So, you’ve had the great news that you’re being given a pay rise. But what’s the most sensible way to make the most of your extra income?
If you don’t want to fritter away the extra cash on impulse shopping or extravagant holidays, it might be worth taking some time to review your finances and consider how you could use your salary increase to contribute to your long-term goals.
Being smart with your money now could help you build financial security well into your retirement years.
Read on to find out three sensible ways to make the most of your extra cash.
1. Increase your pension contributions
According to research published by the Institute of Fiscal Studies, less than 1% of private employees increased their pension contribution rate in response to a 10% pay rise.
Yet, pensions offer several benefits for long-term savers.
Generous tax relief
If you’re a basic-rate taxpayer, the government tops up any contributions you make, so every £1,000 only “costs” you £800.
For higher- and additional-rate taxpayers, the tax relief is even greater: 40% and 45%, respectively. Though relief must be claimed through self-assessment.
Most people have an Annual Allowance of £60,000 (2023/24). Contributions you make within this allowance will benefit from tax relief. You can also carry forward any unused Annual Allowance for up to three years.
So, increasing your pension contributions could allow you to benefit from generous tax relief and grow your savings over time. In fact, research by Standard Life has shown that boosting your contributions just 1% from the age of 45 could add £25,000 to your pension pot.
Employer contributions
If you have a workplace pension, you’ll receive contributions from your employer on top of those you make.
If you start paying more into your pension pot, some employers will increase their contributions too.
Compound investment growth
By reinvesting any returns you make on your investments any growth will multiply.
Pension pots often benefit from such compounding because you typically pay into it over many years without withdrawing any money. The earliest you can withdraw money from your pension is usually 55 (rising to age 57 from April 2028) and you might choose to wait until much later to do so.
The longer your pot remains invested, the more time it has to benefit from the positive effects of compounding.
2. Invest your money
You might feel tempted to plough any surplus cash into your savings account, especially if savings interest rates look attractive.
However, the real value of cash savings can diminish in the long term as inflation rises. For example, the inflation calculator on This is Money shows that a cooker that you paid £800 for in 2013 would cost you £1,123.27 today.
If you feel cautious about investing, it might be worth speaking to a financial planner to learn more about your options. They could help you understand the level of risk you feel comfortable with and build an investment portfolio that aligns with your financial goals.
While investing is unlikely to deliver big returns overnight, investing over the long term has the potential to help you enjoy greater returns than you may see on cash savings.
3. Take advantage of tax-efficient savings options
Keeping an emergency fund in an easy access savings account to help cover costs if something unexpected happens might be a sensible choice that offers peace of mind.
Additionally, cash savings could help you to achieve your short- and medium-term goals. To make the most of cash savings, you could take advantage of tax-efficient savings options.
For the 2023/24 tax year, you can pay up to £20,000 into ISA accounts without paying any Income Tax or Capital Gains Tax (CGT) on your interest or returns.
There are three main types of ISA:
- Cash ISA – a cash savings account that pays tax-free interest on your savings
- Stocks and shares ISA – allows you to invest in shares and funds without paying CGT or Income Tax on any profits made.
- Lifetime ISA – helps people aged 18 to 39 save for their first home or retirement. The government pays a 25% bonus on the total savings amount when it is withdrawn.
You might choose to spread your savings across multiple ISAs or keep them all in one account. Remember though, you can only pay a maximum of £4,000 into a Lifetime ISA in a single tax year and, across all your ISAs, you can save up to £20,000 (2023/24).
Be mindful of tax on savings interest
If you hold cash in a savings account that is not an ISA, you might be charged tax on any interest you earn above your Personal Savings Allowance (PSA). This stands at £1,000 for basic-rate taxpayers and £500 for higher-rate taxpayers (2023/24).
There is no PSA for additional-rate taxpayers – so any interest earned will be taxed at 45% Income Tax, unless the income is specifically tax-free because it’s in an ISA account, for example.
Research published by MoneyWeek reveals that millions of people are paying tax on savings interest for the first time in 2023. Increases in the Bank of England base rate during 2022 and 2023 have resulted in higher savings interest rates, which have pushed some savers beyond their PSA for the first time.
With this in mind, it’s worth exploring your options for saving in a more tax-efficient way to make the most of your salary increase.
Get in touch
If you’d like to discuss how to make the most of your extra cash and create a financial plan that is personalised for your goals, please contact us by email at info@lloydosullivan.co.uk or call 020 8941 9779 to see how we can help you.
Please note
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.
Workplace pensions are regulated by The Pension Regulator.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
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