An annual bonus can sometimes feel like a windfall, fun and exciting. As your bonus isn’t usually depended upon to cover daily expenses. This makes it more tempting to blow it all on luxury items such as a new watch, an exotic holiday or a new car.
An annual bonus can certainly boost your financial well-being; bringing new opportunities you may not have planned for. Before the bonus comes your way, however, you may want to take the time to consider something else you could do with it.
Here are four things you can do with your annual bonus to boost your finances:
1. Pay-off debt
Credit cards, mortgage, car finance; regardless of what type of debt it is, it is likely it will cost more in interest than you can physically make in savings or investing. Paying debt off therefore should always be your priority.
If you can’t, however, settle all your debts, then consider settling the ones with the highest interest rates first, these typically include credit and store cards.
It is crucial to read the T&Cs of your debt to ensure that you will not incur any early repayment charges, as paying these when you settle your debt, could outweigh the benefits.
2. Squirrel away your bonus in your pension
Research from Finder.com illustrates that 72% of people in the U.K. admit that they are not on track to save enough capital for their retirement.
This is a huge concern. Furthermore, when asked how much would be enough to live on in retirement, the guesstimates were broad and largely inaccurate and inadequate. Do you know how much you need to have in your pension pot to be able to live comfortably when you retire?
Contributing a lump sum to your pension will support you in reaching your retirement goals. Even if retirement is the last thing on your mind, starting now means you should benefit from compound interest. In essence, time is on your side when it comes to saving for your retirement.
Bonus sacrifice is one tax-efficient way of investing money into a pension plan. This is particularly the case if your employer increments the bonus given up by the National Insurance contribution.
The cash sacrifice necessitates a signed formal declaration, by you, to relinquish any rights you may have had to any future cash payment. The employer, in return, contributes to a registered pension scheme, on your behalf.
By surrendering your right to the cash payment, you don’t receive it and therefore do not pay tax on it. Additionally, you would not be subject to National Insurance contributions on the amount relinquished.
Furthermore, your employer, by making a payment in lieu as a pension contribution to a registered pension scheme, wouldn’t be subject to their employer National Insurance contribution payments, thus it benefits you and your employer, which can be an appealing as well as a sensible option.
Employer contributions that are the result of a salary or bonus sacrifice are at all times, classed as ‘wholly & exclusively’ meeting the requirements. Consequently, they should reduce your employer’s corporation tax in the same manner.
Alison earns £100,000 and got a 10% annual bonus. The extra £10,000 pushes her into a tax-trap because she loses her personal allowance at a rate of £1 for every £2 earned over £100,000. In addition, Alison pays an extra 2% National Insurance. The effective tax rate on her bonus is 62%. Of her £10,000 bonus, after tax and national insurance, Alison would get £3,800 in her hand.
Alison’s financial planner suggests that she could consider Bonus Sacrifice.
This is agreed with her employer, who then makes the £10,000 contribution directly to Alison’s pension plan. The company agrees to add their national insurance savings.
Alison’s pension plan receives £11,380. This is a staggering improvement upon the £3,800 that she would originally have taken home.
The tapered annual allowance regulations for high-income earners purports there are reduced tax-efficient contribution levels, that is if you have an income that exceeds £150,000 (including your employer’s pension contributions). For more information speak to your financial adviser or read this GOV.UK for guidance.
3. Save your bonus for a rainy day
Rainy day funds are, essentially, a safeguard for any unexpected financial or life mishap. The mishap could be a stressful situation; losing your job, a bitter legal battle, or a serious injury. Neither of which is the ideal time to be worrying about money.
Having an emergency fund in place might help you to negate penalty fees, through dipping into your savings and investments at an inopportune time.
Lloyds Bank’s research revealed that more than a third of adults (36%) have fewer than three months’ essential spending in savings. Moreover, one in eight people in the U.K. do not have a rainy-day fund of any kind.
The optimum scenario is that you should have 6-months’ worth of essential spending saved for emergency and contingency situations. How much money you need will vary depending on your lifestyle, monthly costs, income, and dependents.
It is recommended that you save your rainy-day fund in an easy-access savings account. This means that you can access your cash instantly and easily if you need it in a hurry. This doesn’t mean that you can’t opt for one that offers a good interest rate to help you along the way, just as long as it doesn’t put your capital at risk. Take a look at the ‘Why you need a rainy day fund’ blog to find out more.
4. Invest your bonus
Investing your bonus can be an effective way to increase your money, enabling it to flourish into something which can be meaningful for your future. This cash can then be used for something that you have been wanting to focus on. Things such as paying for education, supporting an aged relative or even establishing the seed capital for your new business. Investing your bonus is a prudent way to accomplish these tasks.
All work and no play could lead to an incredibly dull life. You’ve undoubtedly worked hard all year; you, therefore, deserve to put some of your well-earned bonus to one side to enjoy. Consider allocating up to 25% of your bonus for yourself.
The value of an investment and the income from it could be variable. The return at the end of the investment period is never guaranteed and consequently, you may get back less than you originally invested.
The contents of this blog are for information purposes only and do not constitute individual financial advice.