Receiving a bonus or small windfall is usually a cause for celebration – even more so when it’s unexpected.
You might, for example, choose to splurge it on a big party, or treat your family by spending it on a fabulous holiday. Or you could indulge in a luxury item you previously felt you couldn’t afford.
It’s natural to want to spend a least some of a bonus or small windfall straightaway, but how you use the rest could have a lasting impact on your longer-term goals.
While some windfall payments can be life-changing, smaller amounts – such as those up to £50,000 – can still make a meaningful, though more modest difference. By using the extra funds strategically, you can take a significant step towards financial freedom, giving you greater peace of mind about the future and allowing you to focus on other ambitions and priorities.
It’s natural to want to spend at least some of a bonus or small windfall straightaway, but how you use the rest could have a lasting impact on your longer-term goals.
Read on to discover five ways to maximise a bonus or small windfall payment.
1. Make the most of your tax-efficient allowances
If you receive a bonus or small windfall, it’s a good idea to maximise your tax-efficient allowances, such as your pension contributions or ISAs.
Pension contributions typically receive 20% tax relief automatically. Higher- or additional-rate taxpayers may be eligible to claim an extra 20% or 25% relief by filing a self-assessment tax return.
If you choose to do this, it’s important to check how much of your Annual Allowance you’ve used to ensure your contribution remains tax efficient. This is the maximum amount you can contribute to your pension each year while receiving tax relief at your marginal rate. For the 2024/25 tax year, the limit is £60,000 or 100% of your earnings, whichever is lower.
However, your Annual Allowance may be lower if you’re a high earner or you’ve already accessed your pension flexibly. You can also carry forward any unused Annual Allowance from the past three tax years.
Due to the long-term nature of the investment, pension contributions not only provide valuable tax relief but also offer significant growth potential over time. So, increasing your contributions can help bring you one step closer to your desired retirement fund.
If you’ve maximised your Annual Allowance or want access to more liquid funds, you could also make full use of your ISA allowance, which is set at £20,000 for the 2024/25 tax year.
ISAs offer tax-free interest and investment returns on your savings or investments, making them an efficient way to grow your wealth.
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2. Pay off your mortgage
You could also use your bonus or windfall to pay off your mortgage. This can be particularly beneficial if you’re nearing retirement and want to reduce your outgoings once you finish work, as it means you won’t need to use your pension or other savings to cover any remaining repayments.
Most lenders allow you to overpay up to 10% of your outstanding mortgage balance every year without incurring an early repayment charge (ERC). But be sure to check in with your mortgage provider before doing so to check the specific terms and conditions.
If you’re still a few years off retirement, it may be a better idea to make additional pension contributions as market returns are likely to be higher than your mortgage interest.
So, before deciding to pay off your mortgage it’s a good idea to speak to a financial planner to ensure it’s the most efficient use of your windfall.
3. Top up your emergency fund
An emergency fund acts as an additional financial safety net, helping you cover unexpected costs without dipping into savings you might have earmarked for something else.
While there’s no strict limit on how much your fund should hold, having enough to cover three to six months’ worth of expenses is usually a good ballpark if you’re still working, or one to two years if you’re retired.
To ensure your emergency fund is readily available, it can be useful to keep it in an easy access savings account with a competitive interest rate. Moreover, separating it from your everyday accounts can help you avoid the temptation of dipping into it for non-essential spending.
4. Give gifts
If you want to support your loved ones with your bonus or windfall, gifting them a portion of the money can help improve their financial stability while also boosting the tax efficiency of your estate.
Gifts are generally excluded from your estate for Inheritance Tax (IHT) purposes, as long as you live for seven years after making the gift. If you pass away within seven years, they may be subject to IHT at a tapered rate.
Any gifts you give that are below the annual gifting exemption – £3,000 in the 2024/25 tax year – are not subject to IHT.
So, gifting can be a thoughtful way to share your bonus or windfall while potentially reducing the size of your taxable estate.
5. Donate to charity
Aside from your family and loved ones, you may also want to donate a portion of your bonus or windfall to a cause you care about.
Charitable donations are typically exempt from IHT, and if you donate through Gift Aid, registered charities can claim an extra 25p for every £1 you give, without it costing you a penny.
Moreover, if you’re a higher- or additional-rate taxpayer, you can claim the difference between the highest rate of tax you pay, and the basic rate of tax – which is the 20% the charity has already reclaimed through Gift Aid.
So, if you’re a higher-rate taxpayer you can reclaim an extra 20%, and if you’re an additional-rate taxpayer you can reclaim 25%.
An Amber River financial planner can help you make the most of your bonus or windfall
If you receive a bonus or unexpected windfall, an Amber River financial planner can help you maximise its value by aligning it with your personal and financial goals.
Whether you aim to save for the future, invest, or pay off debt, they can provide expert guidance to support your decision-making.
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Disclaimer
The information within this article was correct at the time of publishing, but laws and tax rules are subject to change. Your circumstances and where you live in the UK may also have an impact on your tax treatment.
To learn about the government’s most recently-announced changes, please read our latest budget roundup: 2024 Autumn Budget Update
