If you receive a bonus or a windfall, the temptation can be to spend a substantial chunk of it right away on something you’ve been eyeing for a while.
However, unless the payment is truly life-changing, it can be wise to resist the urge to spend it on expensive non-essentials.
Avoiding the lifestyle creep of gradually increasing your spending on non-essentials, and instead opting for more prudent financial choices, could stretch your bonus or windfall further than you anticipated and ensure its lasting impact on your financial wellbeing.
Read on for five practical steps for making the most of a bonus or windfall.
1. Make the most of your tax-efficient allowances
Upon receiving a bonus or windfall payment, you may want to boost your pension fund by making an additional tax-efficient contribution. However, before you do this, it’s important to check how much of your Annual Allowance you have used.
The Annual Allowance is the maximum amount you can contribute to your pension in a single financial year without facing an additional tax charge. In the 2023/24 tax year, the Annual Allowance is £60,000 or 100% of your earnings, whichever is lower.
You can also carry forward any unused Annual Allowance from the previous three tax years. So, if in previous years you also didn’t use your full Annual Allowance, you may be able to make further tax-efficient contributions.
Remember, your Annual Allowance may be lower if you are a high earner or you have already flexibly accessed your pension.
If you have already used your Annual Allowance and you still have money left over from your bonus or windfall, consider making the most of your ISA allowance.
Returns on ISAs are free of Income Tax and Capital Gains Tax (CGT), so using your full ISA allowance can help boost your tax-efficient savings.
In 2023/24, you can contribute up to £20,000 across multiple ISAs in a single tax year.
2. Clear any outstanding debts or pay off your mortgage
After receiving a windfall or bonus, you might want to use the money to clear any outstanding debts you may have. This can reduce the amount of interest you pay and give you peace of mind that you don’t have debts to worry about.
Forbes reports that in January 2023 there were an estimated 60 million credit cards in circulation in the UK, with the average credit card debt standing at £1,174.62 per person.
At that time, the average Annual Percentage Rate (APR) was 22.03%, meaning that if you made the minimum monthly repayment, you would pay an additional £1,761 in interest over a period of 20 years.
So, paying off your debt quickly can save you a significant amount by limiting the interest charged on your credit.
If you don’t have outstanding debts or your repayments are manageable, you may also want to consider using your windfall to pay off some or all of your mortgage. This can be particularly beneficial if you are approaching retirement and still have a few years of repayments to make, as it ensures you won’t need to use your pension to cover your mortgage.
You can normally repay up to 10% of your outstanding mortgage balance without incurring an early repayment charge (ERC).
3. Build your emergency fund
An emergency fund can provide a safety net and help you cover the costs in the event of something unexpected happening, such as a medical issue, workplace redundancy, a large bill, or a housing problem not covered by your insurance.
It can also help you to avoid relying on borrowing with interest if you were to suddenly need some extra cash.
Using your bonus or windfall to top up your emergency fund can give you peace of mind. There is no limit to how big your fund can be, though most experts suggest having enough to cover three to six months of your total expenses.
You may want to keep your emergency fund in an easy access savings account with a good interest rate. It is also a good idea to keep it separate from the rest of your money, to avoid the temptation to dip into it.
4. Consider giving gifts or donations
If you feel financially secure and you want to support your loved ones with your bonus or windfall, you could consider gifting them some of your money to help ensure their own financial stability.
Gifts usually fall outside your estate for Inheritance Tax (IHT) purposes, provided you survive for seven years after you make the gift. In the 2023/24 tax year, you can also gift up to £3,000 a year to anyone you wish and no IHT will be due on this.
Similarly, if you want to put your money towards a cause you care about, you could consider donating some of it to charity. Charitable donations also typically fall outside of your estate for IHT purposes, so again, a donation would reduce your IHT liability.
5. Invest in the stock market
If you are confident that your emergency fund is sufficient, you have no significant outstanding debts, and you have maximised your pension and ISA contributions, you could consider investing your lump sum.
Investing your bonus or windfall in the market gives you the potential for better returns than keeping it in a savings account. It could also give your money more of a chance of keeping up with inflation.
However, it is important to remember that investing usually comes with an element of risk. So, it can be beneficial to speak to a financial planner before putting your money into the market, so that you better understand the potential risks and rewards.
A financial planner can help you make the most of your bonus or windfall
If you receive a bonus or windfall, a financial planner can assist you in maximising its potential by aligning it with your personal and financial goals. Whether your objectives are to save for the future, invest wisely, or strategically pay off debt, a financial planner can help you make informed decisions.
If you would like advice on how to make the most of your bonus or windfall, get in touch.
Email enquiries@blackswanfp.co.uk or contact your adviser on 020 3828 8100.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.
The Financial Conduct Authority does not regulate estate planning, tax planning or will writing.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
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