19 Mar Annual bonus – what spending it is REALLY costing you
Why save your annual bonus? Where’s the harm in spending it this time and saving next year’s annual bonus instead?
At this time of year, you may be looking forward to receiving your annual bonus without realising the importance of the decision you face. At Netto Invest we regularly come across individuals who have planned exactly how they will spend their bonus before they have even received it.
With the increase in the cost of living, many South Africans accumulate debt during the year which needs to be paid off – and an annual bonus is the perfect opportunity to do so.
Those who have not racked up debt have other alternatives on how to allocate their annual bonus. Some will choose to spoil themselves for their hard work during the year – this may be in the way of a holiday or a down payment on a new car. Others will decide to invest their hard-earned annual bonus for their retirement, and others may focus on repaying the bond. Most will do a combination of the above.
One thing to remember is that the annual bonus forms part of your taxable income and as such is taxed at your marginal tax rate. Most employers who offer the benefit of a company retirement fund generally do not include the bonus in retirement fund contributions. In such cases, it is up to you to ensure that their tax planning is optimised. A financial planner will be able to assist you with the calculations, but by utilising a unit-trust-based retirement annuity for example, an individual is able to make a lump sum payment into an RA of up to 15% of their non-retirement funding income and obtain a tax break on their contribution. This allows them to invest appropriately for the long term while saving tax.
We must also remember that we may not receive all that many bonuses during our life time. Companies typically don’t pay out bonuses every year and if you are 40 years old, you may only have 20 more bonuses coming your way. When thinking about it this way, the importance of the decision sounds far more significant.
It is a fact that most South Africans are under-saving, and putting away a significant portion of your annual bonus is a great opportunity to catch up on your annual savings.
To illustrate the point, we have taken 3 individuals: Sally, Mark and Joe
They are all 35 years old, each earns R720,000 per annum and they each receive a 13th cheque annual bonus at the end of the year.
The company has a provident fund with annual contributions of R144,000 p.a. (20%) and they all achieve inflation plus 6% on their investments within the fund. The company has a retirement age of 65.
Sally decides to spend her entire annual bonus
And she takes the family on an overseas trip each year. By the time she reaches retirement, her provident fund has grown to R11.3 million and she can retire on an income of R430,000 per annum after tax, in today’s terms, and escalating with inflation.
Mark decides to spend half his annual bonus on a holiday
And he invests the other half in a similar investment, also achieving an inflation-plus-6% return. By the time he reaches retirement, his investment portfolio has grown to over R13 million and he can retire on an income of R500,000 per annum, being R70,000 more than Sally each year. Again, these figures are stated in today’s terms, after tax and escalating with inflation.
Finally, we have Joe, who saves his entire annual bonus each year for his retirement
By the time he reaches retirement, his provident fund has grown to almost R14.5 million and he can retire on an income of R550,000 p.a. being R120,000 p.a. more than Sally and R50,000 p.a. more than Mark.
Looking at these three individuals – and absolutely no gender stereotyping is intended – the concept of delayed gratification is obvious as the numbers speak for themselves.
At Netto, we prefer not to tell you how much of your annual bonus to save. However, our financial planning process allows you to see for yourself the effect of saving your annual bonus versus spending it, so that you can make an informed decision when it comes to your financial strategy.
My advice is to engage an independent, fee-based independent financial planner who is focused on your best interests and can provide impartial advice.
This will allow you to build up your savings (with or without an annual bonus) and plan for your future, giving you financial independence. If you do not have a CERTIFIED FINANCIAL PLANNER®, visit the Financial Planning Institute website to select one.
Debbie Netto-Jonker CFP® is the founder of Netto Invest and was Financial Planner of the Year in 2001.