As the holiday season approaches, many people are eagerly anticipating the possibility of a Christmas bonus. While it might be tempting to immediately splurge on a holiday getaway or a special treat for yourself, there are other smart ways to make the most of this extra cash.

If you find yourself with a bonus and your essential expenses are already covered, consider using this windfall to bolster your financial stability. This unexpected income can be a stepping stone towards achieving significant long-term goals.

Strategically managing your Christmas bonus can ensure that its benefits extend well beyond the festive period, potentially impacting your financial wellbeing for years to come.

To maximize the value of your bonus, think of it as an opportunity to enhance your financial future rather than just a short-term indulgence. Here’s how you can make your holiday payout work harder for you.

While it’s natural to dream about a few indulgences as a reward for your hard work, channeling some of that bonus towards future security can be equally gratifying.

Savings season: You can use your Christmas bonus to reach your financial goals

Deal with debts first

If you’re expecting a Christmas bonus, it’s hard not to think about the small luxuries you might buy yourself for your hard work.

Before you go on a spending spree though, the most sensible option is to cover any short-term financial needs like paying down debt or topping up your emergency fund.

If you don’t have any unsecured debts on credit cards or loans, it might be wise to redirect some of your bonus to paying down a mortgage, especially if you’re about to move to a higher rate.

However, make sure you aren’t hit with early repayment fees for paying off more than your lender’s annual limit. This is often 10 per cent of the total mortgage amount.  

‘Timing is a bit of an issue as borrowers with some time to go on a fixed-rate deal will probably find they can’t just pay down the loan (by more than 10 per cent anyway) without an early repayment charge,’ says Gary Smith, senior partner at wealth manager Evelyn Partners. 

‘In that case they could find a tax-efficient home for the funds, such as an Isa, until the mortgage term expires.’

Set aside cash for emergencies

If you think you’re in a solid financial position, it’s wise to consider setting money aside for longer-term goals.

A Christmas bonus allows you to build a savings habit and find ways to make your money work as hard as possible.

Rosie Hooper, financial planner at Quilter Cheviot says: ‘If you choose this option, then you need to make sure you have a plan for what to do with it. That starts by working out what you are saving for and thus where to put it.’

If you’re looking to build your emergency fund, it is worth opening an easy-access  savings account with a high interest rate so your money isn’t eroded by inflation.

Choosing an easy-access cash Isa means you can put away up to £20,000 per year and won’t pay any tax on the interest. You can also get hold of the money whenever you need. 

This Is Money’s independent savings tables show you the best accounts.

Put it away: A cash Isa is a useful way to stash part of a bonus, as up to £20,000 is tax-free

Hooper adds: ‘What matters crucially is to use it in an as tax efficient manner as possible. This means utilising Isa allowances and your pension – your future financial self will thank you for it.’

Smith warns that if you’re looking to stash your cash in an Isa, it’s more important than ever to secure your allowance for the year given rumoured plans to restrict Isa allowances in the Budget.

‘While pensions may have the edge when it comes to tax relief, Isas win hands down for flexibility as you can make withdrawals at any time and are not locked in.’

Salary sacrifice your pension

What you do with your Christmas bonus will depend on how much you get, but if it’s a larger sum, it is worth thinking about ways to cut your tax bill.

Like your salary, bonuses are subject to income tax at 20, 40 or 45 per cent depending on your total earnings. It’s a good idea to work out whether your bonus could push you into a higher tax band.  

Having a bonus paid into a pension is often the most tax-efficient way to invest a lump sum because you’ll receive tax relief at source.

Susan Hope, retirement expert at Scottish Widows, explains: ‘Let’s say your bonus is £1,000. You can make a personal pension contribution to your workplace pension, and you get 20 per cent tax relief at source. 

‘So, while you part with £800, you get £1,000 invested – leaving you with a nice round £200 for a “To Me, lots of love from Me” present.’

If you’re a higher-rate taxpayer, you can reclaim an additional 20 per cent when you complete your self-assessment tax return. 

Hope adds: ‘Your £1,000 to invest with only costs you £600. That means that in ten years, you double your initial contribution, assuming 5 per cent investment growth for basic rate taxpayers and just under five years for higher rate taxpayers.’

This tax relief will be a present to future you but in the immediate term, it can potentially bring you down a tax band if you’re close to an income tax threshold.

This can help in other areas of your financial life.  

Claire Exley, head of financial advice and guidance at JP Morgan Personal Investing says: ‘For parents with children in nursery who access free childcare, reducing your taxable income and moving down a tax threshold can help you avoid losing any benefits which would be removed if either parent has an adjusted net income of over £100,000 a year.’

There is speculation that the Chancellor will limit the amount of money people can salary sacrifice to £2,000 a year in the Autumn Budget. 

‘This would make it more difficult to salary sacrifice your bonus, but depending on your employer’s arrangements, you might be able to pay some into a pension and take the rest as taxed income, says Smith.

‘If your bonus award has not yet been granted, you should speak to your employer as soon as possible to see if they will facilitate salary sacrifice.’

Invest your bonus

If you’re not keen on setting aside your bonus for your pension, you could use it as a way to start investing.

Brian Byrnes, head of personal finance at Moneybox says: ‘This is where your financial journey truly can take off, and by putting your bonus into a stocks and shares Isa, any gains you make will be completely tax-free.

‘You don’t even have to invest it all in one go. By investing regular amounts, a strategy known as pound cost averaging, you can help smooth out the market’s ups and downs. 

‘It’s a powerful way to let your money benefit from compounding – earning gains on your gains – and to build a pot of wealth for your future, long after the festive season is over.’

Make it last: Putting some of your Christmas bonus into a Junior Isa is a good option

Gift to family or charity

If you’re keen to use your Christmas bonus to pay towards presents for family and friends, you might consider gifting money instead.

Rather than spending it on toys or other gifts, Exley recommends opening a Junior Isa for your children or grandchildren, which they can access when they reach 18.

You can find the best Junior Isa rates in This Is Money’s savings tables.

You can build a substantial pot if you start early enough and any interest or capital earned will be tax-free.

Hooper also suggests charitable gifting, which if you’re a UK taxpayer, means you can claim tax relief. This can be done either by gift aid, which means the charity will receive an extra 25 per cent on top of your donation at no extra cost to you.

She adds: ‘If you are a higher rate taxpayer, you can also claim the additional tax relief for the extra tax you paid on that donation. 

‘The other method is through payroll giving, where the donation will be taken prior to income tax being taken and thus you will not pay that on the donation amount.’

Spend it

The final option if you’re in a good financial position is to reward yourself and spend it, or set aside a portion of the payout to spend guilt-free.

Exley says: ‘While you should definitely reward yourself with your bonus, it’s important to be purposeful with how you deploy the windfall to avoid any regret in the future. 

‘One potential option is spending half of your bonus on yourself and short-term wants then using the other half on longer-term wealth building and financial goals.’

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