This content is for information and inspiration purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice please consult us here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
If you have recently received a large bonus, then first of all – congratulations! It is a great feeling to be financially rewarded for hard work.
However, a high tax bill on your new-found money is a less pleasant experience. Are there ways to protect your reward from the tax man? How can you invest a bonus for the best results? Below, our Burnley financial planners explore these questions in more detail.
We hope these insights are helpful to you. Please get in touch for more information or to discuss your own financial plan with us.
What should I do with a bonus?
The immediate urge many people face is to spend a large bonus on luxuries or something that you have always wanted (e.g. a new car or holiday). However, before charging towards discretionary spending, are there better ways that you could use the money?
A good rule of thumb is to consider spending 30% of your bonus and saving/investing the remaining 70%. This allows you to feel an immediate reward – not simply locking everything away. At the same time, it gives you time to consider how to use it to grow your wealth.
In 2023, bonuses are expected to be more muted as households and firms struggle with the rising cost of living. Companies may have lower profits which they may wish to focus on shoring up the corporate finances, rather than dishing out large rewards to employees.
However, if you are one of the blessed individuals to get a bonus this year, here are some ideas to consider.
Battening down the hatches
It can feel a bit boring to allocate a large portion of a bonus to an emergency fund (easy-access savings). However, you will thank yourself later if you suddenly encounter financial difficulties, such as losing work or a large unexpected expense (e.g. a major home repair).
Having 3-6 months’ worth of living costs readily at hand will help you maintain financial stability during such times. Moreover, it will act as a bulwark against the need to turn to credit. Right now, the average credit card interest rate is 22.2% – a very steep percentage.
On this subject, using some of your bonus to clear costly debts – e.g. personal loans and credit cards – is usually a wise idea. This will free up more of your monthly income, since less of it needs to be spent on servicing expensive interest payments.
Considering your goals
With your immediate finances shored up, you can start to consider your medium and long-term financial goals. For instance, are you trying to save up for a mortgage deposit? Or, maybe your priority is to build your retirement fund?
Your time horizon will likely play a key role in determining how you invest some/most of your bonus. If you want to use it to build a mortgage deposit, then you may wish to consider “safer” investment options such as fixed-rate cash accounts and bonds.
These assets usually involve less volatility for the investor (at the cost of lower potential returns compared to, say, equities). If there is a market crash during your saving/investment period – e.g. 3-5 years – then your mortgage deposit should have a high degree of protection.
However, someone saving for retirement may wish to consider other investments with higher growth potential (albeit also involving higher risk). Equities tend to be the main contender here. If you have a long time horizon and you are comfortable with the risk and volatility involved, then these types of investments could offer higher long-term growth potential than bonds or cash.
The manner and timing(s) of your investment contributions also matter. Specifically, should you invest all of your bonus at once? Or, should you “drip feed” the money gradually into your portfolio? Here, you might want to discuss the pros and cons of each with a financial adviser.
Weighing tax matters
A bonus will be classed as a form of income from the perspective of HMRC. Therefore, it will be treated as earnings for the purposes of determining tax liability.
This means that your bonus is subject to income tax and could, in certain cases, push an individual into a higher marginal rate. For example, a basic rate taxpayer on £45,000 per year usually only pays the 20% basic rate. However, a £10,000 bonus would push them into the higher rate (40%).
Unfortunately, it is very difficult to avoid this. In some cases, planning far in advance can help to reduce a needless income tax bill. For instance, one option is to discuss the option of “salary sacrifice” with your employer.
Here, instead of receiving a bonus (say, at Christmas) which is paid alongside your salary, your employer could pay some/all of the amount straight into your pension. This saves you income tax and National Insurance, boosts your pension (with tax relief) and can reduce the Personal Allowance taper for those earning over £100,000.
Invitation
If you are interested in starting a conversation about your own financial plan or investments, then we’d love to hear from you.
Please contact us to arrange a free, no-commitment consultation with a member of our team here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
Reach us via:
T: 01282 772938
