How to make the most of your annual bonus

Receiving a bonus – whether planned or unexpected – can feel like a huge “life win”. This is usually money you haven’t included in your annual or monthly budget, meaning it is, in essence, entirely “free” money that you can do with as you choose.

If you’re expecting your annual bonus in the coming months or anticipate receiving a one-off bonus from your employer some time soon, you might be wondering how best to use this additional wealth to help reach your financial goals.

Plus, for those who don’t usually receive a bonus, you may be confused by how this windfall might be taxed.
With so many questions unanswered and a potential windfall about to arrive, let’s take a look at the options for spending, saving, or investing your bonus, along with the potential tax implications.

Bonuses are normally taxed at your marginal rate

Before we take a look at the options available for making the most of a bonus, it’s important to note that bonuses are usually taxed at your marginal rate of Income Tax.
If your regular earnings are on the cusp of a higher tax bracket, the bonus may push that month’s earnings over the top, meaning a portion of these funds would be taxed more highly than your regular income.

For instance, if you’re a higher-rate taxpayer earning £50,000, a £5,000 bonus means that £4,729 would likely be subject to additional-rate (45%) Income Tax.

Option 1: Use your bonus to top up your rainy day fund

It’s likely that you have a pot of cash savings stocked away in case of emergency. An illness, injury, or repairs to your home or car could all come out of nowhere and put your financial stability at risk.

With a rainy day fund in place, at least you have the peace of mind that immediate costs can be covered without you needing to liquidate investments or sell property.

Typically, an emergency fund of this nature should consist of between three and six months’ expenses. For you, this could equal many thousands of pounds, particularly as the rate of inflation in recent years has reflected a spike in the cost of living.

If you formed your fund several years ago, you might not appreciate just how much your monthly expenses have risen in that time – taking on a new mortgage, for instance, could increase your outgoings significantly.

So, once you receive your bonus, you could put it to use by topping up your rainy day fund for additional peace of mind.

Option 2: Invest your bonus

At Kellands, we believe that investing a portion of your wealth is essential to long-term growth and building a successful legacy.

While it’s useful to keep some funds in cash for the reasons explained above, your investment portfolio may be the key to building wealth over the long term.

So, if you don’t need to top up your emergency fund, it stands to reason that investing your bonus could be the next best option.

Firstly, there’s the stock market to consider.

It’s likely that you already have a portfolio in place. If it’s a pre-set fund, you may simply wish to top this up with the bonus funds you receive. However, if you’re an active investor, selecting the right home for your bonus – or splitting it up across several investments – is a crucial choice that could have a long-term impact on your wealth.

This is especially true because in recent months, the global stock market has proved volatile, with political elections in particular causing concern for some investors.

Nevertheless, it’s important to select assets for long-term growth, rather than chasing short-term wins in a constantly shifting market landscape.

Read more: Investors cashed in £4.2 billion from equities before the 2024 Autumn Budget. Should you have?

Alternatively, you could consider a property investment.

It’s unlikely that your bonus could help you buy a property in its entirety, but there is always the option of making a mortgage overpayment on either your home or any additional properties you own.

You could be liable for early repayment charges (ERCs) on some loans, so it’s important to consult an adviser before you take this step. But if one of your financial goals is to be mortgage-free, putting your bonus funds towards this ambition might suit.

Option 3: Put your bonus into your pension

We’ve published several recent insights into the topic of retirement and how you can prepare with confidence. Read our guide to retiring successfully in 2025 and our blog about buying retirement bliss to learn more on the topic.

When it comes to your bonus, and whether you can or should route it into your pension, there’s much to consider.

Key factors to think about are:

Your Annual Allowance

This represents the amount you can put into a pension every year (including tax relief and employer contributions) without triggering an additional tax charge. Usually, as of 2024/25, it stands at £60,000 or 100% of your earnings, whichever is lower.

However, high earners and those who have already accessed their pension flexibly could be subject to the Tapered Annual Allowance, which gradually reduces this tax break down to a minimum of £10,000.

Before you think about putting your bonus into your pension, look at how much you’ve already contributed in total within the current tax year, and check that your additional contribution won’t exceed your Annual Allowance.

Tax relief

Normally, pension contributions receive basic-rate (20%) tax relief at source. If you want to claim tax relief at your marginal rate, you can do so by self-assessing, meaning your contributions could benefit from as much as 45% tax relief.

As such, if you’re not in danger of exceeding your Annual Allowance, putting your bonus into your pension and claiming the maximum tax relief available could give your pension fund a considerable boost.

“Bonus sacrifice”

Much like the traditional salary sacrifice option, some employers offer the chance for bonuses to be placed either partly or entirely into the employee’s defined contribution (DC) pension at source.

This means that you wouldn’t be “paid” the bonus at all, nor would you pay Income Tax or National Insurance contributions (NICs) on the amount. It would simply go straight into your pension.

However, seeing as your employer would be paying the funds in, your bonus wouldn’t receive tax relief as it usually would if you put the funds in yourself.

Your retirement time frame

It’s never too early or late to contribute into your pension. Remember, though, that you won’t be able to withdraw the funds again until age 55, rising to 57 in 2028.
As such, it may be wise to discuss your retirement time frame with a financial planner before locking away a lump sum within your pension pot.

Option 4: Spend your bonus on luxuries

Rather than doing the “sensible thing”, you could already be planning to spend this money on a luxury item or experience.

You might be looking at booking some winter sun for 2025/26 and decide to put your bonus towards funding this trip for yourself and your family. Or, you may prioritise making home improvements, putting this cash towards new furniture or structural work that you’ve been waiting to get underway.

In any case, there is nothing wrong with spending your bonus as you please.

If you’re a wealthy individual with a significant estate, it may even be wise to do so, as saving or investing this wealth only increases the overall value of your estate.

Indeed, in terms of Inheritance Tax (IHT), a large estate may cause your loved ones to pay a hefty bill after you pass away, whereas reducing its value over time could lessen this liability. As such, if you know there’s no need to top up your savings, investments, or pension, it could be wise to simply enjoy the money.

Get in touch

Handling a financial windfall of any size presents both the opportunity to succeed and the chance you could make a costly error.

Whether you’re in receipt of a bonus, inheritance, or another type of windfall, our financial planners can help you align your wealth choices with your long-term goals.

Email us at hale@kelland.co.uk, or call 0161 929 8838. 

Please note

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

All information is correct at the time of writing and is subject to change in the future.

Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

The Financial Conduct Authority does not regulate estate planning, cashflow planning, or tax planning.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.

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