Diwali bonus: Splurge, but also repay costly debt, replenish emergency fund

With Diwali around the corner, companies have started announcing bonuses. Some have been particularly lavish.

 

A Chennai-based firm gave away 28 cars, including Mercedes-Benz models, and 29 bikes. A Haryana-based firm, has promised its superstar employees 13 Tata Punch and two Grand Vitara SUVs. Many companies also give generous cash bonuses to their employees. Instead of splurging the entire amount, employees must use this windfall judiciously.

 

“Don’t spend all the money impulsively. Adopt a budgeting mindset,” says Nehal Mota, co-founder & chief executive officer (CEO), Finnovate.

 

The budgeting approach 

 

The bonus money should be divided into various buckets. “You could allocate 30 per cent to electronics purchase or home upgrade, 10 per cent to a memorable family vacation, and another 30 per cent to reducing high-cost debt. Another 10 per cent could go into self-improvement and 5-10 per cent into charitable donations or gifts,” says Mota.

 

Those without high-cost debt can invest the money to achieve financial goals. A budgeting approach balances the impulse to spend while addressing important financial priorities.

 

Bring down debt

 

If you have high-interest loans, like credit card debt, use part of your bonus to pay them off. Investing for a 12-15 per cent return while paying 40 per cent interest is futile.

 

It’s sometimes better to keep lower-cost loans, especially those with tax benefits. “If your education loan carries 8 per cent interest and offers Section 80E tax benefits, continuing it may be wiser if you can invest to earn a 12 per cent return, gaining a 4 percentage point advantage,” says Feroze Azeez, deputy CEO, Anand Rathi Wealth.

 

Build an emergency fund 

 

If you lack an emergency fund or it is depleted, use part of your bonus to build or replenish it. “Keep 6-12 months of monthly expenses in an emergency fund,” says Siddharth Alok, assistant vice-president-investments, Multi Ark Wealth, Epsilon Group. Mota recommends investing the emergency fund in liquid instruments such as liquid funds and ultra-short duration funds.

 

Invest based on asset allocation

 

Invest for various goals using appropriate asset allocation. “For long-term goals like retirement, aim for a portfolio with 80 per cent equity and 20 per cent debt. For medium-term goals, a 70:30 equity-to-debt mix is ideal. For short-term objectives, prioritise liquid investments like debt mutual funds that will preserve capital and provide decent returns,” he says.

 

Don’t overlook taxation   

 

Gifts exceeding specified thresholds (see table) are taxable. “Failure to properly declare taxable gifts can lead to scrutiny, additional taxes, penalties, and interest on unpaid amounts,” says Suresh Surana, a Mumbai-based chartered accountant.

 

Bonuses are also taxable as they are considered part of an employee’s salary. The bonus is added to the salary and is taxed at the applicable slab rates. “TDS (tax deducted at source) must also be deducted by the employer,” says Surana.

 

Avoid long-term commitments

 

Avoid investing your Diwali bonus into products that require long-term commitment. For instance, insurance-cum-investment plans typically require the investor to pay premiums for a long period. Early surrender carries a high cost.

 

“If you are uncertain about future bonuses, avoid tying yourself to such recurring annual commitments,” says Mota.

 

Those who decide to invest in diversified equity funds must take into account elevated equity valuations. Mota suggests either entering via a systematic investment plan or investing in a liquid fund and then transferring the money into an equity fund through a systematic transfer plan.