition to the situation where you move in and have to change the paint, the carpet, some cabinets, some blinds, etc, because this is your place now and you don't like the way it was).

I am just saying so many people fool themselves into believing that owning is so smart and renting is so dumb because owning is building equity and renting is a waste.

Except often times people owning are building a small amount of equity and actually "wasting" more than they were renting, sometimes a whole lot more.

So just make sure you aren't fooling yourself on that argument.

[jim]

My first thought is to pay down the student loans. 8% is a pretty high interest rate and paying off that loan would be a good return.

[JimL]

To phrase this a different way, in the next two years your profile could look as follows:

- significant student debt
- a new mortgage and associated expenses of owning a home
- a spouse that may not be able to return to the workforce in the near term
- a small emergency fund
- twin toddlers with growing expenses

Sounds like a potential formula for financial stress

[Catherine]

This is a complete no brainer.
Emergency fund.

Where I'm coming from is the following: I caught the worst of the 2008 market implosion with a lay-off that resulted in 13 months with no job. Then my spouse became disabled. Four years after the lay-off, I'm settled into a good job with a solid firm and feeling great about being back on track with savings, retirement plans, etc. Then Hurricane Sandy devastated our area.

None of the above were in the plan. We are actually doing far better than most and we do have adequate insurance. However nothing softened the blow quite as well as cash on hand.

You are embarking on a time of tremendous change that will be full of some wonderful moments. Congrats on all of it. You will also face unplanned events that will go much more smoothly with tens of thousands in cash available.

[Ross]

Good points, Apex. I agree that "building equity" is often a poor justification for buying. We'd only take the plunge if it made financial sense, though of course we're susceptible to all the usual irrationalities when it comes to finances. Still, and especially because we'll be moving to a larger space one way or another (our current 1 bedroom isn't gonna cut if much longer...), it seems appropriate to at least run the numbers comparing buying and renting. And for us, the "premium" isn't just the difference in increased rent vs mortgage + equity. We may be in the minority in this, but our past practice has been to rent at the top end of our budget, precisely because it's a short-term commitment. When it comes to buying, we'll probably exhibit more risk aversion and end up near the bottom of our budget. So there's also an idiosyncratic (and, I'll admit, not entirely rational) premium at play.

Thanks again.

[JNEW]

Congrats--- lots of exciting stuff going on in your life. And lots of unknowns. And lots of expenses. And that is exactly why I think you should take it slow.

I would just bank the bonus and wait until the whole picture becomes more clear. Will your wife stop working? Will the new job work out? Will the twins arrive without complication or unexpected expense?

Life is full of surprises and cash on hand is the best insurance you can buy to make sure you you can make the ride as smooth as possible for your new expanded family.

Just wait. Take a deep breath and save as much as possible while you are both working. Once the kids arrive-- enjoy them-- a 1 bedroom is certainly not ideal but-- its just short term. You might want to move to a 2 bedroom for a few years. As Apex said-- you will probably be spending much less renting than you will be buying a new home in the short term.

What's the rush? Interest rates will not skyrocket upwards. They will move slowly and in small increments. And that may not begin for 12+ months at the earliest.

I an very conservative. I think your cash on hand is much too small at the moment. If there is a hiccup-- you will be in trouble.

FIRST- Get your E-fund up to 8 months of expenses ( or better yet- 8 months of anticipated expenses after you buy the new digs). That gives you peace of mind.

Once you have a handle on that-make sure you and your wife have life insurance. You need $1 Million or more. Its not that expensive if you buy term coverage-- but it is critical that you have it in place for the little ones. Also-- get a will in place if you do not have one. Young couples often blow this off.

Finally-- think about the house after a few years have passed-- after you know your job is working out, your savings is at a level that gives you a true cushion, your retirement savings is maxed out and you have a handle on the child costs. The trust your wife has is a good windfall-- but, I would still like to see you keep the home purchase within a range that allows you both to max out your 401K/ roth and also save 20%+ of your take home pay on top of that.

Long winded response-- ( I apologize!)-- but at your stage of life you have time and compounding on your side and i would love to see you take full advantage of it. Owning a home is expensive, time consuming and a money drain. Do it only when you can really afford it.

Best of luck.

[Limey Junior]

Pay off the debt

[Jenny @ Frugal Guru Guide]

Oh, and a 1 bedroom is JUST FINE with kids until they are a year old or so. You can set the cribs up int he master bedroom, and if having them there bothers you guys for nocturnal activities, relocate them to the living room for the time being. :) It will actually be less stressful to keep a very small place picked up than a big one for that first year.

The kids need cribs and a single dresser for the first year as far as furniture goes, and that's IT. You can change them on a blanket on the floor--with my wigglers, this was the safest--or get a sculpted changing pad for the top of the dresser.

Get the high chairs that attach directly to the table. Regular high chairs are now huge.

You will want a swing and a bouncy saucer for the babies and 1-2 bouncy chairs. You will want a double stroller--get one that folds or that can live in the car. You need to have a 4-door sedan and not a 2-door with two new babies--not really a requirement, but it will make life easier. Make room along the wall of the living room to store these things!

With your new health plan, choose the one with the lowest deductible at whatever price. Twins can have substantial hospital costs, and the less you pay, the better.

[Pam]

My neice and her husband lived in an 800 sq ft condo in DC as a big firm lawyer until her baby was 2. They just bought a house in Arlington.

I'd wait until all of the big changes settle down before paying off the school loan.

[Mark]

Trust Fund Baby!!