If you are in full-time work, you might be among the fortunate employees who don’t just get a salary, but an extra bump in the pay packet around this time of year.
Bonus season is approaching, so if you want to get the maximum financial impact from yours, it’s time to start thinking about how you’ll use it or spend it.
Naturally there are additional temptations for extravagance at this time of year too - but thinking of it as a future reward rather than free spending money might transform a bonus’ impact.
1. Bonus sacrifice
Bonus sacrifice is a somewhat off-putting description of perhaps the best way to use your bonus.
There’s no real sacrifice involved – in fact, you actually get to keep more of your bonus with this approach than any other, as you won’t pay any income tax or national insurance on it.
However, you won’t get access to the cash now. Instead, your employer will send the entire bonus amount directly to your workplace pension. There, it will be invested for the remainder of your working life and will have hopefully grown significantly when you get access to it (from the age of 55, rising to 57 in 2028).
The benefits can be substantial: if you earn £50,000 and get a £5,000 bonus, taking the cash payment will result in tax and national insurance deductions that leave you with less than £3,000.
Bonus sacrifice allows you to keep the full £5,000, and over twenty years for example, you can expect this to grow to over £13,000 (assuming a 5 per cent annual growth rate).
2. Emergency fund
Despite the tax advantages, you might not be prepared to lock your bonus away for years or decades. That’s fine - there are plenty of options in the middle ground between doing that and spending it all now.
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For example, you could put your bonus in a high-interest but easy-access account, in preparation for unexpected costs in the future, such as car repairs, a replacement boiler, or a period of unemployment.
Experts suggest that you should have an emergency fund of three to six months’ costs for these eventualities, so if you have less than this, it could be a smart idea to start or top up your fund.
As well as earning interest on it, it’ll help you avoid taking on debt when unforeseen expenses occur.
3. Paying off debt
Speaking of debts, you might decide to use your bonus to pay off some of yours.
According to The Money Charity, the average unsecured debt per adult in the UK is currently around £4,300. The average bonus is less than this, but yours might allow you to pay off a specific debt, like your overdraft or a credit card.
A similar option would be to make a mortgage overpayment, but before doing this, consider how much interest you’ll really save. It’s likely less than the interest you could earn by putting the cash in a high-interest account – or investing it – so weigh up your options carefully.
Another point to bear in mind is that it’s generally sensible to pay off your highest interest debts first, and your mortgage is likely your lowest interest debt.
4. Investing
There are various ways you could use your bonus as an investment in your future. These include:
Of course, with any investment, you’ll need to be comfortable that you may not necessarily get the return you were hoping for - and that patience is almost always a requirement.
5. Christmas spending
It may not be the very smartest financial move, but if we’re being realistic, a lot of people will need to use their bonuses to cover the increased costs of the holiday season.
If it helps you avoid taking on debt through credit cards, overdrafts, and buy-now-pay-later schemes, this can be a sensible choice.
Ideally, though, try to avoid overspending just because you have the cash available. Budgeting before you know your bonus is a good idea, then stick to the plan regardless of your extra amount. Perhaps you could earmark a certain portion of your bonus for spending and another portion for one of the alternatives above?
For next year, if you’d like to have the option to use your bonus more effectively, you could start a festive sinking fund now. This means you’ll put aside 1/12th of the cash you’ll need for Christmas each month, so you’ll have a pot of spending money ready to go this time next year - while your bonus gets to work for you in more productive fashion.
When investing, your capital is at risk and you may get back less than invested. Past performance doesn’t guarantee future results.
