I've Secured a Pay Rise: What Should I Do?

First off, well done on your pay rise! Whether it’s from a new job, a promotion, or recognition for your hard work, a pay increase is something to celebrate. But before you rush to upgrade your lifestyle, it’s a smart move to take a step back and think about how to make the most of your extra income.

In this guide, we’ll take you through a sensible plan to boost your financial health—covering everything from building an emergency fund to maximising your pension and ISA contributions, all while keeping an eye on tax efficiency.

Step 1: Build or Top Up Your Emergency Fund

The first thing to consider is whether you have a solid financial safety net in place. An emergency fund is essential for covering unexpected expenses like medical bills, home repairs, or even sudden job loss. Ideally, you want enough to cover three to six months of living expenses stashed away in an easily accessible account, such as an instant-access savings account.

Do you already have an emergency fund? If not, now is the perfect time to build one using your pay rise. If you’ve already started, it’s a good idea to check whether it’s “full” or needs topping up. Having this safety net in place will give you peace of mind and prevent you from relying on high-interest credit cards when life throws a curveball.

Step 2: Pay Off High-Interest Debts

Once your emergency fund is sorted, it’s time to turn your attention to any high-interest debts. These are usually things like credit cards, payday loans, or personal loans with high Annual Percentage Rates (APRs). These types of debt can be a massive drain on your finances, with interest payments eating into your extra income.

Think about it: if you’re paying 19% APR on a credit card balance, that’s money you could be putting towards something more rewarding, like savings or investments. By tackling high-interest debts first, you’ll free yourself from the weight of those monthly interest payments and make the most of your newfound pay rise.

Tip: If you’ve got multiple debts, consider the debt avalanche method, where you focus on paying off the highest-interest debt first, or the debt snowball method, which has you clearing the smallest balances first for a quicker sense of progress. Both work, so it’s down to what motivates you more.

Step 3: Consider Lower-Interest Debts

After clearing high-interest debts, it’s time to think about any lower-interest loans, such as student loans or your mortgage. While these tend to have more manageable interest rates, paying them off early can still free up your income for other goals. However, it’s important to strike a balance here.

For example, while it’s great to pay off a mortgage early, it might not always be the most tax-efficient move. If you have room to increase your pension contributions or fill up your ISA allowance, these options often offer better long-term returns than reducing low-interest debt.

Step 4: Increase Your Pension Contributions

Here’s where the tax efficiency starts to kick in. Once your debts are under control and your emergency fund is in place, consider putting some of your extra income into your pension. It’s one of the most tax-efficient ways to grow your money over the long term, thanks to the generous tax relief you get on pension contributions.

How does it work? If you’re a basic-rate taxpayer, for every £80 you contribute to your pension, the government adds an extra £20—effectively giving you a 25% boost. If you’re a higher-rate taxpayer, you can claim even more tax relief through your self-assessment tax return, making pensions a fantastic vehicle for building wealth.

Is your employer willing to match increased contributions? If so, definitely take advantage of this. Employer contributions are essentially free money, so don’t leave that on the table.

Remember, pension growth is tax-free, and you don’t pay income tax on it until you withdraw in retirement, making this one of the most powerful tools for securing your future.

Step 5: Maximise ISA Contributions

Next up: the Individual Savings Account (ISA). If your pension contributions are in a good place, focus on maximising your ISA allowance. For the 2024/25 tax year, you can save up to £20,000 in an ISA, and any interest, dividends, or capital gains you make are completely tax-free.

There are different types of ISAs to consider, depending on your goals:

• Cash ISA: A safer option, offering a modest interest rate.
• Stocks and Shares ISA: If you’re comfortable with a bit more risk, this option gives your money the potential to grow by investing in the stock market.
• Lifetime ISA: Ideal for first-time home buyers or retirement savings, offering a 25% government bonus on contributions (up to £4,000 per year).

Filling your ISA allowance is a smart move for anyone looking to grow their wealth while avoiding taxes on earnings. If you’ve already topped up your pension, the flexibility of an ISA makes it a perfect next step for medium- to long-term financial goals.

Step 6: Review Your Discretionary Spending

Once your emergency fund, debt payments, pension, and ISA contributions are covered, you might still have a little extra to play with. This is where it’s perfectly fine to consider increasing your discretionary spending—whether that’s upgrading your lifestyle, treating yourself to a holiday, or dining out more often.

The key here is balance. It’s important to enjoy the fruits of your hard work, but it’s even more satisfying when you know you’ve taken care of the important stuff first. If you’ve followed the previous steps, you’re in a great position to enjoy some of your pay rise without worrying about what’s around the corner.

Step 7: General Investment Accounts (GIA)

For those rare individuals who’ve maxed out their pension and ISA contributions, a General Investment Account (GIA) could be worth exploring. GIAs don’t offer the same tax advantages, but they do provide further options for investing your money in stocks, bonds, or other assets.

Any capital gains or dividends above your annual allowances are subject to tax, so it’s not the most efficient option. However, for higher-income earners who have already taken full advantage of pensions and ISAs, a GIA offers flexibility and potential growth for surplus income.

Don’t Forget: Check Your Tax Code

After a pay rise, it’s essential to check that your tax code is correct. If your tax code is wrong, you could either overpay or underpay tax—neither of which is ideal. Overpaying means you’ll be taking home less income than you should, while underpaying could result in a nasty surprise from HMRC later on.

Take a moment to look at your tax code on your latest payslip. If it looks off, contact HMRC or adjust it through your online HMRC account. Staying on top of this will ensure you’re paying the right amount of tax and avoid any future headaches.

Final Thoughts: Make Your Pay Rise Work for You

Securing a pay rise is exciting, but it’s also an opportunity to make some smart financial decisions. By focusing on building your emergency fund, clearing debt, and making tax-efficient contributions to pensions and ISAs, you’ll set yourself up for long-term success. And don’t forget—it’s okay to treat yourself, too, once your financial foundation is secure.

Remember, making your pay rise work for you today can make a huge difference in your future financial wellbeing.