Wednesday, October 21, 2009

The Benefit of not Including Bonuses in our Budget

When I was working, we lived only on my base salary, even though I received bonuses and stock options during my the last 10 years of employment. For budgeting purposes, we considered my bonuses and stock option grants windfalls, since I wasn't guaranteed to get one every year. The benefit of doing this was as follows:

  • Lived well below our means. Just before retiring, we were saving 20% of my before tax salary. Thus, we never needed the bonus to cover expenses. Since my bonus was typically 10-25% of salary, we were living significantly below means, at about 60% of my income on average.

    We treated the stock options in a similar manner. While working, I never exercised any options.

  • Accelerated savings growth. By saving my bonus, we were contributing the equivalent of 40% of my base salary to our retirement savings every year. Also, since we didn't exercise any stock options, the value of the options was equal to 6X my base salary when I retired.

  • Prepared us for early retirement. Since we were only living on 80% of my base salary, we required less funds in retirement than many of my peers, who had grown accustomed to living on both their bonus and stock options. For us, living more frugally while working was worth the benefit of retiring 10 to 15 years earlier than my peers.
  • I was fortunate that our company was able to pay a bonus for every year that I was eligible. However, since we never counted on getting a bonus, the payment was put into our saving account when it was received. Another benefit of saving the bonus was that it helped to make it through this recession, since our expenses were lower and our savings were high than if we had spent the money.

    For more on The Practice of Personal Finance, check back every Wednesday for a new segment.

    This is not financial or retirement advice. Please consult a professional advisor.

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