Industry experts have warned that bonus season in the Square Mile might not be so bumper this year. In December, research by Emolument.com indicated that just 40 per cent of bankers in mergers and acquisitions found their sweetener satisfactory. And this week, the market leader of PwC’s global financial services HR consulting practice has warned that City bonuses could be down “possibly by 10 per cent in aggregate.” Oh dear.
For anyone not planning a trip to a Knightsbridge estate agent, there are plenty of sensible uses for your annual windfall, whatever its size, such as topping up a pension, paying off a mortgage, or saving for a rainy day. Go on, let your imagination run wild.
Top up your pension
For higher earners, the most tax-efficient option for investing a lump sum is likely to be in a pension, though this would prevent you from accessing it before you retire.
Like your salary, any bonus you receive will be subject to income tax at the highest rate as well as National Insurance (NI). But if your employer offers a “salary sacrifice” scheme, allowing you to put the money in your workplace pension for example, both of you could avoid paying the NI, and many firms will agree to pass the saving onto their employee.
The benefits of pension tax relief cannot be stated enough. There are question marks over whether this “free money” will be reduced for higher earners in the coming years, so it is wise to take advantage of it while you can.
“The exact contribution amount would depend on earnings, as tax relief offers the greatest benefit at the higher rates of 40 and 45 per cent,” says Wayne Berry, investment manager at Brewin Dolphin. “For example, a £10,000 pension contribution will actually only cost £6,000 for 40 per cent taxpayers, and £5,500 for 45 per cent taxpayers – a sizeable free boost.”
And if your bonus pushes you into the “personal allowance trap”, where your annual income is between £100,000 and £122,000, putting any income over £100,000 into a pension is a no-brainer. This group finds their personal allowance – the first £11,000 of their income which isn’t usually taxed – reducing by £1 for every £2 over £100,000, meaning that their marginal rate is an enormous 60 per cent. “A way of regaining it is to make a pension contribution to bring your net earnings down to £100,000,” says Ross Yiend, partner and chartered financial planner at Plutus Wealth.
Pay off a mortgage
If you have a mortgage, paying this down may seem like a more pressing priority than saving for retirement. But deciding whether to use the cash to pay your loan down directly, or to put some in a stocks and shares Isa in the hope of generating higher returns than your mortgage interest, should depend on your appetite for risk and time horizon.
“Now is a good time to pay lump sums off your mortgage because interest rates are so low. More of your money will go on repaying the principal value of the loan, rather than servicing the interest,” says Daren O’Brien, director at Aurora Financial Solutions. “However, any stock market investment has performed pretty well over the last six or seven years,” he adds, so this might prove the better option for mortgage-holders prepared to bear higher risk over a longer period. But with the stock markets being at current high levels, O’Brien says that he would not recommend it to anyone who might want to access the money sooner than that.
Of course, there is nothing stopping you from using part of your bonus to do both.
Even if you know you want to spend the funds, sheltering them in a tax-free wrapper is still a good strategy. As the end of the current tax year approaches, look to make use of any of the current £15,240 Isa allowance you have remaining, as well as the larger £20,000 provision which is made available to all UK savers from 6 April.
Together, a couple could shield £70,480 from tax this calendar year if they pooled their allowances, and a further £4,080 for each of their children (per tax year) through Junior Isas. Any returns are also tax-free.
However, there are more competitive interest rates to be found outside easy-access cash Isas. Despite an interest rate cut late last year, the Santander 123 current account still pays 1.5 per cent on balances up to £20,000, and would allow you to get at your bonus at any time.
Investing in lower risk investments which avoid market volatility might be a better option, even if you know you’ll want to call on the capital within the next five years, says Michael Pate, partner at Killik & Co.
Pate recommends either corporate bonds, which offer a good premium to bank deposit rates and offer a fixed return upon maturity, or alternatives such as investment trusts which enjoy inflation-linked income through asset-backed mortgages, student accommodation or infrastructure projects, or absolute return funds which will target a capital return. “Here you pay higher fees, but ultimately should have more protection to the downside should markets move adversely,” he says.
However, if you are happy for your money to stay invested for longer, the stock market will offer the highest returns and the best protection from inflation. For those receiving bonuses this year, inflation should be their greatest concern. Prices rose at a faster pace in December (1.6 per cent) than in any of the previous 30 months; the value of any savings will be eroded the longer you keep them in cash.
19th January 2017