What should I do with my first bonus: treat myself, save it or invest it?

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I’ve just received my first-ever work bonus, and I’m not sure what to do with it. Part of me wants to celebrate and splurge on something I’ve wanted for ages, but I also feel like I should be sensible and either save or invest it. What’s the best way to balance enjoying the moment with making a smart financial decision?
Anonymous

Laura Suter, AJ Bell Director of Personal Finance, says:

The end of the year marks bonus season for a number of companies – great news for anyone fortunate enough to get one. Bonuses will vary hugely depending on your job, how senior you are and the industry you work in. For some people their bonus can be 100% of their salary (or even more) where for others it will be a few hundred quid bump to their final pay packet of the year (or if you’re Apple boss Tim Cook a few years ago, it’s a $75 million boost to your pay packet). But if you’re fortunate enough to be in the bonus club, here’s your toolkit of what to do with it.

First up, don’t forget tax (and other deductions). You may get a letter from your company confirming your bonus amount but sadly that isn’t how much you’ll actually receive. You need to factor in how much you’ll lose to income tax and National Insurance and also whether some will automatically go into your pension. If you have a student loan you’ll also lose some to that payment.

All of these deductions can really add up.

Everyone’s situation will be different, but it’s good to bear in mind how much you could lose to various deductions. And watch out for emergency tax – you may be charged extra income tax as often the way PAYE systems work is by assuming that the bonus is regular pay for that month, rather than a one-off payment. But this amount should be refunded automatically in your next payslip or at the end of the tax year.

What about splurging?

Right, now you know how much you have to play with you can work out what to do. First, let’s address the temptation to splurge it all. If you’re financially comfortable and on track with your money then that is a totally valid option. After all, you’ve worked hard to earn the bonus so there’s nothing wrong with treating yourself with it (so long as you won’t regret it later).

But it’s important to check in with your finances as this windfall of money could make a big difference to your financial wellbeing or future. So, do you have expensive debt that you should pay off, or is your bank account at zero every month with no buffer? If so, this money could be a great cushion. Generally, it’s a good idea to pay off expensive debt first and then build up an emergency fund of easy-access cash that you can access. Typically, this is three to six months of expenses, to cover you if you lose your job or face another emergency. If you’ve already got this sorted then bravo, and you can move on to the spend/save/invest dilemma.

How deductions can drastically reduce your bonus

Let’s take the example of a graduate on £40,000 a year who pays 5% into a pension and gets a £4,000 bonus. Of that, you’ll pay £200 into your pension, £760 in income tax, and then another £320 in National Insurance. On top of that, the entire amount will be subject to a 9% deduction for student loan, amounting to another £360. All together that means in this example you’ll take home £2,360 of the original £4,000.

Could a bonus help you achieve a goal?

Next up, think about whether you have a particular goal in mind. Are you saving for a particular thing (like buying a house, or your next holiday) and if so is it planned for the next three to five years or further out? Generally, if it’s a longer-term goal, you should consider investing the money. And we have loads of guides and support on AJ Bell to help you do that.

If you invest the money you will benefit from compound interest, meaning that your bonus will grow over time as it benefits from investment growth and the wonder of compounding. While this might not seem as immediately exciting as spending it, it means you can have a bigger pot in future. For example, if you get a £4,000 bonus and it grows at 5% a year, after five years you’d have £5,105 in your pot – so a gain of more than £1,100. And after 10 years that would have grown to £6,516 – adding more than £2,500 to your total.

Creating a ‘fun budget’

My personal view? I spent the first bonus I got from work on an expensive handbag. I used it lots and had a lot of pride that I’d been able to buy something I’d wanted for ages. It wasn’t the most financially smart move, but I had my ducks in a row when it came to my money and I had no responsibilities. Now I have a family, a mortgage and more financial responsibilities I wouldn’t want to splurge it all. But you can split the money: splurge some and be sensible with the rest. It’s nice to reward yourself for working hard, but you might regret frittering it all away. Instead, you could create a ‘fun budget’, where you allocate a percentage to enjoy now and be sensible with the rest.

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Laura Suter, AJ Bell Director of Personal Finance, says:

What about splurging?

How deductions can drastically reduce your bonus

Could a bonus help you achieve a goal?

Creating a ‘fun budget’

Laura Suter: Director of Personal Finance