How to use a pay rise to clear debts, increase savings or set yourself up for the future

Updated on 01 February 2019 | 1 Comment

Three financial experts explain how to make the most out of a salary increase.

With everything going on in the economy and politics, it’s easy to assume that no one gets pay rises these days.

But that’s not the case: last year, the average weekly earnings increased by 3.4%.

Sure, that figure is far from impressive, but remember it’s an average: many people got no pay rise at all, whilst others got a much larger increase.

Even without the boss giving you a raise – and if that's the case you should read this – rising tax thresholds and minimum wage thresholds mean 2019 could see your net salary increase.

So, what should you do next?

We’ve talked to experts from investment platform Willis Owen, pension and investment firm Hargreaves Lansdown and independent financial advisers Chase De Vere to get their tips on making your pay rise go further.

Please note that what you should do with your pay rise ultimately depends on your individual financial situation.

Keep calm and read on

Walking out of the boss’ office with a new number on your paycheque is worth celebrating, not just for the money.

“It is great news if you get a pay rise,” says Patrick Connolly, head of communications at Chase De Vere. “This is likely to mean that your career is progressing and that you are valued by the company you work for.”

Don't spend your pay rise all at once (image: Shutterstock)

Just be realistic about your new earnings. After tax and other contributions, a pay rise of £1,000, for instance, works out at £66 extra a month, or just £40 if you’re a Higher Rate taxpayer.

And that’s even before we talk about inflation, which eats away at the value of everything.

It takes just six weeks for a pay rise to lose its novelty, a study by Direct Line Insurance found. They discovered that one in five workers wouldn’t be able to cope if their income reduced back to its previous level.

By taking action when you get a raise, and not just letting your expenses catch up, you could make yourself richer over the long term. Here’s how.

How to get a pay rise: tips from the experts

A £1,000 raise

This is roughly equivalent to the average wage going up by 3.3%, which is what happened last year.

A rising National Living Wage (the legal minimum) and an increase in the Personal Allowance, which is what you can earn without paying tax, could also help your pay packet.

What our three experts agree on is that any pay rise should first be used to pay off your debts.

According to Adrian Lowcock, head of personal investing at Willis Owen, “paying off an expensive debt sooner would boost your disposable income, effectively giving you two pay rises”.

Just make sure you’ve got enough to pay for living expenses, otherwise you’ll fall back into debt.

Short-term debt paid off, it’s time to look at your savings.

Sarah Coles, a personal finance analyst at Hargreaves Lansdown, suggests you should set up a standing order or direct debit, which takes your extra earnings each month and puts them in a savings account.

Then, try to save for a ‘rainy day fund’ which could cover 3-6 months expenses, in case of emergency (you can read more about these funds here).

It's important to have a 'rainy day' fund (image: Shutterstock)

Paying off debt isn’t particularly fun, so Willis Owen’s Lowcock suggests challenging yourself: “you could set a target of say saving £2,000 and becoming debt free before you get your reward.”

Compare saving accounts with better interest rates here

A £5,000 raise

Even with a bigger salary increase, paying off your debts and making sure you’ve got a rainy day fund should be first priority.

Then it could be worth looking at your pension. Under auto-enrolment, you and your employer pay a percentage of your income into your pension, so it will go up.

However, it’s worth considering if you could afford to pay more still into your pension because most of us aren’t paying nearly enough. An online pension calculator can help here.

“While it is easy to disregard pension savings, thinking it’s a long way in the future, the more you can save now the more grateful you’ll be that you did when you get older”, explains Chase De Vere’s Connolly.

Hargreaves analyst Coles also recommends looking at the medium term, by saving money for home improvements, a house move or a nest egg for your child: “part of your monthly pay increase can go into a Stocks and Shares ISA to help you meet these costs in the longer term.”

Start investing with loveMONEY’s investment centre (capital at risk)

A £10,0000 raise

Lucky you! A big raise can mean big lifestyle changes, but as Willis Owen’s Lowcock notes “any celebratory purchase should be planned and kept moderate and ideally delayed for as long as possible.”

There’s a good reason for this, and it’s not just about savvy spending: you’ll have to wait a full 12 months to actually receive that extra £10,000.

As with other raises, paying off debts, saving into a rainy day fund and your pension should be first priorities. However, according to Chase De Vere’s Connolly explains, “you may be able to consider new, and perhaps more radical, financial planning”.

That could include over-paying on an existing mortgage, moving or buying an investment property or second home.

A big pay rise could allow you to buy a second home (image: Shutterstock)

You could also invest the money in a Stocks and Shares ISA, although note that these can go down as well as up.

It’s worth considering talking to a financial adviser before making any large financial commitments.

Remortgage to a cheaper rate and potentially save thousands

Moving up a tax bracket

The sting in the tail of a pay rise could be moving from paying the Basic Rate of tax to the Higher Rate or Additional Rate.

The 40% Higher Rate kicks in for earnings above £46,351 (£50,000 from April) and the 45% Additional Rate applies to earnings above £150,000.

Whilst those extra taxes don’t apply to your whole paycheque – just the amount over the threshold – you could lose out on other benefits. Those over £60,000, for instance, effectively get no Child Benefit.

Two ways to mitigate the tax hit are through pension contributions and ‘salary sacrifice’, explains Hargreaves Lansdown’s Coles.

“If your earnings are exactly at the [Higher Rate] threshold and you get a £1,000 pay rise, you only end up with £600 more in your pocket.

“However, by paying it into your pension, you can beat the system, because pension contributions are tax-free, so you get the full £1,000 of value.”

Salary sacrifice is where your employer takes part of your salary and puts it straight into your pension, keeping you under the Income Tax threshold.

If you’re already paying a lot into your pension, some employers can use salary sacrifice for bike-to-work schemes, home technology schemes or childcare vouchers. Talk to your employer to find out what’s available.

20 ways to pay less tax: cut your Income Tax, Council Tax, and Inheritance Tax


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