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Windfalls – for business and pleasure

06 December 2012

“Employees in sales and marketing roles, for example,” says David, “often receive bonuses as part of their contract if they’ve met and exceeded previously set targets for the year. Employers may also choose to award employees for performance through some other form of benefit – in kind rather than in cash – and those benefits get taxed quite differently.”

The employee in this case, explains David, receives the full value of the item: a holiday, a laptop, etc. The employer does not have to withhold any tax but does have to pay Fringe Benefits Tax on the value of what has been provided to the employee. Certain items attract concessional tax treatment. For example, a laptop computer provides the employee with the item (and not cash minus tax) and could be tax free to the employer.

The risk with in-kind benefits is to the employer. Businesses need to be aware of the Fringe Benefits Tax attracted by the item(s) they are considering awarding.
Cash bonuses for an employer are tax deductible. For an employee they are taxable when received. The bonus is always taxed at the highest marginal tax rate for the employee. If, in this process, too much tax is withheld, the employee may receive a refund when they do their tax the next financial year.

The following classic tips for what to do with a discretionary employee cash bonus have something in common, they build personal financial stability.
• Use windfalls to pay off credit cards and loans first, especially if they attract high interest, which many credit cards do.
• Pay down your mortgage.
• Depending on age and stage put the cash into your superannuation or your partner’s and, remember, have a look at tax benefits that may be associated with this strategy.

A 50/30/20 strategy
Substantial windfalls may require a more complex strategy, such as this 50/30/20 guideline some financial experts recommend.

Depending on your individual financial position and your own relationship with your finances – how disciplined you are and around what are you disciplined and undisciplined – the ratios could be 50% pays off debt; 30% is put into super or toward building other income streams through investing in property or equity, etc, and 20% is to reward yourself and those you care about.

The strategy has long-term reward in mind as well as providing more short-term personal reward.

Investing the 20% personal reward in a hobby or an experience or philanthropic venture tends to bring longer lasting benefits. Consider the places you spend the most time and the effect having the best in these areas can bring to your long-term wellbeing – comfortable shoes for walking, ergonomically sound office furniture, a personal trainer to get you started on a healthier lifestyle, a professional development course, donations to favourite charities.

Windfall downers and uppers
Windfalls (a tax return, an end of financial year bonus, a Christmas bonus, etc) can be overwhelming, especially if they are substantial.

Spending all the money and ending up in debt because you’ve begun to finance, perhaps through credit, a lifestyle you can’t actually afford on your real salary is not a good look.

According to the financially astute, the clever way to play the windfall card is to dispose of it quickly and in a way that brings you rewards that benefit your long-term financial stability, such as investing it in your superannuation.

In regard to bonus payments: they are discretionary and dependent on any number of factors relating to company and/or individual performance, and you will have absolutely no control over many of the factors in play. Bonuses tend to be awarded annually and as a lump sum.

The traps
Factoring bonus payments into your budget is not effective financial planning.
For example: applying for a loan, negotiating a salary rise or the salary in a new job is dependent on your existing salary. Bonuses you may have received cannot be counted because they’re not guaranteed income.

Taking bonuses at the cost of salary increases may also infringe on your ability to build strong financial foundations. If your base salary remains low, contingent payments, eg superannuation, also remain low. Salary levels affect your ability to borrow and the amounts you can borrow, etc.

The pro
A bonus is a windfall – no matter its size – and that’s fun.