Bonus sacrifice guide
How to save tax on bonuses in the UK
It’s always great to get a bonus after a good year at work; but however much you might appreciate the money, tax doesn’t half take the shine off.
For a higher rate taxpayer, a £10,000 bonus will instantly be whittled down to £6,000 by income tax. National insurance at 2% would take a further £200, leaving you with just £5,800 of your £10,000 bonus.
However, there is a way to (legally) reduce the tax you pay on your bonus, and that’s with bonus sacrifice.
What is bonus sacrifice?
Normally your bonus will be paid alongside your salary, straight into your bank account, with tax already deducted.
Bonus sacrifice involves asking your employer to pay your bonus into your pension instead where it will benefit from tax relief on pension contributions.
In addition to the income tax saving, you’ll pay less national insurance as well.
There could be further savings too, for example, if you receive child benefit and pay the child benefit tax charge, if you are repaying student loans, or earn more than £100,000.
You might have heard of salary sacrifice or salary exchange – this works in the same way, it just relates to your bonus payments rather than your salaried income.
What are the benefits of paying your bonus into your pension?
The key benefit of paying your bonus into your pension is that you’ll receive the full value of your bonus, without losing any of it to tax.
You’ll pay less national insurance as well and, if you are lucky, your employer will pass its national insurance payment on to you too.
Tax savings aside, you’ll also be giving your pension a significant boost, which, over time, could make a very real difference to your eventual retirement income.
Are there any downsides to bonus sacrifice?
The only real catch is that you won’t get to enjoy the benefits of bonus sacrifice until you access your pension, which could be years away.
So, if you have other needs or plans for your bonus, for example paying down your mortgage or taking a holiday, bonus sacrifice won’t work for you.
Another potential downside would be if you wanted to buy a house and were counting on the income you earn from bonuses to increase your mortgage affordability. This is because bonus sacrifice reduces your overall income.
How bonuses are taxed without bonus sacrifice
To properly understand the benefits of bonus sacrifice, it helps to know exactly how much tax you would normally pay on your bonus.
Your bonus will be added to your income for the year and taxed at your marginal rate, that’s the highest rate of income tax that you pay.
You’ll also have to pay national insurance on it too, which will be at a rate of 2% for higher rate tax payers (NI rates drop from 12% on earnings over the higher rate tax threshold).
But there are other factors that could mean you end up paying more tax.
• Child benefit: If you or your partner earns more than £50,000 a year and claim child benefit, the higher earner may need to pay an additional income tax charge.
• Student loans: As your bonus will be taxed in the same way as income. If you’re repaying student loans that means there will be a deduction from your bonus too.
• If you earn more than £100,000: For every £2 you earn over £100,000 your personal allowance will be reduced by £1. This means you pay tax on a greater portion of your income and creates an effective tax rate of 60% on earnings between £100,000 and £125,140 (at which point you have no personal allowance left).
Case study: How Catherine saves £14,200 and boosts the value of her bonus by paying it into her pension.
By sacrificing your bonus and paying it into your pension, you will cut the amount of tax you pay on it.
The following example shows how:
Catherine earns £110,000 a year, and after a particularly good year, has earned a £20,000 bonus.
Although Catherine is only a higher rate taxpayer, she pays an effective tax of 60% on her earnings above £100,000. This is because the personal allowance for tax free income starts to be withdrawn from this point.
Without bonus sacrifice:
If Catherine was to take her £20,000 bonus as cash, it would be taxed as follows:
- Income tax at a rate of 60%: £12,000
- National insurance at 2%: £400
- Student loan at 9%: £1,800
This would mean she would only get to keep £5,800 of her £20,000.
With bonus sacrifice:
However, if Catherine was to pay her bonus into her workplace pension, she’d not only get the full value of her bonus, but increase it too as her employer has agreed to pass on its national insurance savings.
This is because by paying it straight into her pension she would not pay any tax or national insurance on it. She also would not need to make any student loan repayments from it either.
The 13.8% national insurance saving her employee makes (£2,760) is added, boosting the total value of her bonus to £22,760.
How to arrange bonus sacrifice into your pension:
If you’d rather pay less tax on your windfall, it should be relatively easy to set up a bonus sacrifice arrangement with your employer.
Once you are told what your bonus will be you need to decide how much of your bonus you want to sacrifice. You can sacrifice the full amount, or a portion of it, if you want to take some of your bonus now.
It’s then just a case of letting your employer know what you want to do. It will then make the payment for you.
If your pension is a ‘net pay arrangement’ you’ll get the full rate of tax relief straightaway and no further action will be required. But, if you’re on a ‘relief at source’ scheme you’ll only get basic rate tax relief applied automatically and will need to claim any outstanding amount you are owed, back through your tax return. Check with your employer if you aren’t sure how your particular scheme works.
What to consider before you pay your bonus into your pension:
Bonus sacrifice is a great way of paying less tax and boosting your pension, but there are some logistical issues you’ll need to think about too.
You can’t pay as much money into your pension as you like and still get tax relief. The annual allowance limits your contributions to 100% of your income (up to £60,000). The highest earners (those earning £260,000 or more) will also have a tapered allowance, which gradually reduces the amount they can pay into their pensions down to £10,000 a year once earnings reach £360,000 a year.
However, if you have any unused annual allowance from the previous three years you may be able to use that under ‘carry forward’ rules. You just need to ensure that you have earned at least the amount you are contributing in the current tax year.
Should I pay my bonus into my pension?
Bonus sacrifice is a great example of delayed gratification. It’s hard to argue with the numbers, especially if you earn more than £100,000 and fall into the 60% tax trap.
But you might decide it’s not for you, whether that’s because you are close to breaching your pension allowances or could really benefit from a cash lump sum now. It’s a very personal decision.
Frequently asked questions about bonus sacrifice
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